Norfolk Southern Corp. 10-Q Summary
Business Context and Reporting Period
This filing is a Quarterly Report (Form 10-Q) for Norfolk Southern Corporation for the period ended September 30, 2003. The company operates as a Class I railroad, with significant joint ownership and operational agreements regarding Conrail Inc. (Conrail), specifically operating the Pennsylvania Lines LLC (PRR) assets.
Key Financial Metrics
Revenue and Profit (Nine Months Ended Sept. 30, 2003):
- Total Railway Operating Revenues: $4,792 million (up 2% vs. prior year).
- Net Income: $483 million (up 46% vs. prior year, driven by accounting changes).
- Income from Continuing Operations (excl. accounting changes): $359 million (up 8% vs. prior year).
- Earnings Per Share (Diluted): $1.24 (includes $0.29 from accounting changes).
- Operating Margin: Income from railway operations was $840 million on $4,792 million revenue (approx. 17.5%).
Cash Flow and Liquidity:
- Net Cash Provided by Operating Activities: $800 million (up from $622 million in 2002).
- Net Cash Used for Investing Activities: $578 million (primarily property additions of $536 million).
- Net Cash Used for Financing Activities: $248 million.
- Cash and Cash Equivalents: $158 million at period end.
- Working Capital Deficit: $570 million (Current Assets $1,284M vs. Current Liabilities $1,854M).
Debt and Capital Structure:
- Long-Term Debt: $6,823 million.
- Current Maturities of Long-Term Debt: $363 million.
- Debt-to-Total Capitalization: 51.0% (excluding notes payable to PRR subsidiary).
- Dividends: Quarterly dividend increased to $0.08 per share in July 2003.
Material Changes vs. Prior Period
- Accounting Changes: Adoption of SFAS No. 143 (Asset Retirement Obligations) and FIN No. 46 resulted in a cumulative net adjustment of $114 million ($110M from SFAS 143, $4M from FIN 46) included in 2003 net income. This significantly boosted reported earnings but did not affect cash flow.
- Revenue Drivers: Nine-month revenue growth was driven by a 2% increase in traffic volume and a 1% increase in revenue per unit. Coal revenue rose 3% due to higher export volumes; Intermodal revenue rose 3% due to increased trailer and container traffic.
- Expense Trends: Total operating expenses rose 3% year-over-year. Compensation and benefits increased 6% due to higher wage rates and medical costs. Diesel fuel expenses rose 15% due to higher prices, partially mitigated by a hedging program that saved $45 million.
- Discontinued Operations: A $10 million after-tax gain was recorded related to the 1998 sale of the motor carrier subsidiary, North American Van Lines.
Outlook, Risks, and Management Commentary
Guidance and Outlook:
- Coal: Volumes expected to remain higher for the remainder of the year as utilities rebuild stockpiles, though mild weather could dampen demand.
- General Merchandise: Expected to show weakness in the fourth quarter, dependent on economic performance. Automotive and metals/construction volumes remain soft.
- Intermodal: Growth expected due to market share gains and recovery from the 2002 West Coast port shutdown.
Risks and Contingencies:
- Voluntary Separation Program: A program for non-agreement employees announced in Q3 will cost approximately $100 million, to be reflected in Q4 results ($65M cash, $35M non-cash).
- Legal Proceedings: A dispute with WilTel Communications regarding fiber optic infrastructure involves a $36 million judgment plus interest; WilTel has appealed. Management expects to prevail but notes collection risks.
- Environmental: Liabilities for environmental exposures are $25 million across 113 known locations. Management believes recorded liabilities are adequate but notes inherent risks in the railroad business.
- Conrail Spin-Off: A proposed transaction to spin off PRR and NYC from Conrail is pending STB approval and IRS rulings. This would alter the debt structure and operating agreements.
- Market Risks: The company hedges 77% of remaining 2003 diesel fuel needs. A 10% drop in fuel prices would reduce asset value by ~$31 million. A 1% increase in interest rates would increase annual interest expense by ~$6 million.
Investor Verification Checklist
- Verify the impact of the $114 million accounting change (SFAS 143) on reported net income versus cash flow.
- Monitor the resolution of the WilTel litigation ($36M judgment) and the potential for collection shortfalls.
- Track the execution and cost of the $100 million voluntary separation program in Q4 2003.
- Assess the progress of the proposed Conrail/PRR spin-off transaction and its effect on debt obligations.
- Review the sustainability of coal volume growth given the mild weather outlook and utility stockpile levels.
- Confirm the company's ability to manage the $570 million working capital deficit using its $1 billion credit facility and receivables sale program.