Norfolk Southern Corporation — Q3 2009 Form 10-Q
Business context and reporting period. Railroad operator; quarter and nine months ended September 30, 2009, compared with the same periods in 2008. Management attributed weaker results primarily to the economic downturn, reduced freight volumes, and lower fuel-surcharge revenue. Amounts below are in millions of dollars unless stated otherwise.
Financial performance
- Q3 revenue: $2,063, down 29% from $2,894. Revenue fell across coal, general merchandise, and intermodal. Total units declined 20%; average revenue per unit declined 11%.
- Q3 earnings: Railway operating income was $562, down 37%; net income was $303, down 42%; diluted EPS was $0.81 versus $1.37. Operating expenses fell 25% to $1,501, less than the revenue decline. The operating ratio worsened to 72.8% from 69.1%.
- Nine-month results: Revenue was $5,863, down 28%; railway operating income was $1,413, down 38%; net income was $727, down 42%; diluted EPS was $1.94 versus $3.30. Operating expenses decreased 24% to $4,450.
- Drivers: Q3 fuel-surcharge revenue declined $436 to $99; for nine months it declined $1.0 billion to $255. Q3 fuel expense fell 59%, primarily from lower fuel prices and reduced consumption. Rate increases did not offset lower surcharges and volumes.
- Cash flow: Nine-month operating cash flow was $1,375 versus $2,075. Investing cash outflow was $967, including $919 of property additions; financing cash outflow was $27. Cash increased $381 to $999.
- Liquidity: Working capital was $367, compared with a $106 deficit at December 31, 2008. Current assets were $2,233 and current liabilities $1,866. Management said cash on hand and operating cash flows should meet ongoing obligations.
- Debt and capitalization: Long-term debt was $6,685 plus $380 of current maturities, versus $6,183 plus $484 at year-end 2008. Debt-to-total capitalization was 41.2%, compared with 41.0%. The company issued $500 of 5.75% notes due 2016 and $500 of 5.90% notes due 2019; it also repaid $400 of 6.20% senior notes at maturity.
- Shareholder returns: Dividends were $0.34 per share in Q3 and $1.02 for nine months, versus $0.32 and $0.90, respectively, in 2008. No program repurchases occurred in the first nine months of 2009.
Material changes and outlook
- Freight weakness was broad: nine-month coal revenue declined 27%, general merchandise 28%, and intermodal 29%. Management cited reduced utility and steel demand, lower industrial activity, and weaker imports and exports.
- Management expected fourth-quarter coal, general merchandise, and intermodal revenues to remain below 2008 levels, reflecting continued weak volumes and lower fuel surcharges. Total 2009 capital expenditures were expected to be approximately $1.4 billion.
- Management expected agreement-employee health and welfare premiums under multi-employer plans to rise approximately $56 million in 2010.
- NS formed a 50%-owned joint venture, Pan Am Southern LLC. NS had contributed approximately $63 and committed a further $77 over three years, including $75 in notes payable, for rail-line improvements and planned terminals.
Risks, contingencies, and unusual items
- Results remain exposed to economic conditions, freight demand, fuel prices and surcharge timing, competition, labor disruptions and costs, severe weather, regulation, technology disruptions, and litigation. More than 80% of railroad employees are covered by collective bargaining agreements.
- Environmental liabilities were $33 at September 30, 2009, for estimated remediation at 146 known locations. Management did not expect known matters to materially affect the company, but noted that ultimate costs are uncertain.
- Graniteville derailment insurance recoveries include a recorded $100 claim in arbitration and a separate $43 claim for which NS said recovery was probable. Outcomes remain subject to dispute.
- NS reported $52 in receivables under a coal transportation contract; it considered collection probable, but an adverse litigation outcome could affect results in a particular period. A Virginia coal-contract ruling was generally favorable to NS but reduced previously awarded damages; rehearing petitions were pending.
- Other proceedings include environmental claims and fuel-surcharge antitrust class actions. Management stated it did not expect these matters to have a material effect, while cautioning that legal outcomes cannot be predicted with certainty.
- Financial statements were reviewed, not audited, by KPMG. The review report stated it was not aware of material modifications needed for GAAP conformity.
Important facts for investors to verify
- Whether freight volumes and fuel-surcharge revenue stabilized after the quarter, and how quickly pricing and mix can offset continued weakness.
- Whether the $1.4 billion capital-expenditure outlook and management’s liquidity assessment were achieved, including cash flow and debt levels.
- Developments in the Graniteville insurance arbitrations, coal-contract disputes, environmental matters, and other litigation.
- The actual 2010 increase in multi-employer health and welfare premiums and any related labor developments.
- Execution, contributions, and expected returns from Pan Am Southern, including the remaining committed investment.