Norfolk Southern Corp. 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 1999. The reporting period is defined by a major operational shift: on June 1, 1999, Norfolk Southern Railway (NSR) commenced operations over a portion of Conrail's lines (the "Northern Region"), increasing NSR's route miles and workforce by approximately 50%. The second quarter reflects two months of pre-integration operations and one month of integrated operations, which were significantly impacted by system congestion and integration inefficiencies.
Key Financial Metrics
| Metric ($ millions) | Q2 1999 | Q2 1998 | 6M 1999 | 6M 1998 |
|---|---|---|---|---|
| Total Railway Operating Revenues | 1,194 | 1,079 | 2,224 | 2,145 |
| Total Railway Operating Expenses | 996 | 786 | 1,789 | 1,601 |
| Income from Railway Operations | 198 | 293 | 435 | 544 |
| Net Income | 77 | 187 | 189 | 416 |
| Net Cash from Operating Activities | N/A | N/A | 426 | 452 |
| Operating Ratio | 83.4% | 72.8% | 80.4% | 74.6% |
| Cash and Cash Equivalents | 105 | 5 | 105 | 5 |
| Total Debt (Current + Long-term) | 7,964 | 7,624 | 7,964 | 7,624 |
Note: 1998 Net Income included a $98 million after-tax gain from discontinued operations (sale of motor carrier subsidiary), which is not present in 1999.
Material Changes vs. Prior Period
- Revenue Growth: Railway operating revenues increased 11% in Q2 and 4% for the six months, driven primarily by increased traffic volume from the new Northern Region. However, an estimated $40 million in revenue was lost due to traffic diversions caused by congestion.
- Expense Surge: Operating expenses rose 27% in Q2 and 12% for the six months. This was driven by the 50% increase in workforce, new "Conrail rents and services" costs ($51 million in Q2), and an estimated $60 million in additional costs related to system congestion and service alterations.
- Profitability Decline: Net income from continuing operations dropped 59% in Q2 and 41% for the six months compared to 1998. Management attributes an estimated $91 million reduction in operating income to integration difficulties and congestion.
- Coal Segment: Coal revenues declined 6% in Q2 and 9% for the six months due to a 37% drop in export coal tonnage and a shift to lower-yield utility coal, despite volume increases in the Northern Region.
- General Merchandise & Intermodal: Both segments saw significant revenue growth (16% and 23% respectively in Q2) due to the Northern Region addition and consolidation of Triple Crown Services Company (TCS) revenues.
Guidance, Outlook, and Risks
- Operational Outlook: Management expects the adverse effects of system congestion and traffic diversions to continue until operational issues are resolved. Third-quarter expenses will include costs for a special employee incentive program (up to $3,000 per eligible employee).
- Revenue Forecast: General merchandise revenues are expected to be up nearly 50% for the remainder of the year, and intermodal revenues are expected to nearly double, largely due to the Northern Region. Coal revenues are expected to be higher than the prior year period despite weak export demand.
- Liquidity: The company reported a working capital deficit of $632 million, including $400 million in notes due May 1, 2000. NS maintains $600 million of capacity under its shelf registration and uses commercial paper to meet immediate needs.
- Year 2000 Compliance: Remediation is over 99% complete, with testing and implementation expected in Q3 1999. Total incremental costs are estimated at $25 million. Risks remain regarding third-party compliance.
- Conrail Integration: Conrail is expected to generate a net loss for the remainder of 1999 due to integration and wind-down costs. NS has recorded liabilities for employee separation and relocation costs.
- Litigation: A $175 million punitive damage verdict against a subsidiary (AGS) regarding a 1987 explosion is partially settled; management believes the ultimate liability will not have a material adverse effect.
Investor Verification Checklist
- Integration Progress: Verify the timeline for resolving system congestion and the associated cost impact on Q3 and Q4 results.
- Coal Demand: Monitor global economic conditions and the strength of the U.S. dollar, which are driving the decline in export coal volumes.
- Liquidity Management: Confirm the company's ability to refinance the $400 million note due May 2000 and manage the working capital deficit.
- Conrail Financials: Review Conrail's ability to meet obligations despite projected net losses for the remainder of 1999.
- Year 2000 Status: Track the completion of system integration testing in Q3 1999 to ensure no operational disruptions occur at the millennium turn.