Norfolk Southern Corporation — FY 2018 Form 10-K
Business and period. Norfolk Southern operates a freight railroad with approximately 19,500 route miles across 22 states and the District of Columbia. This annual report covers the year ended December 31, 2018; it also reports fourth-quarter results. Figures are in U.S. dollars unless noted.
Financial performance
| Metric | FY 2018 | FY 2017 | Change / context |
|---|---|---|---|
| Railway operating revenue | $11.458 billion | $10.551 billion | Up 9% |
| Railway operating expenses | $7.499 billion | $7.029 billion | Up 7%; higher fuel, purchased services and rents |
| Income from railway operations | $3.959 billion | $3.522 billion | Up 12% reported; up 17% versus 2017 excluding tax-reform adjustments |
| Operating ratio | 65.4% | 66.6% reported; 68.1% adjusted | Lower is better; 2018 was a company record |
| Net income | $2.666 billion | $5.404 billion | Down 51%; 2017 included $3.482 billion of tax-reform benefits |
| Diluted EPS | $9.51 | $18.61 reported; $6.61 adjusted | Down 49% reported; up 44% versus adjusted 2017 |
| Operating cash flow | $3.726 billion | $3.253 billion | Up; company cited improved operating results |
| Capital spending | $1.951 billion | $1.723 billion | Property additions; investing cash outflow was $1.658 billion |
| Debt | $11.145 billion | $9.836 billion | Debt-to-total-capitalization ratio rose to 42.0% from 37.5% |
The 2017 tax reform lowered the federal corporate rate from 35% to 21% and generated a $3.331 billion income-tax benefit plus a $151 million operating-expense benefit. The 2018 effective tax rate was 23.1%; 2017’s was negative 72.8% because of the one-time tax benefit.
Fourth quarter: 2018 revenue was $2.896 billion, income from railway operations was $1.078 billion, net income was $702 million, and diluted EPS was $2.57. For Q4 2017, the corresponding reported figures were $2.669 billion, $998 million, $3.968 billion, and $13.79; the latter net income and EPS were substantially inflated by tax reform.
Revenue mix and operating trends
- Merchandise revenue was $6.744 billion, up 6%; intermodal revenue was $2.893 billion, up 18%; coal revenue was $1.821 billion, up 5%.
- Total units increased 4%. Intermodal units rose 7%, merchandise units 1%, while coal tonnage declined 1%.
- Higher rates and fuel surcharges contributed to revenue growth. Fuel-surcharge revenue increased to $657 million from $359 million; locomotive fuel prices rose 25% and fuel expense increased 29%.
- Intermodal growth reflected higher domestic and international volumes and pricing. Coal’s revenue increase came despite slightly lower tonnage, chiefly from higher revenue per unit.
Liquidity, capital allocation and balance sheet
Cash, cash equivalents and restricted cash were $446 million at year-end, compared with $690 million in 2017. Working capital was negative $729 million. Management said cash on hand and operating cash flows should be sufficient for ongoing obligations. The company had no borrowings outstanding under its $750 million credit facility at year-end and was in compliance with its covenants.
Financing cash outflow was $2.312 billion, including $2.781 billion of share repurchases and $844 million of dividends, partly offset by $2.023 billion of net borrowing proceeds. The annual dividend was $3.04 per share, versus $2.44 in 2017. Long-term debt principal due in 2019 was $585 million; contractual obligations totaled $28.134 billion, including scheduled interest.
Outlook, risks and unusual items
- Management expected 2019 capital spending of approximately 16%–18% of revenue. Its commodity outlook generally anticipated revenue growth in merchandise and intermodal, relatively flat coal revenue, and mixed volume trends by commodity.
- Positive train control hardware installation was complete by the December 31, 2018 statutory deadline, and PTC was operating on some covered lines. Full implementation on remaining lines was required by December 31, 2020; implementation may add costs and affect efficiency and service.
- Material risks include fuel-price and supply volatility, economic and traffic fluctuations, competition, labor negotiations, severe weather, cybersecurity and technology disruption, tighter regulation, and hazardous-material accidents. Management cautioned that a catastrophic accident could exceed insurance coverage.
- Environmental liabilities were $55 million at year-end. The company said known matters were not expected to have a material adverse effect, while noting that latent contamination and future claims could create additional costs.
- Fuel-surcharge antitrust litigation remained subject to appeal after class certification was denied in 2017; management considered the allegations without merit and did not expect a material effect. The 2015 federal tax return was under IRS audit, with no material effect expected from resolution.
- Other notable items: derailment-related claims contributed to higher casualty expense; 2018 included $2.8 billion in share repurchases. Adoption of the new lease standard in January 2019 was expected to recognize about $600 million of lease liabilities and corresponding right-of-use assets.
KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Important facts for investors to verify
- Compare operating performance using the filing’s adjusted 2017 figures, not reported 2017 earnings, which include the large tax-reform benefit.
- Track whether expected 2019 revenue and volume trends materialized, particularly in intermodal, coal, and merchandise.
- Assess whether fuel costs, network velocity, and operating expenses affect the operating ratio and service levels.
- Review debt growth, scheduled maturities, capital spending, dividends, and repurchases against operating cash generation and liquidity.
- Monitor PTC completion, labor negotiations reopening in 2020, and developments in litigation, environmental matters, and accident exposure.