Norfolk Southern Corporation — Q1 2016 Form 10-Q
Business context and reporting period
Unaudited results for the quarter ended March 31, 2016, compared with Q1 2015. Norfolk Southern operates a rail network of approximately 20,000 miles across 22 states and the District of Columbia, with major intermodal, coal, automotive, and industrial businesses.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Railway operating revenues | $2.420 billion | $2.567 billion | Down $147 million, or 6% |
| Railway operating expenses | $1.697 billion | $1.961 billion | Down $264 million, or 13% |
| Income from railway operations | $723 million | $606 million | Up $117 million, or 19% |
| Operating ratio | 70.1% | 76.4% | Improved 6.3 percentage points |
| Net income | $387 million | $310 million | Up $77 million, or 25% |
| Diluted EPS | $1.29 | $1.00 | Up 29% |
| Cash from operating activities | $879 million | $631 million | Up $248 million |
Operating expense reductions were led by fuel (down $115 million), compensation and benefits (down $60 million), materials and other (down $52 million), and purchased services and rents (down $44 million). Fuel expense fell 44%, reflecting lower fuel prices and consumption. Interest expense was $139 million versus $132 million; the effective tax rate was 35.5% versus 37.4%.
Revenue declines reflected lower fuel surcharge revenue and reduced volumes, chiefly coal. Coal revenue fell 23% to $349 million; intermodal revenue fell 12% to $522 million. Merchandise revenue rose 2% to $1.549 billion. Fuel surcharge revenue was $49 million versus $163 million.
Liquidity, debt, and capital allocation
At March 31, cash and cash equivalents were $589 million, down from $1.101 billion at year-end 2015; working capital was $135 million versus $281 million. Operating cash flow was $879 million, capital investment/property additions were $398 million, and cash used in investing activities was $408 million. Cash used in financing activities was $983 million, including $600 million of debt repayments, $200 million of share repurchases, and $176 million of dividends.
Long-term debt was $9.398 billion and short-term debt was $100 million; no current maturities of long-term debt were reported. The debt-to-total-capitalization ratio was 43.7%, down from 45.3% at December 31, 2015. The company had no borrowings under its $750 million credit facility and $100 million outstanding under its $350 million receivables securitization program. The filing states that cash on hand and operating cash flow are expected to meet ongoing obligations.
Changes, outlook, and management commentary
Management cited operating streamlining, improved network performance, lower fuel costs, reduced employee levels, and cost controls for the improved operating ratio, which it described as a first-quarter record. The company combined two operating divisions and reported service levels near all-time best. Share repurchases were $200 million, compared with $415 million a year earlier; quarterly dividends were $0.59 per share in both periods.
Management expected about $200 million of productivity savings and an operating ratio below 70% for full-year 2016. It expected 2016 property additions of $2.0 billion and average headcount about 1,500 below the 2015 average. For the remainder of 2016, management expected merchandise revenue to rise, intermodal revenue to fall, and coal revenue to fall versus 2015. If low fuel prices persisted, fuel surcharge revenue was expected to be lower than in 2015. The expected effective tax rate for remaining quarters was about 37%.
Notable accounting items: adoption of share-based payment guidance produced a $4 million income tax benefit; a change to the spot-rate approach for pension and postretirement service and interest costs reduced Q1 2016 costs by $6 million. Management said the accounting pronouncement adoptions did not materially affect the financial statements.
Risks and contingencies
Coal demand remained pressured by mild winter weather, high utility stockpiles, low natural gas prices, weak export markets, and lower industrial usage. Other stated uncertainties include fuel-price effects on surcharge revenue, labor negotiations covering more than 80% of railroad employees, and the potential for claim and environmental liabilities to differ from recorded estimates. Environmental liabilities were $68 million at March 31, 2016.
Fuel-surcharge antitrust class actions remained pending; the company said it considers the allegations without merit and does not expect a material effect. A customer rate complaint had been resolved in the company’s favor by the STB, subject to possible technical corrections, reconsideration, and appeal. The company also disclosed a Tennessee environmental notice of violation and said any penalties could exceed $100,000, but it did not expect a material effect. The company reported compliance with its credit-facility covenants.
Important facts for investors to verify
- Whether the projected productivity savings and sub-70% operating ratio are achieved, and how sustainable the Q1 cost reductions prove to be.
- Coal and intermodal volume trends, merchandise pricing and volumes, and the effect of fuel prices on surcharge revenue.
- Cash generation, capital spending, debt repayments, share repurchases, and liquidity as cash declined during the quarter.
- Developments in labor negotiations, fuel-surcharge litigation, the STB rate matter, and environmental and casualty claim estimates.