Norfolk Southern Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are primarily with Q1 2017. Norfolk Southern operates a rail network of approximately 19,500 miles across 22 states and the District of Columbia.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Railway operating revenues | $2.717 billion | $2.575 billion | +6% |
| Income from railway operations | $835 million | $757 million | +10% |
| Operating ratio | 69.3% | 70.6% | Improved 1.3 percentage points |
| Net income | $552 million | $433 million | +27% |
| Diluted EPS | $1.93 | $1.48 | +30% |
| Operating cash flow | $816 million | $846 million | Down $30 million |
Operating margin, calculated as railway operating income divided by railway operating revenue, was approximately 30.7%, versus 29.4% in the prior-year quarter. Property additions used $383 million of cash, implying operating cash flow less property additions of approximately $433 million; this is a simple calculation, not a company-reported free-cash-flow measure.
At March 31, cash and equivalents were $1.072 billion, working capital was $91 million, and total debt was approximately $10.287 billion based on balance-sheet debt components. The reported debt-to-total-capitalization ratio was 38.5%, up from 37.5% at year-end 2017. The company issued $500 million of 4.15% senior notes due 2048. Its $750 million credit facility was undrawn, and it reported compliance with its covenants. The $350 million receivables securitization program had $50 million outstanding and expires in June 2018.
Material changes and drivers
- Revenue growth reflected 3% higher traffic volume and 2% higher revenue per unit, including pricing gains and increased fuel surcharges. Intermodal revenue rose 19%; merchandise rose 1%; coal rose 3%.
- Operating expenses increased 4% to $1.882 billion. Fuel expense rose 25%, mainly from higher locomotive fuel prices and slightly greater consumption; purchased services and rents rose 6%, partly due to intermodal volume and lower network velocity. Compensation expense fell 3%.
- Net income and EPS also benefited from a lower effective tax rate: 21.9% versus 33.9%, reflecting tax reform and certain tax credits. Other income, net, declined to $8 million from $40 million.
- Cash provided by operations declined despite higher earnings, mainly because of increased incentive compensation payments. Financing cash use was $63 million versus $443 million, with higher borrowing proceeds partly offset by increased share repurchases.
Outlook, risks, and unusual items
- Management expected full-year effective tax rate of approximately 24%. It anticipated higher merchandise and intermodal revenue for the rest of 2018, while coal revenue was expected to be flat.
- Management said cash on hand and operating cash flow should be sufficient for ongoing obligations. It expected headcount to remain relatively flat for the year; future repurchases would depend on market conditions and other factors.
- Network velocity issues affected costs and shipments across several markets. Fuel-price changes, weather, commodity demand, truck-market conditions, and traffic mix also influenced results.
- Labor negotiations remained in progress: agreements with two bargaining coalitions covered about 80% of the unionized workforce, with some agreements pending ratification; arbitration for the remaining coalition was expected in late May 2018.
- Key operating and regulatory exposures include implementation of positive train control, with stated deadlines of December 31, 2018 for some lines and December 31, 2020 for the remainder; environmental regulation and potential cleanup liabilities; and possible additional rail regulation and climate-related measures.
- Environmental liabilities were $56 million at March 31, 2018. The company also disclosed railroad-operation lawsuits and casualty-claim estimation uncertainty. Management considered recorded liabilities adequate and did not expect known matters to have a material adverse effect, while noting outcomes and future costs could differ.
- Adoption of revenue-recognition guidance had no material effect. A tax-effect reclassification increased accumulated other comprehensive loss and retained income by $88 million each, with no change in total equity.
Important facts for investors to verify
- Whether traffic growth, pricing, and fuel surcharges persist, particularly given lower merchandise units and coal tonnage.
- Whether network velocity improves and whether associated service costs and casualty expenses moderate.
- Progress on labor ratification and arbitration, and the timing and cost of positive train control implementation.
- Debt, liquidity, and refinancing developments, including the June 2018 expiration of the receivables securitization program.
- Developments in environmental, casualty, and legal contingencies, including appeals in the fuel-surcharge antitrust litigation.