Norfolk Southern Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Norfolk Southern operates an approximately 20,000-mile rail network across 22 states and the District of Columbia. Financial statements are unaudited interim statements; KPMG performed a review, not an audit.
Key financial results
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Railway operating revenue | $3.023 billion | $2.824 billion | $8.754 billion | $8.364 billion |
| Income from railway operations | $998 million | $849 million | $2.684 billion | $2.376 billion |
| Net income | $559 million | $482 million | $1.489 billion | $1.397 billion |
| Diluted EPS | $1.79 | $1.53 | $4.75 | $4.40 |
| Railway operating expenses | $2.025 billion | $1.975 billion | $6.070 billion | $5.988 billion |
- Q3 revenue grew 7% and net income 16%; nine-month revenue grew 5% and net income 7%. Q3 volume increased 8%, while average revenue per unit declined modestly.
- The operating ratio improved to 67.0% from 69.9% in Q3, a 2.9 percentage-point improvement. Management characterized Q3 net income, diluted EPS, and operating ratio as company third-quarter records.
- For the first nine months, operating cash flow was $2.346 billion, versus $2.404 billion a year earlier. Investing used $1.254 billion, including $1.379 billion of property additions; financing used $1.103 billion. Cash ended the period at $1.432 billion.
- At September 30, 2014, total debt carrying value was approximately $8.921 billion, versus $9.448 billion at December 31, 2013; the total debt-to-total capitalization ratio was 41.8%, down from 45.6%. Working capital was $930 million. The company reported no borrowings under its $750 million credit facility and compliance with its covenants.
- Cash dividends were $0.57 per share in Q3 and $1.65 per share for the first nine months, compared with $0.52 and $1.52, respectively, in 2013. Nine-month share repurchases were $166 million, down from $564 million.
Material changes and operating trends
- General merchandise revenue rose 10% in Q3, led by chemicals, metals and construction, and automotive. Intermodal revenue rose 10%, with volume growth in domestic and international traffic.
- Coal revenue declined 2% in Q3 and 3% year to date; coal volumes fell 3% year to date, including weakness in utility and export shipments. Management expected coal revenue for the remainder of 2014 to be lower year over year.
- Operating expenses rose 3% in Q3 and 1% year to date. Materials and other costs increased, including higher locomotive maintenance and casualty claims expense; compensation costs fell, partly reflecting lower pension and postretirement benefit costs.
- Nine-month 2013 results included a $97 million Michigan land-sale gain in other income, which benefited net income by $60 million and EPS by $0.19. Its absence contributed to lower year-to-date other income in 2014.
- A 2014 retiree medical plan amendment generated a $367 million prior-service benefit in other comprehensive income; a discount-rate change caused $80 million of actuarial losses. Management cited the plan amendment and lower amortization of actuarial losses as factors reducing benefit costs.
Outlook, liquidity, and risks
- Management said demand remained high, but higher-than-expected volumes weakened network fluidity. It expected network performance to improve as additional employees and equipment came online.
- For the remainder of 2014, management expected general merchandise and intermodal revenues to increase year over year, while coal revenue was expected to decline. The filing provides no consolidated earnings or EPS guidance.
- Management expected cash on hand and operating cash flow to be sufficient for ongoing obligations. Outstanding purchase commitments totaled approximately $1.2 billion, for equipment, track and yard projects, and long-term services through 2018.
- Environmental liabilities were $66 million, compared with $58 million at year-end 2013. The company considered known matters unlikely to have a material adverse effect, but noted that environmental exposure can change and unknown issues may arise.
- Other disclosed uncertainties include railroad injury and casualty claims, the fuel-surcharge antitrust class action, and potential appeals or reconsideration in customer rate cases. The STB had ruled in Norfolk Southern’s favor in the DuPont and Sunbelt rate cases; those decisions remained subject to further proceedings.
- Management identified external risks including regulation, hazardous-material transportation, economic and customer-industry conditions, competition, labor disruptions, severe weather, fuel prices, litigation, and technology interruptions. Risk factors were unchanged from the 2013 Form 10-K.
Important facts for investors to verify
- Whether network-fluidity constraints eased and whether added staff and equipment supported service reliability and operating costs.
- Whether coal weakness continued and whether growth in intermodal and general merchandise offset it.
- Whether the $1.2 billion purchase commitments, capital spending, dividends, and debt repayments remained supportable from operating cash flow.
- Developments in casualty claims, environmental remediation, fuel-surcharge litigation, customer rate cases, and the IRS audits of 2011 and 2012 returns.
- How the retiree medical plan amendment and changed pension assumptions affect future benefit expense, cash contributions, and reported equity.