Remarks by:
James A. Squires
Executive Vice President Finance and Chief Financial Officer
Norfolk Southern Corporation
Thank you Don. I’ll now provide an overview of our financial results for the fourth quarter as well as a free cash flow and capital structure review.
Operating Results
Fourth Quarter 2008 vs. 2007
Let’s start with our operating results.
As Don described, railway operating revenues for the quarter were $2.5 billion, up $48 million, or 2 percent.
Operating Results
Fourth Quarter 2008 vs. 2007
Slide 3 displays the corresponding operating expenses, which decreased by 4% for the quarter. The resulting income from railway operations was $813 million, up 19%, and the 67.5 operating ratio is a 6% improvement versus prior year. These results reflect fourth quarter records for Norfolk Southern. In fact, the operating ratio is a record for any quarter.
Railway Operating Expense Analysis
Fourth Quarter 2008 vs. 2007
Turning to our expense detail, this slide presents the major components driving the decrease.
As you can see, the largest reason for our overall expense decline was sharply lower fuel costs, which decreased by $84 million, or 24 percent.
Fuel Expense Analysis
Fourth Quarter 2008 vs. 2007
This reduction was a combination of lower usage and lower prices. Our consumption for the quarter declined 10%, which compares favorably to the 8% traffic volume decline Don discussed, and correlates to lower train hours. A concerted effort to match locomotive horsepower with specific train requirements has yielded positive results. This consumption improvement accounted for approximately $38 million of the fuel expense decrease.
In addition, lower fuel prices, as illustrated on our next slide, provided a $46 million benefit.
Locomotive Diesel Fuel Average Prices
2007-2008
This graph shows our average price per gallon for each of the last 8 quarters. The $2.19 average price in the fourth quarter of 2008 was a 14% decline compared with the $2.56 price per gallon in the fourth quarter of 2007.
Railway Operating Expense Analysis
Fourth Quarter 2008 vs. 2007
The other expense category that declined this quarter was compensation and benefits, which decreased by $14 million, or 2%.
Compensation and Benefits Analysis Fourth Quarter 2008 vs. 2007
Slide 8 presents the major components driving this change.
First, stock-based compensation fell $43 million, due largely to a $19.16 per share decrease in our stock price during the quarter.
Second, train and engine crew hours were down in response to the lower volumes. Steve Tobias will review with you some of the train and crew optimization models that have allowed us to respond quickly to changes in the market.
Somewhat offsetting these reductions were incentive compensation and higher wage rates. Incentive compensation for the quarter was $19 million higher than last year, reflecting the improved operating results as well as a higher eligible bonus percentage for our union employees. Wage rates were higher by $15 million, reflective of the union pay increase that went into effect last July.
Railway Operating Expense Analysis
Fourth Quarter 2008 vs. 2007
Purchased services and rents rose $9 million, or 2%. This small increase in a quarter of declining volume was related to several projects that have longer-term effects. The first is expenses related to positive train control technology and the second is an energy conservation project to upgrade lighting efficiency at many of our offices and shops.
Railway Operating Expense Analysis
Fourth Quarter 2008 vs. 2007
The two remaining operating expense categories also reported small increases:
$9 million, or 5%, for depreciation ; and, $1 million, or 1%, for materials and other.
I would like to point out that within the “other” category we continued to see positive development in our personal injury accrual, a tribute to and a direct result of our safety program and the employees who make it a part of their daily work.
In this particular quarter that improvement was offset by increased environmental remediation costs at existing sites.
Other Income – Net
Fourth Quarter 2008 vs. 2007
Now let’s turn to our non-operating items on slide 11.
Equity in Conrail earnings declined by $18 million due to the absence of a federal tax audit settlement that benefited 2007.
Gains on property sales and investments were $10 million lower this quarter, a result of softening in the real estate market.
Somewhat offsetting these declines were coal royalties, which increased $6 million, and the absence of expenses for synthetic fuel investments, the tax credits for which you’ll recall expired at the end of 2007.
Income Before Income Taxes
Fourth Quarter
As illustrated on slide 12, the combination of the $127 million improvement in operating profits and the $20 million decline in non-operating items yielded a 17% improvement in pre-tax results.
Income Taxes
Fourth Quarter
Income taxes for the fourth quarter were $267 million, for an effective tax rate of 37.1%, which compares with $213 million, or an effective rate of 34.8%, last year.
The increase in the rate for 2008 was primarily due to the absence of the Conrail tax adjustment, as well as the expiration of the synthetic fuel-related credits.
Net Income and
Diluted Earnings per Share
Fourth Quarter
Slide 14 depicts our bottom line results. Net income was a fourth-quarter record of $452 million, an increase of $53 million, or 13 percent.
Diluted earnings per share were $1.21, which was 19 cents per share, or 19 percent, above last year.
Net Income and
Diluted Earnings per Share
Year
Wrapping up a record year, 2008 net income of $1.7 billion was a quarter of a billion, or 17 percent, above 2007.
Diluted earnings per share for 2008 were $4.52, which was 84 cents per share, or 23 percent, more than 2007.
Now I’d like to provide you with a outlook on some of our 2009 expense drivers, as well as an overview of our cash flows and capital structure.
2009 Expense Drivers
Slide 16 highlights some of the key expense drivers that will impact operating expenses in 2009. First, we have seen a significant decrease in the price of diesel fuel as noted earlier in this presentation. While we expect that prices may creep somewhat higher compared to the levels we are seeing in January, we do not foresee a return in 2009 to the record high levels experienced in 2008.
Next, contract wage rates will increase in 2009. Most of our union employees will receive a 4.5% wage rate increase as of July 1st.
Third, in 2008 our net pension credit was approximately $40 million; however, there will be no such benefit in 2009, primarily due to the decline in the value of pension assets.
On the volume side we also expect expense reductions, including fewer crew starts and lower fuel consumption to the extent possible without sacrificing service. Additionally, we are targeting overtime expenses relating not only to train crew costs, but also to our roadway maintenance and mechanical areas. And finally, equipment costs are expected to decrease somewhat relative both to car programs and equipment rents.
Cash Flows
2005 - 2008
With respect to cash flows, for the fourth consecutive year, our cash provided by operating activities exceeded $2 billion. As you can see, capital spending increased over this same period; however, it remained relatively stable as a percentage of cash from operations. And free cash flow was approximately $1 billion in each year; well above historical levels.
This cash was used to repurchase shares, including $229 million in the 4th quarter, as well as increase our dividends. For the time being we have reined in our share purchases as we await additional insight regarding the effects of the economic downturn. We do have the option to acquire an additional 10 million shares through 2010 under existing authorities.
Financial Leverage
As of December 31, 2008
Slide 18 depicts some primary measures of financial leverage. Our balance sheet remains very strong with cash at year end of $618 million, a debt-to-capitalization ratio, including operating leases, of 46.2%, and interest coverage of over 9 times.
In addition, since the end of the year, we’ve repaid $200 million of our receivables securitization and issued $500 million of 7-year debt with a yield of 5.83 percent. This has further increased our cash on hand.
Projected Liquidity
Looking forward to 2009, we project strong liquidity. We will continue to focus on operating cash flow and especially on cost control in light of the economic situation.
Our access to credit markets is good, as illustrated by the successful debt offering. Norfolk Southern currently maintains the highest investment grade rating of Class I Railroads in the U. S. In addition, we have access to non-capital markets’ borrowing such as our Accounts Receivable Facility and Commercial Paper Facility.
Debt maturities in 2009 are $484 million and, based on our current capital structure, will decline over the next five years.
Our pension plan, while currently somewhat underfunded, will not require payments until 2010 at the earliest, and then only if the value of the plan assets don’t recover.
Norfolk Southern will continue to view dividend commitments as a high priority for distributions of free cash flow, and will remain flexible with regard to share repurchases in 2009.
And finally, as Deb Butler will cover with you in more detail, we plan to maintain our commitment to capital spending, while still managing the timing of some of these investments in response to economic developments. We have contingency plans in place to reduce capital spending, if economic conditions continue to deteriorate.
Thank you for your attention and now, for an update on our operations, I will turn the program over to Steve Tobias. |
