Norfolk Southern Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparative income and cash-flow figures are for Q1 2010. The interim financial statements are unaudited and were reviewed by KPMG, which reported no material modifications it believed were needed.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Railway operating revenue | $2.620 billion | $2.238 billion | +17% |
| Railway operating expenses | $2.020 billion | $1.683 billion | +20% |
| Income from railway operations | $600 million | $555 million | +8% |
| Railway operating ratio | 77.1% | 75.2% | Worsened 1.9 percentage points |
| Income before income taxes | $515 million | $456 million | +13% |
| Net income | $325 million | $257 million | +26% |
| Diluted EPS | $0.90 | $0.68 | +32% |
| Dividends per share | $0.40 | $0.34 | +18% |
| Operating cash flow | $652 million | $758 million | −14% |
| Property additions | $423 million | $256 million | +65% |
Revenue growth reflected $201 million from higher revenue per unit and $181 million from increased traffic volume. Coal revenue rose 30%, general merchandise 10%, and intermodal 18%. Coal and intermodal volumes increased; general merchandise volume growth was modest.
Fuel expense increased $135 million (53%), including $104 million from higher prices and $31 million from greater consumption. The average locomotive fuel price rose 35%, while consumption rose 11%. Management said increased fuel-surcharge revenue lagged the increase in fuel expense, in part because of a two-month surcharge pricing lag.
The effective income tax rate was 36.9%, compared with 43.6% in Q1 2010. The prior-year rate included a $27 million deferred tax charge associated with health-care legislation.
Financial position and liquidity
- At March 31, cash and cash equivalents were $236 million and short-term investments were $252 million, totaling $488 million, down from $1.110 billion at December 31, 2010.
- Working capital was $265 million, compared with $389 million at year-end. Current assets were $1.832 billion and current liabilities $1.567 billion.
- Total debt, including current maturities, was approximately $6.617 billion, versus $6.925 billion at December 31. The debt-to-total-capitalization ratio declined to 38.4% from 39.7%.
- Q1 financing cash outflow was $861 million, including $343 million for repurchases of 5.3 million shares, $142 million in dividends, and $408 million in debt repayments. The company repaid $300 million of 6.75% senior notes at maturity.
- NS reported no borrowings under its $1 billion credit agreement and said it was in covenant compliance. Its $350 million receivables securitization program had $100 million outstanding at quarter-end.
- Management expected cash on hand and operating cash flows to be sufficient for ongoing obligations. The company also reported $1.2 billion in outstanding purchase commitments, including long-term services and capital-program equipment.
Material changes and unusual items
- Net income increased $68 million year over year, supported by higher railway operating income, lower income-tax expense, and higher non-operating income.
- A March 2011 unfavorable insurance-arbitration ruling related to the 2005 Graniteville derailment led to $58 million of expense: $43 million for a contested insurance receivable and $15 million for other affected receivables. Management estimated the ruling reduced net income by $36 million.
- Operating cash flow was lower than in Q1 2010, partly because the prior-year period included a favorable $100 million insurance settlement and because of changes in accounts payable.
- Share repurchases resumed: 5.3 million shares were repurchased for $343 million in Q1 2011, versus none in Q1 2010. The board had authorized an additional 50 million shares for repurchase through December 31, 2014.
Outlook, risks and contingencies
- Management expected coal, general merchandise, and intermodal revenues for the remainder of 2011 to exceed 2010 levels, citing improved pricing, fuel surcharges, and/or higher volumes. The filing provides no consolidated earnings or revenue guidance.
- Management described improving domestic and global economic conditions, but identified fuel-price volatility, general economic conditions, traffic demand, labor issues, severe weather, regulation, litigation, and operational disruption as factors that could affect results.
- Two customers, DuPont and SMEPA, challenged the reasonableness of certain tariff rates before the Surface Transportation Board. NS continued billing and collecting the challenged rates; resolution was expected in late 2012 or 2013. The filing says possible loss could not yet be estimated and that adverse rulings could materially affect future revenue.
- NS recorded $32 million of environmental liabilities for 142 known locations; it said the amount and timing of ultimate exposure are uncertain. Management believed known matters were adequately provided for and unlikely to have a material adverse effect.
- The IRS was examining the 2008 tax return and certain prior-year refund claims. A favorable resolution could reduce income-tax expense by approximately $40 million; completion was expected within six months.
- More than 80% of railroad employees were covered by collective bargaining agreements. National labor negotiations were ongoing, and their outcome was uncertain.
- CREATE, Crescent Corridor, and MidAmerica Corridor projects entail continuing capital spending. Management estimated up to $227 million of Crescent Corridor spending to substantially complete relevant work, expected in 2012; planned remaining-2011 spending was up to $65 million.
Important facts for investors to verify
- Whether fuel prices and surcharge timing continue to pressure operating margins and the operating ratio.
- Progress and eventual outcomes of the DuPont and SMEPA rate cases, including any revenue or refund exposure.
- Developments in Graniteville insurance recovery and any further effects on earnings or receivables.
- Cash generation, capital spending, debt repayment, share repurchases, and liquidity as cash balances declined during the quarter.
- Results of the IRS examination and the potential tax benefit, alongside labor negotiations and environmental or casualty claims.
- Execution, funding, and expected returns of major corridor projects and the company’s purchase commitments.