NSC

Norfolk Southern Corp. 10-Q Summary: Q1 1998

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1998. Norfolk Southern Corporation (NS) is a Class I railroad operating in the eastern United States. The reporting period is significantly influenced by the ongoing joint acquisition of Conrail with CSX Corporation, pending Surface Transportation Board (STB) approval, and the divestiture of its motor carrier subsidiary, North American Van Lines (NAVL).

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Surge: Net income increased $101 million (79%) to $229 million, driven primarily by a $98 million after-tax gain from the sale of the motor carrier subsidiary (NAVL), classified as discontinued operations.
• Continuing Operations: Income from continuing operations rose modestly by $7 million (6%) to $132 million. This growth was offset by Conrail-related costs, including interest on $5.8 billion of acquisition debt and integration expenses, which reduced net income by approximately $50 million.
• Revenue Growth: Railway operating revenues increased 2% to $1,066 million, entirely due to a 5% increase in traffic volume (carloads). Revenue per unit declined, partially offsetting volume gains.
• Expense Increases: Operating expenses rose 7% to $815 million. Key drivers included higher compensation (wage rates and stock-based compensation), Conrail integration costs, and increased traffic-related repair costs. Diesel fuel expenses dropped 24% due to lower fuel prices.
• Operating Ratio: The railway operating ratio worsened to 76.5% from 73.1%, largely due to Conrail integration costs and stock-based compensation. Excluding these items, the ratio would have been 73.3%.

Guidance, Outlook, and Risks

• Conrail Acquisition: The transaction remains contingent on STB approval, not expected before August 1998. Management anticipates integration expenses may accelerate as the year progresses. If the STB denies approval, NS could face a significant loss on its Conrail investment.
• Revenue Outlook:
  • Coal: Expected to remain flat compared to 1997.
  • General Merchandise: Expected to post moderate gains, supported by automotive mixing center traffic.
  • Intermodal: Expected to continue increasing, though likely not at the double-digit growth rate seen in Q1.
• Liquidity: Operating cash flow remains the primary liquidity source. A small working capital deficit of $19 million exists as of March 31, 1998, primarily due to accrued interest on Conrail acquisition debt. NS plans to issue commercial paper to fund upcoming interest payments.
• Capital Spending: NS maintains an aggressive capital spending program to integrate Conrail operations, including new connections, terminals, and route improvements.
• Legal Contingency: A tax court decision regarding tax benefit leases from 1981 is under appeal. Management expects no loss due to indemnification provisions in the lease agreement.

Investor Verification Checklist

• Verify the status of the Surface Transportation Board (STB) approval for the Conrail acquisition and potential timelines for closing.
• Confirm the final purchase price of North American Van Lines (NAVL) and any working capital adjustments post-closing.
• Monitor the trajectory of Conrail integration costs and their impact on the operating ratio in subsequent quarters.
• Review the performance of automotive mixing centers and the resolution of Western rail service issues affecting intermodal volumes.
• Assess the company's ability to service its increased debt load ($5.8 billion for Conrail) amidst fluctuating interest rates.