Norfolk Southern Corp. 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2003, for Norfolk Southern Corporation (NS), a major freight railroad. The filing includes unaudited consolidated financial statements for the three and six months ended June 30, 2003, compared to the same periods in 2002. NS operates a significant portion of the Northeastern U.S. rail network through its joint ownership of Conrail Inc. (58% economic interest).
Key Financial Metrics
| Metric ($ millions) | 3 Months Ended Jun 30, 2003 |
6 Months Ended Jun 30, 2003 |
6 Months Ended Jun 30, 2002 |
|---|---|---|---|
| Total Railway Operating Revenues | 1,633 | 3,194 | 3,091 |
| Net Income | 137 | 346 | 205 |
| Income from Continuing Ops (excl. accounting changes) | 137 | 222 | 205 |
| Net Cash Provided by Operating Activities | N/A | 366 | 385 |
| Net Cash Used for Investing Activities | N/A | (432) | (379) |
| Long-Term Debt | 6,848 | 6,848 | 7,006 |
| Cash and Cash Equivalents | 110 | 110 | 184 |
| Working Capital Deficit | (763) | (763) | (554) |
Note: Working capital deficit calculated as Current Assets ($1,306) minus Current Liabilities ($2,069).
Material Changes vs. Prior Period
- Revenue Growth: Six-month operating revenues increased 3% ($103 million) driven by higher traffic volume (+$57 million impact) and increased revenue per unit/mix (+$46 million impact). Coal revenues rose 5% due to higher utility and export volumes.
- Profitability: Net income for the six months increased 69% ($141 million) primarily due to a $114 million non-cash gain from the cumulative effect of changes in accounting principles (SFAS No. 143 and FIN No. 46) and a $10 million gain from discontinued operations. Excluding these items, income from continuing operations rose 8%.
- Expense Increases: Operating expenses rose 5% year-over-year. Key drivers included higher compensation and benefits (8% increase in Q2), increased diesel fuel costs (19% increase in 6 months), and higher casualty claims (36% increase in 6 months).
- Liquidity: Operating cash flow decreased 5% to $366 million, largely due to unfavorable changes in working capital, specifically growth in accounts receivable. Cash on hand declined from $184 million to $110 million.
Guidance, Outlook, and Risks
- Outlook: Management expects coal volumes to remain higher for the remainder of the year, though mild weather could dampen demand. General merchandise revenues are expected to show weakness in the second half of the year, dependent on economic performance. Intermodal revenues are expected to benefit from service improvements and truck-to-rail diversion.
- Conrail Spin-Off: NS, CSX, and Conrail filed a petition with the Surface Transportation Board in June 2003 to establish direct ownership of Conrail's operating subsidiaries (PRR and NYC). This transaction is subject to regulatory approval and an IRS ruling.
- Accounting Changes: Adoption of SFAS No. 143 (Asset Retirement Obligations) lowered depreciation but increased other expenses. Adoption of FIN No. 46 consolidated a variable interest entity, increasing depreciation and interest expense.
- Risks and Contingencies:
- Legal: A $36 million judgment against Williams Communications (telecom codeveloper) is under appeal; collection is uncertain due to the defendant's financial condition. Several hundred labor arbitration claims regarding "New York Dock" benefits are pending, though management expects to prevail.
- Environmental: NS has recorded $24 million in liabilities for environmental exposures at 110 known locations. Future costs could be significant if new sites are identified or cleanup technologies change.
- Market Risks: NS hedges 72% of its remaining 2003 diesel fuel needs. A 10% drop in fuel prices would reduce the asset value of these swaps by approximately $30 million.
- Dividends: On July 22, 2003, NS increased its quarterly dividend to $0.08 per share.
Investor Verification Checklist
- Accounting Adjustments: Verify the sustainability of earnings by excluding the $114 million one-time gain from accounting changes and the $10 million discontinued operations gain.
- Working Capital: Monitor the widening working capital deficit ($763 million) and the company's ability to manage cash flow given the $500 million in debt maturities due in the next 12 months.
- Conrail Transaction: Track the progress of the Surface Transportation Board approval for the proposed spin-off of Conrail's operating subsidiaries, which could alter NS's capital structure and debt obligations.
- Legal Exposure: Assess the likelihood of collecting the $36 million judgment against Williams Communications and the potential liability from pending labor arbitrations.
- Fuel Hedging: Review the effectiveness of the diesel fuel hedging program in mitigating margin volatility given the 19% increase in fuel expenses year-to-date.