XNYS:NSC Norfolk Southern Corporation Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

 

(X)   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended JUNE 30, 2012

 

(  )    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF

         1934 for the transition period from ___________ to___________

 

Commission file number 1-8339

 

 

NORFOLK SOUTHERN CORPORATION

(Exact name of registrant as specified in its charter)

 

Virginia

(State or other jurisdiction of incorporation)

52-1188014

(IRS Employer Identification No.)

Three Commercial Place

Norfolk, Virginia

(Address of principal executive offices)

 

23510-2191

(Zip Code)

(757) 629-2680

(Registrant’s telephone number, including area code)

No Change

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 

 

Large accelerated filer  [X] Accelerated filer [  ]  Non-accelerated filer [  ]  Smaller reporting company [   ] 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at June 30, 2012

Common Stock ($1.00 par value per share)

 

319,516,715 (excluding 20,320,777 shares held by the registrant’s consolidated subsidiaries)

1



 

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES (NS)

 

 

 

 

 

 

 

 

 

 

 

Page

Part I.

Financial Information:

 

Item 1.

Financial Statements:

 

 

 

 

Consolidated Statements of Income

Three and Six Months Ended June 30, 2012 and 2011

 

 

3

 

 

Consolidated Statements of Comprehensive Income

Three and Six Months Ended June 30, 2012 and 2011

 

4

 

 

Consolidated Balance Sheets

As of June 30, 2012 and December 31, 2011

 

 

5

 

 

Consolidated Statements of Cash Flows

Six Months Ended June 30, 2012 and 2011

 

 

6

 

 

Notes to Consolidated Financial Statements

 

7

 

 

Report of Independent Registered Public Accounting Firm

 

18

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

19

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

28

 

Item 4.

Controls and Procedures

 

28

Part II.

Other Information:

 

 

 

Item 1.

Legal Proceedings

 

29

 

Item 1A.

Risk Factors

 

30

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

30

 

Item 6.

Exhibits

 

30

Signatures

 

 

31

 

 

 

 

 

Exhibit Index

 

 

32

 

 

 

 

 

2



PART 1. FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

 

Norfolk Southern Corporation and Subsidiaries

Consolidated Statements of Income

(Unaudited)

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

($ in millions, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

Railway operating revenues

$

2,874

 

$

2,866

 

$

5,663

 

$

5,486

 

 

 

 

 

 

 

 

 

 

 

 

Railway operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

724

 

 

739

 

 

1,510

 

 

1,504

Purchased services and rents

 

392

 

 

405

 

 

783

 

 

788

Fuel

 

390

 

 

412

 

 

803

 

 

801

Depreciation

 

229

 

 

213

 

 

453

 

 

424

Materials and other

 

205

 

 

222

 

 

435

 

 

494

Total railway operating expenses

 

1,940

 

 

1,991

 

 

3,984

 

 

4,011

 

 

 

 

 

 

 

 

 

 

 

 

Income from railway operations

 

934

 

 

875

 

 

1,679

 

 

1,475

 

 

 

 

 

 

 

 

 

 

 

 

Other income – net

 

31

 

 

34

 

 

60

 

 

61

Interest expense on debt

 

122

 

 

113

 

 

242

 

 

225

 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

843

 

 

796

 

 

1,497

 

 

1,311

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

319

 

 

239

 

 

563

 

 

429

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

524

 

$

557

 

$

934

 

$

882

 

 

 

 

 

 

 

 

 

 

 

 

Per share amounts:

 

 

 

 

 

 

 

 

 

 

 

Net income:

 

 

 

 

 

 

 

 

 

 

 

Basic

$

1.62

 

$

1.58

 

$

2.86

 

$

2.49

Diluted

 

1.60

 

 

1.56

 

 

2.82

 

 

2.45

 

 

 

 

 

 

 

 

 

 

 

 

Dividends

 

0.47

 

 

0.40

 

 

0.94

 

 

0.80

 

See accompanying notes to consolidated financial statements.

 

3



Norfolk Southern Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

524 

 

$

557 

 

$

934 

 

$

882 

Other comprehensive income, before tax:

 

 

 

 

 

 

 

 

 

 

 

Pension and other postretirement benefits

 

32 

 

 

29 

 

 

64 

 

 

57 

Other comprehensive loss of equity investees

 

 

 

 

 

(4)

 

 

Other comprehensive income, before tax

 

32 

 

 

29 

 

 

60 

 

 

57 

Income tax expense related to items of other   

 

 

 

 

 

 

 

 

 

 

 

comprehensive income

 

(13)

 

 

(13)

 

 

(25)

 

 

(22)

Other comprehensive income, net of tax

 

19 

 

 

16 

 

 

35 

 

 

35 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

$

543 

 

$

573 

 

$

969 

 

$

917 


See accompanying notes to consolidated financial statements.

4



Norfolk Southern Corporation and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

 

 

June 30,

 

December 31,

 

2012

 

2011

 

($ in millions)

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

356 

 

 

$

276 

Short-term investments

 

 

15 

 

 

 

25 

Accounts receivable - net

 

 

1,086 

 

 

 

1,022 

Materials and supplies

 

 

242 

 

 

 

209 

Deferred income taxes

 

 

133 

 

 

 

143 

Other current assets

 

 

52 

 

 

 

76 

Total current assets

 

 

1,884 

 

 

 

1,751 

 

 

 

 

 

 

 

 

Investments

 

 

2,278 

 

 

 

2,234 

Properties less accumulated depreciation of $9,738 and

 

 

 

 

 

 

 

$9,464, respectively

 

 

24,968 

 

 

 

24,469 

Other assets

 

 

61 

 

 

 

84 

 

 

 

 

 

 

 

 

Total assets

 

$

29,191 

 

 

$

28,538 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

1,126 

 

 

$

1,092 

Short-term debt

 

 

 

 

 

100 

Income and other taxes

 

 

322 

 

 

 

207 

Other current liabilities

 

 

299 

 

 

 

252 

Current maturities of long-term debt

 

 

27 

 

 

 

50 

Total current liabilities

 

 

1,774 

 

 

 

1,701 

 

 

 

 

 

 

 

 

Long-term debt

 

 

7,972 

 

 

 

7,390 

Other liabilities

 

 

2,028 

 

 

 

2,050 

Deferred income taxes

 

 

7,639 

 

 

 

7,486 

Total liabilities

 

 

19,413 

 

 

 

18,627 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

Common stock $1.00 per share par value, 1,350,000,000 shares

 

 

 

 

 

 

 

authorized; outstanding 319,516,715 and 330,386,089 shares,

 

 

 

 

 

 

 

respectively, net of treasury shares

 

 

321 

 

 

 

332 

Additional paid-in capital

 

 

1,904 

 

 

 

1,912 

Accumulated other comprehensive loss

 

 

(991)

 

 

 

(1,026)

Retained income

 

 

8,544 

 

 

 

8,693 

Total stockholders’ equity

 

 

9,778 

 

 

 

9,911 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

29,191 

 

 

$

28,538 

See accompanying notes to consolidated financial statements.

 

5



Norfolk Southern Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

 

Six Months Ended

 

June 30,

 

2012

 

2011

 

($ in millions)

Cash flows from operating activities:

 

 

 

 

 

Net income

$

934 

 

$

882 

Reconciliation of net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

456 

 

 

428 

Deferred income taxes

 

138 

 

 

243 

Gains and losses on properties

 

(2)

 

 

Changes in assets and liabilities affecting operations:

 

 

 

 

 

Accounts receivable

 

(64)

 

 

(184)

Materials and supplies

 

(33)

 

 

(32)

Other current assets

 

23 

 

 

36 

Current liabilities other than debt

 

162 

 

 

221 

Other – net

 

49 

 

 

106 

Net cash provided by operating activities

 

1,663 

 

 

1,700 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Property additions

 

(968)

 

 

(888)

Property sales and other transactions

 

15 

 

 

20 

Investments, including short-term

 

(12)

 

 

(67)

Investment sales and other transactions

 

33 

 

 

134 

Net cash used in investing activities

 

(932)

 

 

(801)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Dividends

 

(308)

 

 

(283)

Common stock issued – net

 

47 

 

 

69 

Purchase and retirement of common stock

 

(850)

 

 

(792)

Proceeds from borrowings – net

 

696 

 

 

396 

Debt repayments

 

(236)

 

 

(438)

Net cash used in financing activities

 

(651)

 

 

(1,048)

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

80 

 

 

(149)

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

At beginning of year

 

276 

 

 

827 

 

 

 

 

 

 

At end of period

$

356 

 

$

678 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest (net of amounts capitalized)

$

232 

 

$

219 

Income taxes (net of refunds)

 

264 

 

 

45 

See accompanying notes to consolidated financial statements.

6



Norfolk Southern Corporation and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

 

In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly Norfolk Southern Corporation (Norfolk Southern) and subsidiaries’ (collectively, NS) financial condition as of June 30, 2012, and December 31, 2011, its results of operations and comprehensive income for the three and six months ended June 30, 2012 and 2011, and its cash flows for the six months ended June 30, 2012 and 2011, in conformity with U.S. generally accepted accounting principles.

 

These Consolidated Financial Statements should be read in conjunction with the consolidated financial statements and notes included in NS’ latest Annual Report on Form 10-K.

 


1.  Stock-Based Compensation

 

During the first quarter of 2012, a committee of non-employee directors of Norfolk Southern’s Board of Directors granted stock options, restricted stock units (RSUs) and performance share units (PSUs) pursuant to the Long-Term Incentive Plan (LTIP) and granted stock options pursuant to the Thoroughbred Stock Option Plan (TSOP) as discussed below. Stock-based compensation expense was $7 million during both the second quarters of 2012 and 2011. For the first six months of 2012 and 2011, stock-based compensation expense was $41 million and $49 million, respectively. The total tax effects recognized in income in relation to stock-based compensation were net benefits of $3 million and $2 million for the quarters ended June 30, 2012 and 2011, respectively, and net benefits of $14 million and $16 million for the first six months of 2012 and 2011, respectively.

 


Stock Options

 

In the first quarter of 2012, 567,300 options were granted under the LTIP and 210,300 options were granted under the TSOP. In each case, the grant price was $75.14, which was the greater of the average fair market value of Norfolk Southern common stock (Common Stock) or the closing price of the Common Stock on the effective date of the grant, and the options have a term of ten years. The options granted under the LTIP and TSOP in 2012 may not be exercised prior to the fourth and third anniversaries of the date of grant, respectively. Holders of the 2012 options granted under the LTIP who remain actively employed receive cash dividend equivalent payments for four years in an amount equal to the regular quarterly dividends paid on Common Stock. Dividend equivalent payments are not made on TSOP options.

 

The fair value of each option award in 2012 was measured on the date of grant using a lattice-based option valuation model. Expected volatilities are based on implied volatilities from traded options on Common Stock and historical volatility of Common Stock. NS uses historical data to estimate option exercises and employee terminations within the valuation model. The average expected option life is derived from the output of the valuation model and represents the period of time that options granted are expected to be outstanding. The average risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. For options granted that include dividend equivalent payments, a dividend yield of zero was used. A dividend yield of 2.3% was used for LTIP options for periods where no dividend equivalent payments are made as well as for TSOP options, which do not receive dividend equivalents.

7


 

The assumptions for the 2012 LTIP and TSOP grants are shown in the following table:

 

Expected volatility range

27% - 29%

Average expected volatility

27%

LTIP average expected option life

8.9 years

TSOP average expected option life

8.8 years

Average risk-free interest rate

1.96%

LTIP per-share grant-date fair value

$23.84

TSOP per-share grant-date fair value

$19.55

 

During the second quarter of 2012, options relating to 396,939 shares were exercised, yielding $10 million of cash proceeds and $6 million of tax benefit recognized as additional paid-in capital. During the second quarter of 2011, options relating to 889,853 shares were exercised, yielding $25 million of cash proceeds and $12 million of tax benefit recognized as additional paid-in capital.

 

For the first six months of 2012, options relating to 773,296 shares were exercised, yielding $21 million of cash proceeds and $12 million of tax benefit recognized as additional paid-in capital. For the first six months of 2011, options relating to 1,649,046 shares were exercised, yielding $45 million of cash proceeds and $22 million of tax benefit recognized as additional paid-in capital.

 


Restricted Stock Units

 

There were 140,000 RSUs granted in 2012, with an average grant-date fair value of $75.14 and a five-year restriction period. The RSUs granted in 2012 will be settled through the issuance of shares of Common Stock.

 

During the second quarter of 2012, 30,000 RSUs were earned and paid out. There were 311,900 earned and paid out during the first six months of 2012. There were no RSUs earned or paid out during the first six months of 2011. The total related tax benefit recognized as additional paid-in capital was less than $1 million for the second quarter of 2012 and $3 million for the first six months of 2012. The total related tax benefit recognized as additional paid-in capital was less than $1 million for both the second quarter of 2011 and the first six months of 2011.

 


Performance Share Units

 

PSUs provide for awards based on achievement of certain predetermined corporate performance goals (total shareholder return, return on average invested capital, and operating ratio) at the end of a three-year cycle and are paid in the form of shares of Common Stock. During the first quarter of 2012, there were 468,850 PSUs granted with a grant-date fair value of $75.14.

 

During the first six months of 2012, 782,889 PSUs were earned and paid out in shares of Common Stock. The total related tax benefit recognized as additional paid-in capital was $11 million for the first six months of 2012.

 

During the first six months of 2011, 850,595 PSUs were earned and paid out, one-half in shares of Common Stock and one-half in cash. These PSUs had a grant-date fair value of $50.47 per unit and a fair value at payout of $62.75 per unit. The total related tax benefit recognized as additional paid-in capital was $2 million for the first six months of 2011.

 

8



2.  Income Taxes

 

There have been no material changes to the balance of unrecognized tax benefits reported at December 31, 2011.  NS anticipates that the Internal Revenue Service (IRS) will complete its examination of NS' 2009 and 2010 federal income tax returns by the end of 2012.  NS does not expect that the resolution of the examination will have a material effect on its financial position, results of operations, or liquidity.

 


3.  Earnings Per Share

 

 

Basic

 

Diluted

 

Three Months Ended June 30,

 

2012

 

2011

 

2012

 

2011

 

($ in millions, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

524 

 

$

557 

 

$

524 

 

$

557 

Dividend equivalent payments

 

(2)

 

 

(2)

 

 

 

 

Income available to common stockholders

 

522 

 

 

555 

 

 

524 

 

 

557 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

322.7 

 

 

351.0 

 

 

322.7 

 

 

351.0 

Dilutive effect of outstanding options and share-settled awards

 

 

 

 

 

 

 

4.8 

 

 

6.3 

Adjusted weighted-average shares outstanding

 

 

 

 

 

 

 

327.5 

 

 

357.3 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share

$

1.62 

 

$

1.58 

 

$

1.60 

 

$

1.56 

 

 

 

Basic

 

Diluted

 

Six Months Ended June 30,

 

2012

 

2011

 

2012

 

2011

 

($ in millions, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

934 

 

$

882 

 

$

934 

 

$

882 

Dividend equivalent payments

 

(4)

 

 

(4)

 

 

(2)

 

 

(2)

Income available to common stockholders

 

930 

 

 

878 

 

 

932 

 

 

880 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

325.5 

 

 

353.1 

 

 

325.5 

 

 

353.1 

Dilutive effect of outstanding options and share-settled awards

 

 

 

 

 

 

 

4.7 

 

 

5.8 

Adjusted weighted-average shares outstanding

 

 

 

 

 

 

 

330.2 

 

 

358.9 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share

$

2.86 

 

$

2.49 

 

$

2.82 

 

$

2.45 



During the second quarters and first six months of 2012 and 2011, dividend equivalent payments were made to holders of stock options and RSUs. For purposes of computing basic earnings per share, the total amount of dividend equivalent payments made to holders of stock options and RSUs were deducted from net income to determine income available to common stockholders. For purposes of computing diluted earnings per share, NS evaluates on a grant-by-grant basis those stock options and RSUs receiving dividend equivalent payments under the two-class and treasury stock methods to determine which method is the more dilutive for each grant. For those grants for which the two-class method was more dilutive, net income was reduced by the amount of dividend equivalent payments on these grants to determine income available to common stockholders. The diluted calculations exclude options having exercise prices exceeding the average market price of Common Stock as follows: 0.8 million in 2012 and zero in 2011.

9


 


4.  Stockholders’ Equity

 

Common stock is reported net of shares held by consolidated subsidiaries (Treasury Shares) of Norfolk Southern. Treasury Shares at June 30, 2012 and December 31, 2011, amounted to 20,320,777 shares, respectively, with a cost of $19 million as of both dates.

 


5.  Stock Repurchase Program

 

NS repurchased and retired 12.3 million shares of Common Stock in the first six months of 2012, at a cost of

$850 million. NS repurchased and retired 11.6 million shares at a cost of $792 million for the same period of  2011. The timing and volume of purchases is guided by management’s assessment of market conditions and other pertinent factors. Any near-term share repurchases are expected to be made with internally generated cash, cash on hand, or proceeds from borrowings. Since the beginning of 2006, NS has repurchased and retired 121.9 million shares at a total cost of $7.1 billion.

 


6.  Investment in Conrail

 

Through a limited liability company, Norfolk Southern and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primary subsidiary is Consolidated Rail Corporation (CRC). NS has a 58% economic and 50% voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests. NS’ investment in Conrail was $984 million at June 30, 2012, and $969 million at December 31, 2011.

 

CRC owns and operates certain properties (the Shared Assets Areas) for the joint and exclusive benefit of Norfolk Southern Railway Company (NSR) and CSX Transportation, Inc. (CSXT). The costs of operating the Shared Assets Areas are borne by NSR and CSXT based on usage. In addition, NSR and CSXT pay CRC a fee for access to the Shared Assets Areas. “Purchased services and rents” and “Fuel” include expenses for the use of the Shared Assets Areas totaling $30 million and $32 million for the second quarters of 2012 and 2011, respectively, and

$66 million and $65 million for the first six months of 2012 and 2011, respectively. NS’ equity in the earnings of Conrail, net of amortization, included in “Other income – net” was $9 million and $7 million for the second quarters of 2012 and 2011, respectively, and $15 million and $13 million for the first six months of 2012 and 2011, respectively.

 

“Accounts payable” includes $157 million at June 30, 2012, and $160 million at December 31, 2011, due to Conrail for the operation of the Shared Assets Areas. In addition, “Other liabilities” includes $133 million at both June 30, 2012 and December 31, 2011, for long-term advances from Conrail, maturing 2035, that bear interest at an average rate of 4.4%.

 

10



7.  Debt

 

In the first quarter of 2012, NS borrowed $100 million and repaid $200 million under its accounts receivable securitization facility.  At June 30, 2012 and December 31, 2011, the amounts outstanding under the facility were $100 million (at an average variable interest rate of 1.3%) and $200 million (at an average variable interest rate of 1.35%), respectively.  In October 2011, NS renewed its accounts receivable securitization facility with a 364-day term to run until October 2012.

 

During the first quarter of 2012, NS issued $600 million of 3.0% senior notes due 2022.

 

NS has authority from its Board of Directors to issue an additional $400 million of debt or equity securities through public or private sale.

 

11



8.  Pensions and Other Postretirement Benefits

 

Norfolk Southern and certain subsidiaries have both funded and unfunded defined benefit pension plans covering principally salaried employees. Norfolk Southern and certain subsidiaries also provide specified health care and death benefits to eligible retired employees and their dependents. Under the present plans, which may be amended or terminated at NS’ option, a defined percentage of health care expenses are covered, reduced by any deductibles, co-payments, Medicare payments, and in some cases, coverage provided under other group insurance policies.

 

 

Pension Benefits

 

Other Benefits

 

Three Months Ended June 30,

 

2012

 

2011

 

2012

 

2011

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

 

$

 

$

 

$

Interest cost

 

22 

 

 

23 

 

 

13 

 

 

14 

Expected return on plan assets

 

(35)

 

 

(35)

 

 

(3)

 

 

(3)

Amortization of net losses

 

19 

 

 

17 

 

 

13 

 

 

11 

Amortization of prior service cost

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Net cost

$

15 

 

$

13 

 

$

27 

 

$

26 

 

 

 

Pension Benefits

 

Other Benefits

 

Six Months Ended June 30,

 

2012

 

2011

 

2012

 

2011

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

17 

 

$

14 

 

$

 

$

Interest cost

 

44 

 

 

46 

 

 

27 

 

 

29 

Expected return on plan assets

 

(69)

 

 

(70)

 

 

(7)

 

 

(7)

Amortization of net losses

 

38 

 

 

34 

 

 

26 

 

 

22 

Amortization of prior service cost

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Net cost

$

30 

 

$

25 

 

$

54 

 

$

52 

 

 

12



9.  Fair Value

 

Fair Value Measurements

 

The Financial Accounting Standards Board (FASB) Accounting Standards Codifications (ASC) 820-10, “Fair Value Measurements,” established a framework for measuring fair value and a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:

 

Level 1

Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that NS has the ability to access.

 

 

Level 2

Inputs to the valuation methodology include:

 

  • Quoted prices for similar assets or liabilities in active markets;
  • Quoted prices for identical or similar assets or liabilities in inactive markets;
  • Inputs other than quoted prices that are observable for the asset or liability;
  • Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

 

 

If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.

 

 

Level 3

Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

The asset’s or liability’s fair value measurement level within the hierarchy is based on the lowest level of any input that is significant to the fair value measurement. There were no assets or liabilities measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011.  

 


Fair Values of Financial Instruments

 

NS has evaluated the fair values of financial instruments and methods used to determine those fair values. The fair values of “Cash and cash equivalents,” “Short-term investments,” “Accounts receivable,” “Accounts payable,” and “Short-term debt” approximate carrying values because of the short maturity of these financial instruments. The carrying value of corporate-owned life insurance is recorded at cash surrender value and, accordingly, approximates fair value. The carrying amounts and estimated fair values for the remaining financial instruments, excluding investments accounted for under the equity method, consisted of the following:

 

 

June 30, 2012

 

December 31, 2011

 

Carrying

 

Fair

 

Carrying

 

Fair

 

Amount

 

Value

 

Amount

 

Value

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Long-term investments

$

137 

 

$

171 

 

$

151 

 

$

186 

Long-term debt, including current maturities

 

(7,999)

 

 

(10,258)

 

 

(7,440)

 

 

(9,469)


 

13


Underlying net assets were used to estimate the fair value of investments with the exception of notes receivable, which are based on future discounted cash flows. The fair values of long-term debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, company rating, and remaining maturity.

 

The following table sets forth the fair value of long-term investment and long-term debt balances disclosed above by valuation technique level, within the fair value hierarchy (there were no level 3 valued assets or liabilities).

 

 

June 30, 2012

 

Level 1

 

Level 2

 

Total

 

($ in millions)

 

 

 

 

 

 

 

 

 

Long-term investments

$

38 

 

$

133 

 

$

171 

Long-term debt, including current maturities

 

(9,962)

 

 

(296)

 

 

(10,258)

 

Sales of available-for-sale securities were zero and $132 million (which included current maturities) for the six months ended June 30, 2012 and 2011, respectively.

 


10.  Commitments and Contingencies

 

Lawsuits

 

Norfolk Southern and/or certain subsidiaries are defendants in numerous lawsuits and other claims relating principally to railroad operations. When management concludes that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, it is accrued through a charge to earnings. While the ultimate amount of liability incurred in any of these lawsuits and claims is dependent on future developments, in management’s opinion, the recorded liability is adequate to cover the future payment of such liability and claims. However, the final outcome of any of these lawsuits and claims cannot be predicted with certainty, and unfavorable or unexpected outcomes could result in additional accruals that could be significant to results of operations in a particular year or quarter. Any adjustments to the recorded liability will be reflected in earnings in the periods in which such adjustments are known.

 

One of NS’ customers, DuPont, has a rate reasonableness complaint pending before the Surface Transportation Board (STB) alleging that the NS tariff rates for transportation of regulated movements are unreasonable. NS disputes these allegations. Since June 1, 2009, NS has been billing and collecting from DuPont amounts based on the challenged tariff rates. Management presently expects resolution of the case to occur in 2013 and believes the estimate of reasonably possible loss will not have a material effect on NS’ financial position, results of operations, or liquidity.  With regard to rate cases, management records adjustments to revenues in the periods, if and when, such adjustments are probable and estimable.

 

On November 6, 2007, various antitrust class actions filed against NS and other Class 1 railroads in various Federal district courts regarding fuel surcharges were consolidated in the District of Columbia by the Judicial Panel on Multidistrict Litigation.  On June 21, 2012, the court certified the case as a class action.  NS believes the allegations in the complaints are without merit and intends to vigorously defend the cases. NS does not believe that the outcome of these proceedings will have a material effect on its financial position, results of operations, or liquidity.  A lawsuit containing similar allegations against NS and four other major railroads that was filed on March 25, 2008, in the U.S. District Court for the District of Minnesota was voluntarily dismissed by the plaintiff subject to a tolling agreement entered into in August 2008.

 

14



Casualty Claims

 

Casualty claims include employee personal injury and occupational claims as well as third-party claims, all exclusive of legal costs. To aid in valuing its personal injury liability and determining the amount to accrue with respect to such claims during the year, NS’ management utilizes studies prepared by an independent consulting actuarial firm. Job-related accidental injury and occupational claims are subject to the Federal Employers’ Liability Act (FELA), which is applicable only to railroads. FELA’s fault-based system produces results that are unpredictable and inconsistent as compared with a no-fault workers’ compensation system. The variability inherent in this system could result in actual costs being different from the liability recorded. While the ultimate amount of claims incurred is dependent on future developments, in management’s opinion, the recorded liability is adequate to cover the future payments of claims and is supported by the most recent actuarial study. In all cases, NS records a liability when the expected loss for the claim is both probable and estimable.

 

The Consolidated Balance Sheets reflect long-term receivables for estimated recoveries from NS’ insurance carriers for claims associated with the January 6, 2005, derailment in Graniteville, S.C.  In the first quarter of 2011, NS received an unfavorable ruling for an arbitration claim with an insurance carrier, and was denied recovery of the contested portion ($43 million) of the claim.  As a result, NS recorded a $43 million charge during the first quarter of 2011 for the receivables associated with the contested portion of the claim and a $15 million charge for other receivables affected by the ruling for which recovery was no longer probable.

 

Employee personal injury claims – The largest component of casualties and other claims expense is employee personal injury costs. The independent actuarial firm engaged by NS provides quarterly studies to aid in valuing its employee personal injury liability and estimating its employee personal injury expense. The actuarial firm studies NS’ historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences. The actuary uses the results of these analyses to estimate the ultimate amount of liability, which includes amounts for incurred but unasserted claims. NS adjusts its liability quarterly based upon management’s assessment and the results of the study. The estimate of loss liabilities is subject to inherent limitation given the difficulty of predicting future events such as jury decisions, court interpretations, or legislative changes and as such the actual loss may vary from the estimated liability recorded.

 

Occupational claims – Occupational claims (including asbestosis and other respiratory diseases, as well as conditions allegedly related to repetitive motion) are often not caused by a specific accident or event but rather allegedly result from a claimed exposure over time. Many such claims are being asserted by former or retired employees, some of whom have not been employed in the rail industry for decades. The independent actuarial firm provides an estimate of the occupational claims liability based upon NS’ history of claim filings, severity, payments, and other pertinent facts. The liability is dependent upon management’s judgments made as to the specific case reserves as well as judgments of the consulting independent actuarial firm in the periodic studies. The actuarial firm’s estimate of ultimate loss includes a provision for those claims that have been incurred but not reported. This provision is derived by analyzing industry data and projecting NS’ experience into the future as far as can be reasonably determined. NS adjusts its liability quarterly based upon management’s assessment and the results of the study. However, it is possible that the recorded liability may not be adequate to cover the future payment of claims. Adjustments to the recorded liability are reflected in operating expenses in the periods in which such adjustments become known.

 

Third-party claims – NS records a liability for third-party claims including those for highway crossing accidents, trespasser and other injuries, automobile liability, property damage, and lading damage. The independent actuarial firm assists with the calculation of potential liability for third-party claims, except lading damage, based upon NS’ experience including number and timing of incidents, amount of payments, settlement rates, number of open claims, and legal defenses. The actuarial estimate includes a provision for claims that have been incurred but have not yet been reported. Each quarter, NS adjusts its liability based upon management’s assessment and the results of the study. Given the inherent uncertainty in regard to the ultimate outcome of third-party claims, it is possible that the actual loss may differ from the estimated liability recorded.

 

15



Environmental Matters

 

NS is subject to various jurisdictions’ environmental laws and regulations. It is NS’ policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably. Claims, if any, against third parties for recovery of cleanup costs incurred by NS are reflected as receivables (when collection is probable) in the Consolidated Balance Sheets and are not netted against the associated NS liability. Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates. NS also has an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy.

 

NS’ Consolidated Balance Sheets include liabilities for environmental exposures of $36 million at June 30, 2012, and $35 million at December 31, 2011 (of which $12 million is classified as a current liability at the end of each period). At June 30, 2012, the liability represents NS’ estimate of the probable cleanup and remediation costs based on available information at 141 known locations and projects. As of that date, seven sites accounted for $17 million of the liability, and no individual site was considered to be material. NS anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period.

 

At 25 locations, one or more Norfolk Southern subsidiaries in conjunction with a number of other parties, have been identified as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or comparable state statutes that impose joint and several liability for cleanup costs. NS calculates its estimated liability for these sites based on facts and legal defenses applicable to each site and not solely on the bases of the potential joint liability.

 

With respect to known environmental sites (whether identified by NS or by the EPA, or comparable state authorities), estimates of NS’ ultimate potential financial exposure for a given site or in the aggregate for all such sites are necessarily imprecise because of the widely varying costs of currently available cleanup techniques, the likely development of new cleanup technologies, unpredictable contaminant recovery and reduction rates associated with available clean-up technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant’s share of any estimated loss (and that participant’s ability to bear it), and evolving statutory and regulatory standards governing liability.

 

The risk of incurring environmental liability – for acts and omissions, past, present, and future – is inherent in the railroad business. Some of the commodities in NS’ traffic mix, particularly those classified as hazardous materials, pose special risks that NS and its subsidiaries work diligently to minimize. In addition, several NS subsidiaries own, or have owned, land used as operating property, or which is leased and operated by others, or held for sale. Because environmental problems may exist on these properties that are latent or undisclosed, there can be no assurance that NS will not incur environmental liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and potentially other unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial position, results of operations, or liquidity in a particular year or quarter.

 

Based on its assessment of the facts and circumstances now known, management believes that it has recorded the probable and reasonably estimable costs for dealing with those environmental matters of which NS is aware. Further, management believes that it is unlikely that any known matters, either individually or in the aggregate, will have a material adverse effect on NS’ financial position, results of operations, or liquidity.

 

16



Insurance

 

Norfolk Southern obtains on behalf of itself and its subsidiaries insurance for potential losses for third-party liability and first-party property damages. NS is currently self-insured up to $50 million and above $1 billion per occurrence for bodily injury and property damage to third parties and up to $25 million and above $175 million per occurrence for property owned by NS or in NS’ care, custody, or control.

 


Purchase Commitments

 

At June 30, 2012, NS had outstanding purchase commitments totaling approximately $507 million for long-term service contracts through 2019, as well as locomotives, freight cars, and track material in connection with its capital programs through 2014.

 


11.  New Accounting Pronouncements

 

In the first quarter of 2012, NS adopted Accounting Standards Update (ASU) No. 2011-05, “Comprehensive Income (Topic 220):  Presentation of Comprehensive Income.”  This update requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements.  This update does not change what items are reported in other comprehensive income or the requirement to report reclassification of items from other comprehensive income to net income.

 

In the first quarter of 2012, NS adopted ASU No. 2011-04, “Fair Value Measurements (Topic 820):  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.”  This update provides clarification about the application of existing fair value measurements and disclosure requirements, and expands certain other disclosures requirements.

17



Report of Independent Registered Public Accounting Firm

 

 

The Board of Directors and Stockholders

Norfolk Southern Corporation:

 

We have reviewed the accompanying consolidated balance sheet of Norfolk Southern Corporation and subsidiaries as of June 30, 2012, the related consolidated statements of income and comprehensive income for the three-month and six-month periods ended June 30, 2012 and 2011 and the related consolidated statements of cash flows for the six-month periods ended June 30, 2012 and 2011. These consolidated financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Norfolk Southern Corporation and subsidiaries as of December 31, 2011, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated February 15, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2011, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

 

/s/KPMG LLP

KPMG LLP

Norfolk, Virginia

July 27, 2012

 

18



Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Norfolk Southern Corporation and Subsidiaries

 

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes.

 

OVERVIEW

 

NS’ second quarter net income was $524 million in 2012, a decline from $557 million in 2011, reflecting the absence of the prior year’s non-recurring income tax-related benefits of $63 million. Increased income taxes were  partially offset by a $59 million, or 7%, increase in income from railway operations, primarily driven by lower operating expenses.  Earnings per share improved to $1.60 from $1.56 in the prior year reflecting fewer shares outstanding as a result of share repurchases (see below). As economic conditions slowly improved, growth in NS’ general merchandise and intermodal traffic volumes were able to offset declines in NS’ coal business.  Railway operating revenues were relatively flat as increased traffic volumes were almost completely offset by lower average revenue per unit.  The railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) improved to 67.5%, compared with 69.5% for the second quarter of 2011.

 

Cash provided by operating activities for the first six months of 2012 was $1.7 billion, which along with cash on hand and proceeds from borrowings allowed for property additions, share repurchases, dividends, and debt repayments. In the first six months of 2012, 12.3 million shares of Norfolk Southern Corporation common stock (Common Stock) were repurchased at a total cost of $850 million. Since the beginning of 2006, NS has repurchased and retired 121.9 million shares of Common Stock at a total cost of $7.1 billion. At June 30, 2012, cash, cash equivalents, and short-term investments totaled $371 million.

 


SUMMARIZED RESULTS OF OPERATIONS

 

Second quarter 2012 net income was $524 million, down $33 million, or 6%, compared with the same period last year. The decrease primarily resulted from a higher effective income tax rate due to the absence of $59 million of income tax expense benefits in the second quarter of 2011. The decline was partially offset by a $59 million increase in income from railway operations which was primarily composed of a $51 million decrease in railway operating expenses.

 

For the first six months of 2012, net income was $934 million, up $52 million, or 6%, compared with the same period last year. Income from railway operations increased 14%, reflecting a 3% improvement in railway operating revenues and a 1% decline in operating expenses (which reflects the absence of the prior year’s $58 million unfavorable insurance arbitration ruling), offset in part by increased income tax expense.

 

Oil prices affect NS’ results of operations in a variety of ways and can have an overall favorable or unfavorable impact in any particular period. In addition to the impact of oil prices on general economic conditions, traffic volume, and supplier costs, oil prices directly affect NS’ revenues through market-based fuel surcharges and contract escalators (see “Railway Operating Revenues”) and also affect fuel costs (see “Railway Operating Expenses”).  For the second quarter of 2012, excluding the impact of decreased consumption, fuel surcharge revenue increased while fuel expense decreased.  For the first six months of 2012, the increase in fuel surcharge revenue was greater than the increase in fuel expense.  Future changes in oil prices may cause volatility in operating results that could be material to a particular year or quarter.

19



DETAILED RESULTS OF OPERATIONS

 

Railway Operating Revenues

 

Second quarter railway operating revenues were $2.9 billion in 2012, up $8 million compared with the second quarter of 2011. For the first six months of 2012, railway operating revenues were $5.7 billion, up

$177 million, or 3%, compared with the same period last year. As shown in the following table, the increase for the quarter was the result of higher traffic volume, offset in part by lower average revenue per unit (which includes the effects of fuel surcharges). For the first six months, higher average revenue per unit and traffic volume drove the revenue increase.  Fuel surcharges amounted to $365 million in the second quarter (up $4 million) and $690 million for the first six months (up $80 million).

 

 

Second Quarter

 

First Six Months

 

2012 vs. 2011

 

2012 vs. 2011

 

 

Increase (Decrease)

 

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

Traffic volume (units)

 

$

20 

 

 

 

$

50 

 

Revenue per unit

 

 

(12)

 

 

 

 

127 

 

  Total

 

$

 

 

 

$

177 

 

 

Many of NS’ negotiated fuel surcharges for coal and general merchandise traffic are based on the monthly average price of West Texas Intermediate Crude Oil (WTI Average Price). These surcharges are reset the first day of each calendar month based on the WTI Average Price for the second preceding calendar month. This two-month lag in applying WTI Average Price coupled with the change in fuel prices increased fuel surcharge revenue by approximately $61 million for the second quarter and $35 million for the first six months.

One of NS’ customers, DuPont, has a rate reasonableness complaint pending before the Surface Transportation Board (STB) alleging that the NS tariff rates for transportation of regulated movements are unreasonable.  NS disputes these allegations.  Since June 1, 2009, NS has been billing and collecting from DuPont amounts based on the challenged tariff rates.  Management presently expects resolution of the case to occur in 2013 and believes the estimate of reasonably possible loss will not have a material effect on NS’ financial position, results of operations, or liquidity.  With regard to rate cases, management records adjustments to revenues in the periods, if and when, such adjustments are probable and estimable.

20


Revenues, units and average revenue per unit for NS’ market groups were as follows:

 

 

Second Quarter

 

Revenues

 

Units

 

Revenue per Unit

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

($ in millions)

 

(in thousands)

 

($ per unit)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Coal

$

755

 

$

893

 

354.8

 

402.6

 

$

2,126

 

$

2,217

General merchandise:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Agriculture/consumer/gov’t

 

370

 

 

369

 

150.1

 

150.1

 

 

2,464

 

 

2,460

  Chemicals

 

379

 

 

355

 

98.5

 

95.4

 

 

3,844

 

 

3,727

  Metals and construction

 

369

 

 

320

 

180.2

 

173.3

 

 

2,047

 

 

1,846

  Automotive

 

239

 

 

198

 

98.4

 

84.6

 

 

2,431

 

 

2,334

  Paper/clay/forest

 

199

 

 

191

 

76.9

 

78.9

 

 

2,593

 

 

2,420

General merchandise

 

1,556

 

 

1,433

 

604.1

 

582.3

 

 

2,576

 

 

2,461

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intermodal

 

563

 

 

540

 

840.4

 

802.0

 

 

671

 

 

674

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Total

$

2,874

 

$

2,866

 

1,799.3

 

1,786.9

 

 

1,597

 

 

1,604

 

 

 

First Six Months

 

Revenues

 

Units

 

Revenue per Unit

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

($ in millions)

 

(in thousands)

 

($ per unit)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Coal

$

1,521

 

$

1,709

 

713.8

 

808.7

 

$

2,130

 

$

2,113

General merchandise:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Agriculture/consumer/gov’t

 

740

 

 

720

 

302.4

 

305.7

 

 

2,446

 

 

2,357

  Chemicals

 

741

 

 

693

 

194.5

 

191.1

 

 

3,808

 

 

3,629

  Metals and construction

 

711

 

 

589

 

345.7

 

321.7

 

 

2,057

 

 

1,830

  Automotive

 

465

 

 

375

 

194.7

 

163.2

 

 

2,388

 

 

2,297

  Paper/clay/forest

 

395

 

 

375

 

153.6

 

158.8

 

 

2,573

 

 

2,361

General merchandise

 

3,052

 

 

2,752

 

1,190.9

 

1,140.5

 

 

2,563

 

 

2,413

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intermodal

 

1,090

 

 

1,025

 

1,625.4

 

1,548.9

 

 

671

 

 

662

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Total

$

5,663

 

$

5,486

 

3,530.1

 

3,498.1

 

 

1,604

 

 

1,568

 

 

 

 

21



Coal

 

Coal revenues decreased $138 million, or 15%, in the second quarter, reflecting a 12% decrease in traffic volume and a 4% decline in average revenue per unit as compared with the same period last year.  For the first six months, coal revenues decreased $188 million, or 11%, reflecting a 12% decline in traffic volume, partially offset by a 1% improvement in average revenue per unit. Coal tonnage by market was as follows:

 

 

Second Quarter

 

First Six Months

 

2012

 

2011

 

2012

 

2011

 

(tons in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Utility

 

23,527

 

 

29,455

 

 

49,788

 

 

60,965

Export

 

8,530

 

 

7,938

 

 

15,254

 

 

15,376

Domestic metallurgical

 

5,019

 

 

4,859

 

 

9,591

 

 

8,633

Industrial

 

1,880

 

 

1,906

 

 

3,801

 

 

3,731

  Total

 

38,956

 

 

44,158

 

 

78,434

 

 

88,705

 

Utility coal tonnage decreased 20% in the second quarter and 18% in the first six months, reflecting competition from low natural gas prices and reduced electrical demand in NS-served regions.  Export coal tonnage increased 7% in the second quarter due to strong thermal shipments, but decreased 1% in the first six months.  Both periods were negatively impacted by the return of Australian supply and weaker global demand for steel production.  Domestic metallurgical coal tonnage was up 3% in the second quarter and 11% in the first six months, as domestic steel production improved and a softening export coal market increased coking coal availability for the domestic market. 

 

Coal revenues for the remainder of the year are expected to decrease compared to last year due to lower average revenue per unit and lower traffic volumes.

 


General Merchandise

 

General merchandise revenues increased $123 million, or 9%, in the second quarter and $300 million, or 11%, in the first six months as compared with the same periods last year.  Both increases reflect improvements in average revenue per unit (up 5% for the quarter and 6% for the first six months) and traffic volume (up 4% in both periods).

 

Agriculture, consumer products, and government volume was flat during the second quarter, but decreased 1% for the first six months.  The first six months reflected reduced corn shipments driven by plant closures and fewer shipments of fertilizer due to certain network classification changes. These volume declines were offset in part by more revenue movements of empty equipment, as well as more shipments of corn-based feed to Texas. 

 

Chemicals volume increased 3% in the second quarter and 2% for the first six months, reflecting more shipments of crude oil, additional shipments of liquefied petroleum gas, and improved shipments of plastics driven by increased demand for plastic bottles.  These volume increases were offset in part by fewer shipments of rock salt as the recent mild winter resulted in higher inventory levels, as well as reduced shipments of chlor-alkali traffic due to soft domestic demand for chlorine. 

 

Metals and construction volume increased 4% in the second quarter and 7% for the first six months, reflecting higher shipments of fractionating sand for natural gas drilling, as well as more shipments of coil and scrap metal driven by increased steel and automotive production.  The first six months also reflected more iron and steel shipments.

 

Automotive volume grew 16% in the second quarter and 19% for the first six months, primarily a result of increased North American light vehicle production at NS-served plants, in addition to new business.  

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Paper, clay, and forest products volume was down 3% in the second quarter and for the first six months, reflecting reduced shipments of miscellaneous wood driven by the loss of business.  Both periods also reflect fewer shipments of pulp due to declining consumption.   

 

General merchandise revenues for the remainder of the year are expected to increase compared to last year due to higher traffic volumes and slightly higher average revenue per unit.

 


Intermodal

 

Intermodal revenues increased $23 million, or 4%, in the second quarter, compared with the same period last year, reflecting a 5% increase in traffic volumes and a slight decline in average revenue per unit.  For the first six months, intermodal revenues increased $65 million, or 6%, reflecting a 5% increase in traffic volume and 1% improvement in average revenue per unit. 

 

Domestic (which includes truckload and intermodal marketing companies’ volumes) increased 10% for the second quarter and 11% for the first six months, reflecting continued highway conversions. 

 

Premium business, which includes parcel and less-than-truckload (LTL) carriers, increased 3% for the second quarter and 1% for the first six months, reflecting stronger demand. 

 

International traffic volume declined 1% for the second quarter and 2% in the first six months, reflecting the loss of business from a shipping line. 

 

Triple Crown Services, a service with rail-to-highway trailers, experienced a volume decline of 1% in the second quarter due to reduced trailer inventory but an increase of 1% for the first six months, reflecting stronger demand.

 

Intermodal revenues for the remainder of the year are expected to increase, reflecting higher traffic volumes partially offset by lower average revenue per unit.

 


Railway Operating Expenses

 

Second quarter railway operating expenses were $1.9 billion in 2012, down $51 million, or 3%, compared to the same period last year.  For the first six months, expenses were $4.0 billion, down $27 million, or 1%, compared to the same period last year.  Both periods reflect improved network fluidity which reduced costs despite increased volumes.  In addition, second quarter benefited from effective cost control.  The first six months also reflects the absence of the prior year’s first quarter $58 million unfavorable arbitration ruling.  These decreases were offset in part by higher depreciation expense as a result of an increased capital base.

 

Compensation and benefits expenses decreased $15 million, or 2%, in the second quarter, but increased $6 million in the first six months.  Both periods reflect changes in:

 

·         employee activity levels (down $17 million for the quarter and $12 million for the first six months),

·         health and welfare benefit costs for employees (down $7 million for the quarter and

$1 million for the first six months),

·         payroll taxes (down $4 million for the quarter, but up $2 million for the first six months),

·         incentive compensation (up $4 million for the quarter and $3 million for the first six months), and

·         pay rates (up $5 million for the quarter and $16 million for the first six months).

 

The first six months also reflects lower stock-based compensation (down $8 million) and higher pension costs (up $5 million).

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Purchased services and rents includes the costs of services provided by outside contractors, the net costs of operating joint (or leased) facilities with other railroads and the net cost of equipment rentals. This category of expenses decreased $13 million, or 3%, for the second quarter and $5 million, or 1%, for the first six months, reflecting lower equipment rents and haulage expenses, which were offset in part by increased costs associated with intermodal operations, and professional and consulting fees.  The first six months also reflects increased advertising and utilities expenses.

 

Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, decreased $22 million, or 5%, for the second quarter, but increased $2 million for the first six months. The decrease for the quarter was principally the result of lower fuel prices (locomotive fuel prices declined 3%), which had an impact of $14 million, as well as decreased fuel consumption (locomotive fuel consumption decreased 2%), which had an impact of $8 million.  The increase for the first six months was principally the result of higher fuel prices (locomotive fuel prices grew 3%), which had an impact of $23 million, offset in part by decreased fuel consumption (locomotive fuel consumption declined 2%), which had an effect of $21 million.

 

Materials and other expenses (including the estimates of costs related to personal injury, property damage, and environmental matters) decreased $17 million, or 8%, in the second quarter and $59 million, or 12%, for the first six months.  Both periods reflect more favorable personal injury claims development. The quarter also reflects decreased costs for materials, whereas the first six months reflect the absence of the prior year’s unfavorable Graniteville-related arbitration ruling, partially offset by higher costs associated with materials used for equipment and roadway repairs.

 

The following table shows the components of materials and other expenses:

 

 

Second Quarter

 

First Six Months

 

2012

 

2011

 

2012

 

2011

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Materials

$

95

 

$

103

 

$

207

 

$

197

Casualties and other claims

 

30

 

 

43

 

 

68

 

 

142

Other

 

80

 

 

76

 

 

160

 

 

155

  Total

$

205

 

$

222

 

$

435

 

$

494

The Consolidated Balance Sheets reflect long-term receivables for estimated recoveries from NS’ insurance carriers for claims associated with the January 6, 2005, derailment in Graniteville, S.C.  In the first quarter of 2011, NS received an unfavorable ruling for an arbitration claim with an insurance carrier, and was denied recovery of the contested portion ($43 million) of the claim.  As a result, NS recorded a $43 million charge during the first quarter of 2011 for the receivables associated with the contested portion of the claim and a $15 million charge for other receivables affected by the ruling for which recovery was no longer probable.


Other Income – Net

 

Other income – net decreased $3 million in the second quarter and $1 million for the first six months, primarily reflecting higher interest expense on uncertain tax positions (up $5 million for the quarter and $8 million for the first six months) offset in part by higher other miscellaneous income items (up $2 million for the quarter and $7 million for the first six months). 

 


Provision for Income Taxes

 

The second quarter and year-to-date effective income tax rates were 37.8% and 37.6% in 2012, respectively, compared with 30.0% and 32.7%, respectively, for the same periods last year.  The higher effective rates for both periods primarily reflect the absence of the prior year’s favorable resolution of an Internal Revenue Service (IRS) examination of NS’ 2008 return and review of certain claims for refund ($40 million) and the absence of a favorable reduction in deferred tax expense for state law changes ($19 million).

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In December 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act increased bonus depreciation to 100 percent for the period September 2010 through the end of 2011 and allows 50 percent bonus depreciation in 2012.  Bonus depreciation does not affect NS’ total provision for income taxes or effective tax rate, but does significantly lower current tax expense and the related cash outflows for income taxes paid.

NS’ consolidated income tax returns for 2009 and 2010 are being audited by the IRS and NS expects the examinations to be completed by the end of 2012.  NS does not expect that the results of the examinations will have a material effect on income tax expense.

 


FINANCIAL CONDITION AND LIQUIDITY

 

Cash provided by operating activities, NS’ principal source of liquidity, was $1.7 billion for the first six months of both 2012 and 2011.  NS had working capital of $110 million at June 30, 2012, compared with $50 million at December 31, 2011, reflecting higher borrowings net of repayments. Cash, cash equivalents, and short-term investment balances totaled $371 million at June 30, 2012, and were invested in accordance with NS’ corporate investment policy as approved by the Board of Directors. The portfolio contains securities that are subject to market risk.  There are no limits or restrictions on NS’ access to the assets.  NS expects that cash on hand combined with cash flows from operations will be sufficient to meet its ongoing obligations.  During the first quarter of 2012, NS issued $600 million of 3.0% senior notes due 2022. Other than this item, there have been no material changes to the information on NS’ future obligations contained in NS’ Form 10-K for the year ended December 31, 2011.

 

Cash used in investing activities was $932 million in the first six months of 2011, compared with $801 million in the same period last year, reflecting an increase in property additions and a decrease in investment sales, net of purchases.

The Crescent Corridor consists of a program of projects for infrastructure and other facility improvements geared toward creating a seamless, high-capacity intermodal route spanning 11 states from New Jersey to Louisiana and offering truck-competitive service along several major interstate highway corridors, including I-81, I-85, I-20,     I-40, I-59, I-78, and I-75.  Based on the public benefits that stand to be derived in the form of highway congestion relief, NS plans to implement certain elements of the Crescent Corridor through a series of public-private partnerships.  Currently, the Crescent Corridor has received or expects to receive a total of $306 million in public capital funding commitments from the Commonwealths of Pennsylvania and Virginia, the State of Tennessee, the federal TIGER Stimulus Program and other federal funding sources related to projects in Alabama, Pennsylvania, Tennessee, and North Carolina.  With respect to the private funding component, NS currently anticipates spending up to $393 million for the substantial completion of work on these projects, which is expected in 2014, including planned investments for the remainder of 2012 of approximately $104 million.

Cash used in financing activities was $651 million in the first six months of 2012 compared with $1.0 billion in the same period last year. The change reflected increased proceeds from borrowings and lower debt repayments and maturities, offset in part by increased share repurchases.  Share repurchases were 12.3 million, totaling $850 million in the first six months of 2012, compared to 11.6 million shares, totaling $792 million in the same period last year. The timing and volume of future share repurchases will be guided by management’s assessment of market conditions and other pertinent factors. Any near-term purchases under the program are expected to be made with internally generated cash, cash on hand, or proceeds from borrowings.  NS’ total debt-to-total capitalization ratio was 45.0% at June 30, 2012 and 43.2% at December 31, 2011.

As of June 30, 2012, NS has authority from its Board of Directors to issue an additional $400 million of debt or equity securities through public or private sale.  NS has on file with the Securities and Exchange Commission a Form S-3 automatic shelf registration statement for well-known seasoned issuers under which securities may be issued pursuant to this authority.

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NS also has in place and available a $750 million, five-year credit agreement expiring in 2016, which provides for borrowings at prevailing rates and includes covenants.  NS had no amounts outstanding under this facility at   June 30, 2012, and NS is in compliance with all of its covenants.  In October 2011, NS renewed its $350 million accounts receivable securitization program with a 364-day term to run until October 2012. There was $100 million and $200 million outstanding under this program at June 30, 2012 and December 31, 2011, respectively.