Norfolk Southern Corporation — Q2 2010 Form 10-Q
Business context and reporting period. Norfolk Southern (NS) operates a railroad. This unaudited filing covers the quarter and six months ended June 30, 2010, with comparisons to 2009. Management attributed improved results primarily to economic recovery, higher traffic volumes, and better revenue per unit. KPMG reviewed the interim financial statements; its review was not an audit.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Railway operating revenue | $2.430 billion | $1.857 billion | $4.668 billion | $3.800 billion |
| Income from railway operations | $733 million | $468 million | $1.288 billion | $851 million |
| Net income | $392 million | $247 million | $649 million | $424 million |
| Diluted EPS | $1.04 | $0.66 | $1.72 | $1.13 |
| Railway operating ratio | 69.8% | 74.8% | Not stated | Not stated |
- Margins and expenses: Q2 operating ratio improved 5.0 percentage points. Operating expenses rose 22% in Q2 and 15% year to date, below revenue growth of 31% and 23%, respectively. Higher fuel prices and volume-related costs contributed to expense increases.
- Cash flow: Operating cash flow was $1.382 billion for the first six months, versus $643 million in 2009. Property additions were $569 million; investing cash outflow was $731 million. Financing cash outflow was $792 million, including $468 million of debt repayments, $252 million of dividends, and $114 million of share repurchases.
- Liquidity: Cash and cash equivalents were $855 million, with $205 million of short-term investments, at June 30; combined, $1.060 billion. Working capital was $391 million, down from $457 million at year-end 2009. NS said cash on hand and operating cash flows should meet ongoing obligations.
- Debt and capitalization: Balance-sheet current maturities and long-term debt totaled $6.689 billion, versus $7.053 billion at December 31, 2009; no short-term debt was reported at June 30. Debt-to-total capitalization was 38.3%, down from 40.9%. The $1 billion revolving credit facility was unused, and NS reported covenant compliance. The receivables securitization facility had $100 million outstanding.
Material changes versus prior comparable periods
- Q2 net income increased 59%; six-month net income increased 53%. Revenue growth reflected higher traffic and average revenue per unit, including fuel surcharges and rate increases.
- Q2 volumes rose across coal, general merchandise, and intermodal. Utility coal tonnage declined, while export and domestic metallurgical coal tonnage increased sharply. General merchandise and intermodal revenue also benefited from the recovery in industrial, automotive, and domestic freight activity.
- Fuel expense rose 69% in Q2 and 64% year to date, mainly from higher locomotive fuel prices and increased consumption. Compensation and benefits also increased, including higher incentive and stock-based compensation.
- Six-month operating cash flow more than doubled, reflecting better results, lower working-capital investment, and a favorable settlement of an insurance claim related to the 2005 Graniteville derailment.
Outlook, management commentary, risks, and unusual items
- NS expected coal, general merchandise, and intermodal revenues for the remainder of 2010 to exceed 2009, supported by higher volumes and revenue per unit. Total 2010 capital expenditures were expected to be approximately $1.5 billion.
- Positive train control was expected to require at least $700 million of additional capital expenditures during 2011–2015, plus $400 million of systems and track upgrades accelerated from later years to meet the 2015 deadline.
- On July 27, 2010, after quarter-end, the board authorized repurchases of up to 50 million additional shares through 2014. NS had repurchased 2.0 million shares for $114 million during the first six months of 2010.
- A $27 million deferred-tax charge in Q1 reflected legislation eliminating, after 2012, a tax deduction related to Medicare Part D retiree drug subsidies. The six-month effective tax rate was 40.5%, compared with 37.1% in 2009.
- Fuel-price movements can affect both fuel expense and surcharge revenue, with timing lags; management cautioned that oil-price changes could materially affect a particular period. Other stated risks include economic conditions, labor disputes, regulation, hazardous-material incidents, severe weather, technology disruptions, litigation, and availability and cost of fuel and other inputs.
- Environmental liabilities were $36 million at June 30, based on 148 known sites; 31 locations had NS subsidiaries identified as potentially responsible parties. Management did not expect known environmental matters to have a material adverse effect. The Graniteville federal environmental claims were resolved under a consent decree, including a $4 million civil fine and specified training and restoration actions.
- NS disclosed ongoing fuel-surcharge antitrust class actions and a shareholder litigation demand; it intended to defend the claims and did not expect a material effect. It also disclosed Ohio and Pennsylvania environmental proceedings and said it did not expect a material effect. A disputed $43 million Graniteville insurance recovery was considered probable by management, while arbitration with the carrier remained ongoing.
- More than 80% of railroad employees were covered by collective bargaining agreements; a coalition of unions had sought mediation, and the outcome of negotiations was uncertain.
Important facts for investors to verify
- Whether improving traffic volumes and revenue per unit continued, and how much growth depended on fuel surcharges versus rates and mix.
- Whether fuel and labor-cost increases, including incentive compensation, remain below revenue growth and preserve operating-ratio improvement.
- Cash generation and funding needs for planned capital spending, positive train control, and infrastructure projects.
- Progress on debt reduction and share repurchases, including the effect of the additional buyback authorization on liquidity and capital allocation.
- Developments in labor negotiations, fuel-surcharge litigation, environmental proceedings, and recovery of the disputed $43 million insurance amount.