Norfolk Southern Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. Norfolk Southern operates a rail network across 22 states and the District of Columbia, with major exposure to coal, general merchandise, and intermodal freight.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Railway operating revenue | $2.713 billion | $3.042 billion | $5.280 billion | $5.731 billion |
| Railway operating expenses | $1.899 billion | $2.023 billion | $3.860 billion | $4.045 billion |
| Income from railway operations | $814 million | $1.019 billion | $1.420 billion | $1.686 billion |
| Net income | $433 million | $562 million | $743 million | $930 million |
| Diluted EPS | $1.41 | $1.79 | $2.41 | $2.97 |
| Operating ratio | 70.0% | 66.5% | Not stated | Not stated |
Q2 revenue declined 11% and net income fell 23%; first-half revenue declined 8% and net income fell 20%. Lower fuel surcharge revenue and weaker coal traffic were the main headwinds. Lower fuel costs partially offset reduced revenue: first-half fuel expense fell 38%, while compensation, purchased services, and depreciation increased. The first-half effective tax rate was 37.8%, versus 36.0% in 2014.
Coal was the largest market-group weakness: first-half coal revenue fell 25% and tonnage fell 15%. General merchandise revenue declined 4% despite 2% volume growth; intermodal revenue declined 2% while volume rose 4%. First-half fuel surcharge revenue was $282 million, compared with $653 million in 2014.
Cash flow, liquidity, and debt
- First-half operating cash flow was $1.473 billion, versus $1.437 billion in 2014. Property additions were $886 million; investing cash outflow was $852 million.
- Cash and cash equivalents were $889 million at June 30, 2015, versus $973 million at year-end. Working capital was $210 million, down from $998 million, reflecting higher current maturities of debt and lower prepaid income taxes.
- Total debt was approximately $9.390 billion, including $500 million of current maturities; long-term debt was $8.890 billion. Debt-to-total capitalization was 43.7%, versus 42.0% at year-end.
- During Q2, the company issued $500 million of 4.45% senior notes due 2045. It had $100 million outstanding under its accounts receivable securitization program and no borrowings under its $750 million credit facility; the company reported covenant compliance.
- Financing cash outflow was $705 million, including $765 million of share repurchases and $360 million of dividends. The company repurchased 7.4 million shares in the first half.
Outlook, commentary, and notable items
- Management said network fluidity improved in Q2 and expected the trend to continue in the second half. It expected full-year 2015 property additions of $2.3 billion and more than $800 million of post-2015 positive train control-related additions.
- If the prevailing fuel-price environment continued, fuel surcharge revenue for the remainder of 2015 was expected to be less than half the amount generated in the last six months of 2014. Management expected coal revenue to be lower for the rest of the year; general merchandise revenue to decline; and intermodal revenue to increase, supported by volume growth.
- Severe winter weather and service recovery efforts added an estimated $67 million of operating expense in the first half, including $25 million in Q2. The Roanoke office closure and employee relocation incurred about $5 million in first-half expense, with another $30 million expected, mostly in Q3.
- The company was evaluating whether to continue using RoadRailer trailers. A decision to phase them out could shorten asset useful lives; the related net book value was approximately $65 million.
- Outstanding purchase commitments were approximately $1.0 billion. Environmental liabilities were $70 million, with payments expected largely over five years, though some may extend longer.
- More than 80% of railroad employees were covered by collective bargaining agreements; negotiations had begun after moratorium provisions expired. The company had separately reached an agreement with the BLET covering wages and work rules through 2019.
- Contingencies include fuel-surcharge antitrust litigation, which the company intends to defend, and environmental and injury claims. Management said it did not expect the cited rate cases or IRS audit resolution to materially affect financial position, results, or liquidity; outcomes remain subject to uncertainty. The filing reports no material change to previously disclosed risk factors.
Key investor verification points
- Track coal demand, export-market conditions, and the effect of low natural-gas prices on utility coal shipments.
- Assess how lower fuel surcharges and fuel prices affect revenue per unit, operating costs, and the operating ratio.
- Monitor service performance, capital spending—including positive train control—and the timing and cost of the Roanoke relocation.
- Review debt maturities, liquidity, share repurchases, and the company’s ability to fund planned capital additions and distributions.
- Follow labor negotiations, litigation and environmental exposures, and any decision regarding RoadRailer assets.