Norfolk Southern Corporation — Q3 2011 Form 10-Q
Business context and period. Norfolk Southern operates a railroad business. This unaudited quarterly filing covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods; balance-sheet figures are compared with December 31, 2010. The interim financial statements received an independent accountant’s review, not an audit.
Financial performance
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Railway operating revenue | $2,889 | $2,456 | $8,375 | $7,124 |
| Railway operating expenses | $1,951 | $1,710 | $5,962 | $5,090 |
| Income from railway operations | $938 | $746 | $2,413 | $2,034 |
| Net income | $554 | $445 | $1,436 | $1,094 |
| Diluted EPS | $1.59 | $1.19 | $4.03 | $2.91 |
| Railway operating ratio | 67.5% | 69.6% | Not clearly stated | Not clearly stated |
- Q3 revenue rose 18%, operating expenses rose 14%, and net income increased 24%. Management attributed the earnings improvement primarily to higher railway operating income, partly offset by higher income taxes.
- For the first nine months, revenue increased 18%, operating expenses 17%, and net income 31%. The year-to-date effective tax rate was 34.6%, versus 39.4% in 2010; Q3 rates were 37.3% and 37.7%, respectively.
- Revenue growth reflected higher revenue per unit, including fuel surcharges, and higher traffic. Q3 coal revenue rose 27%, general merchandise 12%, and intermodal 19%. Year-to-date increases were 28%, 11%, and 19%, respectively.
- Fuel expense increased 49% in Q3 and 54% year to date, chiefly from higher fuel prices and increased consumption. Fuel surcharge revenue increased $179 million in Q3 and $431 million year to date.
Cash flow, liquidity and debt
- Operating cash flow for the first nine months was $2.764 billion, up from $2.128 billion. Property additions were $1.433 billion, compared with $907 million; net cash used in investing was $1.205 billion.
- Financing used $2.144 billion, mainly reflecting $1.611 billion of share repurchases and $432 million of dividends. Cash declined $585 million to $242 million. Cash plus short-term investments totaled $394 million, versus $1.110 billion at year-end 2010; working capital was negative $111 million.
- At September 30, long-term debt was $6.782 billion and current maturities were $55 million. The debt-to-total-capitalization ratio was 40.0%, compared with 39.7% at year-end. The filing reports $100 million outstanding under the receivables securitization facility.
- NS had no borrowings under its $1 billion credit agreement, was in compliance with its covenants, and said cash on hand and operating cash flows should cover ongoing obligations. The receivables securitization facility was renewed in October 2011 through October 2012.
Material changes and unusual items
- NS repurchased 23.8 million shares for $1.611 billion in the first nine months, compared with 7.8 million shares for $437 million in 2010. Shares outstanding, net of treasury shares, fell to 336.1 million from 357.4 million at year-end.
- Year-to-date tax results benefited from a $40 million favorable IRS examination and refund review outcome and a $19 million deferred-tax benefit from state law changes. The 2010 comparison included a $27 million deferred-tax charge tied to Medicare Part D tax-law changes. Bonus depreciation lowered current tax expense and cash taxes but did not affect total tax provision or the effective tax rate.
- A first-quarter 2011 unfavorable insurance arbitration ruling resulted in $58 million of expense: $43 million for the contested recovery and $15 million for other affected receivables.
- In Q3, NS issued $600 million of unsecured notes and exchanged $526 million of older notes, paying a $146 million premium. The premium is recorded as a reduction of debt and will be amortized as additional interest expense. NS also issued $400 million of 6.00% senior notes in Q2.
Outlook, risks and contingencies
- Management expected coal revenue for the rest of 2011 to exceed the prior-year period, supported by higher revenue per unit and modestly higher volume. It also expected general merchandise revenue to exceed Q4 2010 and intermodal revenue to be above the prior year, based on pricing and volume. No specific full-year earnings or revenue guidance was provided.
- Management identified oil and fuel-price volatility, economic conditions, traffic demand, severe weather, labor disputes, litigation, environmental obligations, and operational or technology disruptions as risks. A two-month lag in some fuel surcharge formulas affected Q3 revenue by approximately $52 million.
- Labor negotiations with two union coalitions remained unresolved after mediation ended. A Presidential Emergency Board delayed potential strike action, but NS warned that a strike could occur in early December 2011 if negotiations failed; a disruption could materially affect results, financial position, or liquidity.
- NS reported $32 million of environmental liabilities at September 30, 2011, covering approximately 154 known sites or projects; it considered no individual site material and said known matters were unlikely to have a material adverse effect. It cautioned that actual environmental costs and casualty claims could differ from estimates.
- The DuPont rate case remained pending, with resolution expected in late 2012 or 2013; management did not expect the reasonably possible loss to be material. The SMEPA complaint was settled without material effect. NS also disclosed other legal and regulatory matters and did not expect their resolution to materially affect the company.
- Purchase commitments totaled approximately $813 million. The filing also described planned spending on the CREATE, Crescent, and MidAmerica corridor projects.
Important facts for investors to verify
- Whether revenue growth and operating-ratio improvement persist as fuel costs, surcharges, and traffic volumes change.
- The pace and funding of capital additions, share repurchases, dividends, and debt obligations, given the lower cash and short-term-investment balance.
- Developments in labor negotiations and the potential for service disruption.
- Outcomes of the DuPont rate case, other litigation, and environmental and casualty claims, including the uncertainty of estimated liabilities.
- Whether the favorable tax items are nonrecurring and how bonus depreciation affects cash taxes in subsequent periods.