NSC

Norfolk Southern Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, for Norfolk Southern Corporation, a major freight railroad operating in the eastern United States. The filing includes unaudited consolidated financial statements for the three and six months ended June 30, 2002, compared to the same periods in 2001.

Key Financial Metrics

Margins: Railway operating income margin for the six months ended June 30, 2002, was approximately 18.1% ($559M / $3,091M), compared to 15.5% in the prior year period.

Material Changes vs. Prior Period

• Revenue: Six-month revenues declined 1% ($41 million) primarily due to a 10% drop in coal revenues ($79 million) driven by lower utility and export volumes. This was partially offset by growth in general merchandise (+1%) and intermodal (+3%) segments.
• Expenses: Total railway operating expenses decreased 4% ($113 million) for the six months. Significant savings were realized in diesel fuel expenses, which dropped 26% ($58 million) due to lower fuel prices and hedging activities.
• Profitability: Net income increased 13% ($24 million) for the six months. Excluding a $13 million gain from discontinued operations in 2001, net income actually increased 22%.
• Liquidity: Cash and cash equivalents decreased from $204 million to $94 million. However, the working capital deficit improved significantly from $1.3 billion to $560 million, aided by debt repayments and changes in Conrail-related financing terms.

Guidance, Outlook, and Risks

• Outlook: Management expects coal volumes to strengthen in August due to utility projections and contract settlements. General merchandise and intermodal revenues are expected to remain favorable or strengthen as the economy improves.
• Capital Program: Outstanding purchase commitments for the 2002 capital program were approximately $11 million. Forward fuel purchase commitments cover 13 million gallons for the remainder of 2002 at an average cost of 64 cents per gallon.
• Debt Management: The company issued $300 million in new senior notes in April 2002 and repaid $500 million of maturing debt. A $1 billion credit facility is available through 2006.
• Legal and Contingencies:
  • Labor Arbitration: Claims regarding "New York Dock" income protection benefits could result in losses ranging from $0 to $75 million if NS does not prevail.
  • Williams Communications: A receivable of $36 million from a codeveloper is at risk due to the parent company's Chapter 11 bankruptcy filing.
  • Environmental: Recorded liabilities for environmental exposures were $29 million at June 30, 2002, covering 124 identified locations.
• Market Risks: NS hedges approximately 57% of expected diesel fuel requirements for the remainder of 2002. A 10% decrease in fuel prices would reduce swap assets by approximately $24 million.

Investor Verification Checklist

• Coal Volume Recovery: Verify if the projected August strengthening in coal volumes materializes to offset the 10% year-to-date decline.
• Conrail Earnings: Monitor Conrail's operating performance, as NS's equity in earnings (net of amortization) declined to $19 million for the six months ended June 30, 2002, from $26 million in 2001.
• Legal Exposure: Track the resolution of the Williams Communications receivable ($36 million) and the labor arbitration claims (potential $75 million exposure).
• Debt Refinancing: Confirm the company's ability to manage the potential redemption of $734 million in 7.05% notes due May 1, 2037, which holders may require to be redeemed starting May 1, 2004.
• Fuel Hedging Effectiveness: Assess the impact of diesel fuel price volatility on operating margins given the current hedging position.