NSC

Norfolk Southern Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 1998, and the six-month period ended on the same date. Norfolk Southern Corporation (NS) is a Class I railroad operating in the eastern United States. A material event during this period was the Surface Transportation Board's approval (July 23, 1998) of the joint acquisition of Conrail with CSX Corporation, with the transaction expected to close by the end of 1998 or early 1999. Additionally, NS completed the sale of its motor carrier subsidiary, North American Van Lines (NAVL), in March 1998.

Key Financial Metrics

Note: Debt figures represent total long-term debt ($7,539M) plus current maturities ($64M) as of June 30, 1998. Q2 cash flow is not explicitly broken out in the summary table; 6M figures are provided.

Material Changes vs. Prior Period

• Revenue Growth: Railway operating revenues increased 1% in Q2 and 2% for the six months, driven entirely by higher traffic volume (carloads up 2% in Q2, 4% for 6M). Revenue per unit declined due to traffic mix changes.
• Profitability: Net income for the six months rose 31% ($98M increase), primarily due to a $98 million after-tax gain from the sale of NAVL (discontinued operations). Income from continuing operations increased only 3% ($8M) for the six months.
• Expenses: Railway operating expenses rose 5% in Q2 and 6% for the six months. Increases were driven by higher compensation, materials/services (due to equipment rents and repair costs), and Conrail integration costs. Diesel fuel expenses decreased 18% in Q2 due to lower prices.
• Operating Ratio: The railway operating ratio worsened to 72.8% in Q2 (from 70.0%) and 74.6% for the six months (from 71.5%), impacted by the shift toward more resource-intensive automotive and intermodal traffic and coal mix changes.
• Conrail Impact: Interest expense on debt increased significantly due to the $5.8 billion debt issued in 1997 to finance the Conrail acquisition. NS recorded $50M (Q2) and $82M (6M) in equity earnings from Conrail.

Guidance, Outlook, and Risks

• Conrail Integration: The joint acquisition of Conrail is expected to close by year-end 1998 or Q1 1999. NS anticipates realizing traffic and revenue gains and operating synergies post-closing. However, integration risks include service disruptions and the need for significant capital investment in new connections and terminals.
• Revenue Outlook:
  • Coal: Revenues expected to be slightly below last year's levels due to a mix shift toward shorter-haul utility coal and declines in export/metallurgical coal.
  • General Merchandise: Expected to post moderate gains, supported by automotive recovery and mixing center traffic.
  • Intermodal: Revenues expected to be below last year's levels due to a network redesign and market forces (truck competition).
• Liquidity: Operating cash flow remains the principal source of liquidity. A small working capital deficit ($38M) exists as of June 30, 1998, attributable to accrued interest on term notes due in Q4. NS expects to issue commercial paper to fund these payments.
• Year 2000 Compliance: NS expects to complete system remediation by mid-1999. Incremental costs through June 1998 were under $10 million, with total costs expected under $25 million. Risks remain regarding third-party failures.
• Contingencies: A tax court decision regarding tax benefit leases from 1981 was affirmed; NS expects no loss due to indemnification provisions in the lease agreement.

Investor Verification Checklist

• Conrail Closing Date: Verify the actual closing date of the Conrail transaction and any regulatory delays beyond the expected Q1 1999 timeframe.
• Operating Ratio Trends: Monitor if the operating ratio improves post-merger as anticipated synergies are realized, or if integration costs persist.
• Coal Traffic Mix: Confirm the sustainability of the shift to shorter-haul utility coal and its impact on long-term revenue per unit.
• Debt Servicing: Review the impact of the $5.8 billion acquisition debt on future interest expenses and liquidity, particularly regarding the Q4 interest payments.
• Intermodal Network Redesign: Assess the impact of the service redesign on volume and revenue in the coming quarters.