Norfolk Southern Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Norfolk Southern operates a major eastern U.S. freight rail network. Interim financial statements are unaudited; the independent accountant conducted a review, not an audit.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First six months 2014 | First six months 2013 |
|---|---|---|---|---|
| Railway operating revenue | $3.042 billion | $2.802 billion | $5.731 billion | $5.540 billion |
| Income from railway operations | $1.019 billion | $836 million | $1.686 billion | $1.527 billion |
| Net income | $562 million | $465 million | $930 million | $915 million |
| Diluted EPS | $1.79 | $1.46 | $2.97 | $2.87 |
| Operating ratio | 66.5% | 70.2% | 70.6% | 72.4% |
| Operating margin | 33.5% | 29.8% | 29.4% | 27.6% |
Q2 revenue rose 9% and net income 21%; management attributed the quarterly revenue gain mainly to an 8% increase in volume. First-half revenue rose 3%, while net income increased 2%. First-half 2013 included a $97 million pretax land-sale gain that benefited net income by $60 million ($0.19 per share).
- Revenue mix and trends: Q2 general merchandise revenue increased 8%, intermodal 11%, and coal 7%. First-half coal revenue fell 4%, while general merchandise grew 5% and intermodal 7%. Management expected coal revenue to be lower for the rest of 2014, and general merchandise and intermodal revenue to be higher, versus the prior year.
- Expenses and taxes: Q2 operating expenses rose 3%, slower than revenue; first-half expenses rose 1%. Q2 fuel expense increased 4%, primarily from 4% higher locomotive fuel consumption. First-half effective tax rate was 36.0%, versus 36.2%; absence of 2013 tax credits affected comparison, and lack of federal bonus depreciation in 2014 was expected to increase current tax payments.
- Cash flow: First-half operating cash flow was $1.437 billion, versus $1.506 billion. Property additions were $809 million; cash used in investing activities was $647 million and in financing activities was $566 million. Cash increased $224 million to $1.667 billion.
Financial position and liquidity
At June 30, 2014, total assets were $33.040 billion and stockholders’ equity was $12.077 billion. Cash was $1.667 billion; current assets were $3.266 billion and current liabilities $2.368 billion (working capital $898 million). Short-term debt was zero. Long-term debt was $8.814 billion, with $433 million of current maturities; total debt including current maturities was $9.247 billion. Debt-to-total capitalization was 43.4%, down from 45.6% at year-end 2013.
Management said cash on hand and operating cash flow should cover ongoing obligations. It expected to repay $431 million of debt maturing in Q3 from cash on hand. The company had no borrowings under its $750 million credit facility, was in covenant compliance, and reported no floating-rate debt outstanding. Outstanding purchase commitments were approximately $889 million through 2018.
Material changes, outlook and risks
- Railway operating income increased 22% in Q2 and 10% in the first half. Q2 operating ratio reached a company record low, according to management.
- A first-quarter retiree medical plan amendment generated a $367 million prior-service benefit, partly offset by $80 million of actuarial losses from a lower discount rate; the net decrease in the benefit obligation was $287 million. The change also contributed to lower pension and postretirement expenses. Management expected those expenses to be about $40 million lower per quarter for the rest of 2014.
- Environmental liabilities were $65 million, up from $58 million at year-end, covering 147 known locations. The company considered known matters unlikely to have a material adverse effect, but noted remediation estimates and ultimate exposure are uncertain.
- DuPont and Sunbelt rate cases were resolved in the company’s favor by the Surface Transportation Board, subject to further correction, reconsideration, or appeal. Fuel-surcharge antitrust class actions remained pending; the company disputed the allegations and did not expect a material effect.
- Other disclosed proceedings included a Tennessee environmental notice involving soil runoff and a West Virginia investigation concerning possible asbestos abatement issues. The company did not expect either to have a material effect.
- Management identified risks including severe weather, labor disruption, fuel-price volatility, economic and customer-industry conditions, regulation, hazardous-material transportation, litigation, and operational or technology disruptions. More than 80% of railroad employees were covered by labor agreements extending through December 31, 2014.
Most important facts for investors to verify
- Whether the expected coal weakness and growth in general merchandise and intermodal developed as projected.
- Whether cost control and the lower operating ratio were sustained, including the effect of weather, maintenance, fuel consumption, and casualty claims.
- Cash generation, capital spending, the Q3 debt maturity repayment, and the level of share repurchases and dividends.
- Developments in environmental liabilities, the fuel-surcharge litigation, and the appeal status of the STB rate decisions.
- The effect of the retiree medical plan amendment and the 2014 tax-payment increase on future earnings and cash flow.