Norfolk Southern Corp. 10-Q Summary
Business Context and Reporting Period
This filing is a Quarterly Report (Form 10-Q) for Norfolk Southern Corporation (NS), a Class I railroad operating in the eastern United States. The report covers the quarterly period ended September 30, 2006, and the nine-month period ended on the same date. NS is a large accelerated filer incorporated in Virginia.
Key Financial Metrics
Revenue and Profit (Nine Months Ended Sept. 30, 2006):
- Total Railway Operating Revenues: $7,088 million (up 13% vs. prior year).
- Net Income: $1,096 million (up 19% vs. prior year).
- Earnings Per Share (Diluted): $2.62 (up from $2.24).
- Income from Railway Operations: $1,943 million (up 28% vs. prior year).
Expenses and Margins:
- Total Railway Operating Expenses: $5,145 million (up 8% vs. prior year).
- Operating Ratio: Improved to 70.1% for the third quarter (down 5.4 percentage points from the prior year quarter).
- Diesel Fuel Expense: $748 million for the nine months (up 49% vs. prior year), driven by higher prices and reduced hedging benefits.
Cash Flow, Debt, and Liquidity:
- Net Cash Provided by Operating Activities: $1,717 million (nine months).
- Cash and Short-Term Investments: $803 million as of Sept. 30, 2006.
- Long-Term Debt: $6,141 million (down from $6,616 million at year-end 2005).
- Debt-to-Total Capitalization: 40.9%.
- Working Capital: $27 million (down from $729 million at Dec. 31, 2005, largely due to share repurchases).
Material Changes vs. Prior Period
Revenue Drivers: Revenue growth was primarily driven by higher rates and fuel surcharges, which accounted for approximately 40% of the revenue per unit increase in the third quarter. Traffic volume was flat in the third quarter but increased 3% year-to-date, led by gains in intermodal and metals/construction sectors. Coal volumes declined 3% in the quarter but rose 1% year-to-date.
Expense Drivers: Operating expenses rose significantly due to higher diesel fuel prices and the adoption of SFAS 123(R) for stock-based compensation, which added $30 million in expense for the nine months. Compensation and benefits increased $125 million year-to-date due to higher salaries, benefits, and the new accounting standard.
Accounting Changes: NS adopted SFAS 123(R) effective January 1, 2006, requiring the expensing of the fair value of stock options. This reduced net income by $22 million (5 cents per share) for the nine months ended Sept. 30, 2006.
Guidance, Outlook, and Risks
Outlook: Management expects revenue increases to moderate in the fourth quarter due to tempered volume growth and comparisons to a strong fourth quarter in 2005. Fuel surcharge benefits are expected to be lower in Q4 as oil prices are projected to be comparable to Q4 2005 levels. Capital expenditures for 2006 are expected to be approximately $1.2 billion, funded by internally generated cash.
Share Repurchases: NS purchased and retired 17.1 million shares in the third quarter at a cost of $730 million. For the first nine months, 20.7 million shares were retired at a cost of $916 million under a program authorized for up to 50 million shares through 2015.
Risks and Contingencies:
- Environmental Litigation: The Pennsylvania Department of Environmental Protection (PDEP) filed proceedings seeking penalties of $8.89 million plus daily fines for a sodium hydroxide discharge from a June 2006 derailment. NS intends to vigorously defend the action and does not believe the outcome will be material.
- Environmental Liabilities: Recorded liabilities for environmental exposures were $55 million at Sept. 30, 2006, covering 175 known locations.
- Labor Agreements: Approximately 85% of employees are covered by collective bargaining agreements. Negotiations are ongoing with seven rail unions; a strike could occur if mediation fails and an Emergency Board is not appointed.
- Market Risks: NS has ended its diesel fuel hedging program. It remains exposed to interest rate fluctuations on $245 million of variable-rate debt.
Investor Verification Checklist
- Verify the impact of the new fuel surcharge program (trigger price raised to $64/barrel) on Q4 revenue projections.
- Monitor the status of labor negotiations with the Rail Labor Bargaining Coalition to assess strike risk.
- Review the outcome of the Pennsylvania environmental penalty proceedings regarding the June 2006 derailment.
- Assess the sustainability of the operating ratio improvement given the volatility of diesel fuel prices without hedging.
- Confirm the timeline and financial impact of the $300 million investment in the Meridian Speedway joint venture with Kansas City Southern.