Norfolk Southern Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparison is Q1 2018 unless otherwise noted. Amounts are in U.S. dollars.
Business context and results
Norfolk Southern operates a freight railroad across approximately 19,500 route miles in 22 states and the District of Columbia. Management said Q1 results reflected initial steps in a strategic plan unveiled in February and reported first-quarter records for revenue, railway operating income, net income, diluted EPS, and operating ratio.
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Railway operating revenue | $2.840 billion | $2.717 billion | +5% |
| Railway operating expenses | $1.874 billion | $1.882 billion | Approximately flat |
| Income from railway operations | $966 million | $835 million | +16% |
| Operating ratio | 66.0% | 69.3% | Improved 3.3 percentage points |
| Net income | $677 million | $552 million | +23% |
| Diluted EPS | $2.51 | $1.93 | +30% |
Revenue growth reflected higher average revenue per unit, including pricing gains and fuel surcharges; total units were essentially unchanged. Merchandise revenue rose 5%, intermodal 6%, and coal was approximately flat. Merchandise and intermodal gains were offset by lower coal and merchandise volumes. Diluted EPS growth exceeded net income growth partly because of share repurchases.
Cash flow, balance sheet, and liquidity
- Operating cash flow was $881 million, up from $816 million. Investing cash outflow was $350 million, including $467 million of property additions. Financing cash outflow was $478 million.
- Cash, cash equivalents, and restricted cash totaled $499 million at quarter-end; balance-sheet cash and cash equivalents were $411 million, with $88 million restricted.
- Debt comprised $10.569 billion of long-term debt, $585 million of current maturities, and $250 million of short-term debt: approximately $11.404 billion total. The total-debt-to-total-capitalization ratio was 42.7%, versus 42.0% at December 31, 2018.
- Working capital deficit was $963 million, compared with $729 million at year-end. Management said cash on hand and operating cash flows should be sufficient for ongoing obligations.
- The company had no borrowings under its $750 million credit facility, which expires in May 2021, and reported compliance with its covenants. It had $250 million outstanding under a $400 million receivables securitization program expiring in May 2019.
Material changes and unusual items
- Operating expenses were broadly flat: lower compensation, fuel, and materials costs were offset in part by higher purchased services and depreciation. Management cited increased network velocity as contributing to lower equipment rents.
- Other income, net, increased to $44 million from $8 million, primarily due to higher investment returns on corporate-owned life insurance. The effective tax rate was 21.4%, compared with 21.9%.
- Share repurchases totaled $500 million for 2.9 million shares, versus $300 million for 2.1 million shares. Dividends were $230 million, or $0.86 per share, versus $205 million, or $0.72 per share.
- Adoption of lease accounting guidance added $593 million of operating lease right-of-use assets and corresponding liabilities at March 31. A new office-building lease is expected to commence in 2021, with estimated construction cost of $550 million and a residual value guarantee of up to 90% of construction cost.
Outlook, risks, and contingencies
- Management expected merchandise revenue to remain higher year over year for the rest of 2019, driven by pricing; intermodal revenue to increase through volume growth and pricing; and coal revenue to decline, reflecting market, pricing, and supply pressures.
- Management expected year-end rail headcount to be at least 500 lower than the prior year. Future repurchases would depend on market conditions and other factors; near-term purchases could be funded with internal cash or borrowings.
- Risks include weather and flooding, coal-market weakness, operational disruptions, labor negotiations, and uncertainty in casualty and environmental claims. Environmental liabilities were $58 million at March 31, 2019, including $15 million current. The company said known environmental matters were not expected to have a material adverse effect, but future costs could differ from estimates.
- Fuel-surcharge antitrust litigation remains subject to appeal after class certification was denied; the company considers the claims without merit and does not expect a material effect. Other lawsuits and claims could require additional accruals if outcomes are unfavorable.
- The filing’s forward-looking statements are subject to risks and uncertainties; the company reported no change to the risk factors in its 2018 Form 10-K.
Important facts for investors to verify
- Whether operating improvement and pricing gains can continue if volumes remain flat or coal and merchandise traffic weaken.
- The May 2019 expiration of the receivables securitization program and the company’s plans for the $250 million outstanding balance.
- Capital spending, debt, and liquidity trends alongside substantial share repurchases and the higher working capital deficit.
- Execution and financial implications of the strategic plan, headcount reductions, and the future office lease and residual value guarantee.
- Developments in environmental, casualty, and fuel-surcharge litigation exposures, which involve estimates and uncertain outcomes.