Norfolk Southern Corporation — Q2 2012 Form 10-Q
Business context and period: The filing covers the quarter and six months ended June 30, 2012. Norfolk Southern operates a freight railroad. Financial statements are unaudited; KPMG conducted an interim review and reported no material modifications needed for GAAP conformity, but did not express an audit opinion.
Financial results and condition
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Railway operating revenue | $2.874 billion | $2.866 billion | $5.663 billion | $5.486 billion |
| Income from railway operations | $934 million | $875 million | $1.679 billion | $1.475 billion |
| Net income | $524 million | $557 million | $934 million | $882 million |
| Diluted EPS | $1.60 | $1.56 | $2.82 | $2.45 |
| Operating ratio | 67.5% | 69.5% | Not stated | Not stated |
- Q2 operating expenses fell 3% to $1.940 billion; first-half expenses fell 1% to $3.984 billion. Q2 improvement reflected lower costs and improved network fluidity.
- First-half operating cash flow was $1.663 billion, versus $1.700 billion. Capital additions were $968 million versus $888 million; cash used in investing was $932 million versus $801 million.
- At June 30, cash and cash equivalents were $356 million, short-term investments $15 million, and working capital $110 million. Management said available cash and operating cash flows should cover ongoing obligations.
- Debt, including current maturities, was approximately $7.999 billion; debt-to-total capitalization was 45.0%, up from 43.2% at year-end 2011. The company issued $600 million of 3.0% senior notes due 2022. It had $100 million outstanding under its receivables facility, no borrowings under its $750 million credit facility, and reported covenant compliance.
- First-half dividends were $308 million and share repurchases were $850 million for 12.3 million shares. Cash increased by $80 million to $356 million during the half.
Changes versus prior periods
- Q2 net income declined 6%, while diluted EPS rose from $1.56 to $1.60, reflecting fewer shares after repurchases. The net income decline primarily reflected the absence of prior-year tax benefits; the effective tax rate rose to 37.8% from 30.0%.
- First-half net income rose 6%, and diluted EPS increased from $2.45 to $2.82. Operating income increased 14%, supported by higher revenue and lower expenses.
- Coal revenue fell 15% in Q2 and 11% in the first half, principally due to lower traffic. General merchandise revenue rose 9% and 11%, respectively; intermodal revenue rose 4% and 6%.
- Q2 railway revenue was nearly flat: higher traffic was mostly offset by lower average revenue per unit. First-half revenue rose 3%, with growth in both traffic and average revenue per unit.
Outlook, commentary, risks and contingencies
- Management expected coal revenue for the rest of 2012 to decline year over year, citing lower volume and average revenue per unit. It expected general merchandise revenue to increase on higher volume and slightly higher revenue per unit, and intermodal revenue to increase on volume growth partly offset by lower revenue per unit.
- Management attributed utility coal weakness to low natural-gas prices and reduced electricity demand. It cited improved automotive, chemicals, metals and construction activity as supports for general merchandise growth.
- Oil-price changes can affect fuel costs, surcharge revenue and volumes; management warned that future oil-price changes could materially affect results in a particular quarter or year. Other identified risks include economic conditions, competition, fuel and other input costs, severe weather, hazardous-material transportation, labor, regulation, litigation and technology disruptions.
- Environmental liabilities were $36 million at June 30, 2012, including $12 million current, across 141 known locations and projects. Management considered known matters unlikely to have a material adverse effect, while noting estimates and potential exposures are uncertain.
- A federal court certified a fuel-surcharge antitrust case as a class action on June 21, 2012. Norfolk Southern disputed the allegations and did not expect a material effect. The DuPont rate case was expected to be resolved in 2013; management estimated no material effect. The company also disclosed a Tennessee environmental notice concerning soil runoff and did not expect a material effect.
- The IRS was expected to complete its examinations of the 2009 and 2010 federal returns by year-end 2012; management did not expect a material effect. The filing also notes $507 million of outstanding purchase commitments and expected private spending of up to $393 million on Crescent Corridor projects, including approximately $104 million for the remainder of 2012.
Important facts for investors to verify
- Whether continued coal-volume weakness, particularly in utility coal, is offset by general merchandise and intermodal growth.
- How operating costs, fuel prices and fuel-surcharge timing affect operating ratio and margins in subsequent quarters.
- Cash generation and capital spending relative to share repurchases, dividends, and rising debt and capitalization leverage.
- Developments in the fuel-surcharge class action, DuPont rate case, environmental matters, and IRS examinations; disclosed outcomes could differ from management’s estimates.
- Progress, funding and remaining company commitments for the Crescent Corridor and other capital programs.