Norfolk Southern Corporation — Q2 2011 Form 10-Q
Business context and reporting period: Norfolk Southern is a railroad operator. This unaudited quarterly report covers the three and six months ended June 30, 2011, with comparisons to the same 2010 periods. Financial statements were reviewed by KPMG, not audited.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Railway operating revenue | $2.866 billion | $2.430 billion | $5.486 billion | $4.668 billion |
| Income from railway operations | $875 million | $733 million | $1.475 billion | $1.288 billion |
| Net income | $557 million | $392 million | $882 million | $649 million |
| Diluted EPS | $1.56 | $1.04 | $2.45 | $1.72 |
| Operating ratio | 69.5% | 69.8% | Not stated | Not stated |
| Operating cash flow | Not stated | Not stated | $1.700 billion | $1.382 billion |
- Margins and drivers: Q2 revenue increased 18%, while operating expenses rose 17%; income from railway operations increased 19%. For the first six months, revenue rose 18% and expenses rose 19%. Higher fuel prices and traffic-related costs were major expense drivers.
- Cash and liquidity: At June 30, cash and cash equivalents were $678 million and short-term investments were $228 million, totaling $906 million. Working capital was $562 million. Management said cash on hand and operating cash flows were expected to cover ongoing obligations.
- Debt: Long-term debt was $6.931 billion, with $55 million of current maturities; short-term debt was nil. The debt-to-total-capitalization ratio was 39.7%. During the half, NS repaid $300 million of 6.75% senior notes and issued $400 million of 6.00% senior notes due 2111. It had $100 million outstanding under its receivables securitization program and no borrowings under its $1 billion credit facility.
- Capital returns and investment: Six-month property additions were $888 million. NS repurchased 11.6 million shares for $792 million and paid $283 million in dividends. The quarterly dividend was $0.40 per share, versus $0.34 a year earlier.
Material changes versus the prior comparable period
- Q2 net income rose 42%; six-month net income rose 36%. Share repurchases reduced weighted-average shares, contributing to EPS growth.
- Higher average revenue per unit and increased traffic lifted revenue. Q2 fuel surcharges were $361 million, up $162 million; six-month surcharges were $610 million, up $252 million.
- Fuel expense rose 60% in Q2 and 56% year to date, reflecting higher fuel prices and increased consumption. For the first six months, operating expenses also included a $58 million charge related to an unfavorable insurance arbitration ruling.
- Effective income tax rates were 30.0% for Q2 and 32.7% year to date, down from 38.3% and 40.5%. A $40 million IRS examination and refund-claim resolution and $19 million of state tax law changes reduced tax expense. These nonrecurring tax benefits totaled $63 million, or about $0.18 per share, in Q2.
- Cash from operations increased from $1.382 billion to $1.700 billion, while property additions rose from $569 million to $888 million. Financing outflows increased, principally due to higher share repurchases.
Outlook, commentary, risks and contingencies
- Management expected coal revenue for the remainder of 2011 to increase year over year, supported by improved revenue per unit and higher traffic. General merchandise and intermodal revenue were also expected to exceed the corresponding prior-year periods, with the latter supported by volume and pricing. These are expectations, not quantified earnings guidance.
- Management cited an uncertain but improving economic environment. It noted that oil-price movements can affect demand, supplier costs, fuel expense and surcharge revenue; surcharge formulas may lag changes in fuel prices.
- Two customers, DuPont and South Mississippi Electric Power Association, challenged tariff rates before the Surface Transportation Board. NS disputed the claims; resolution was expected in late 2012 or 2013, but possible losses could not be estimated. Unfavorable rulings could materially affect future revenue.
- Environmental liabilities were $33 million, including $12 million current, for approximately 157 known locations and projects. Management considered known matters unlikely to have a material adverse effect, while warning that ultimate costs are uncertain.
- Other exposures include railroad injury and casualty claims, fuel-surcharge antitrust and derivative litigation, environmental proceedings, and pipeline notices of probable violation. Management did not expect the identified legal proceedings to have a material effect, but outcomes remain uncertain.
- More than 80% of railroad employees were covered by collective bargaining agreements. A tentative agreement with the United Transportation Union was subject to ratification; other national negotiations continued.
- Outstanding purchase commitments were approximately $1.2 billion through 2019. NS also disclosed planned corridor investments, including up to $242 million for Crescent Corridor projects and approximately $17 million of MidAmerica Corridor improvements for the remainder of 2011.
Most important facts for investors to verify
- How much of earnings growth reflects sustainable operating improvement versus the $63 million of tax benefits and reduced share count.
- Whether fuel surcharge revenue continues to offset fuel-cost inflation, including the effect of contractual pricing lags.
- Outcomes and potential financial exposure from the DuPont and SMEPA rate cases, insurance recovery disputes, and other litigation or environmental matters.
- Capital expenditure and corridor-project requirements, alongside the pace of share repurchases, dividends and debt issuance.
- Future operating trends across coal, general merchandise and intermodal markets, and progress in labor negotiations.