NSC

Norfolk Southern Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1999. Norfolk Southern Corporation (NS) is a major freight railroad operator. A critical business event during this period is the pending joint acquisition of Conrail Inc. with CSX Corporation, with a scheduled Closing Date of June 1, 1999. NS is currently integrating systems and preparing to lease and operate a portion of Conrail's route system.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total railway operating revenues decreased 3% ($36 million) primarily due to a 4% decline in traffic volume (carloads). Coal revenues dropped 13% due to weak export demand and domestic steel coal declines. Conversely, General Merchandise revenues rose 3%, driven by a 16% increase in automotive traffic.
• Profitability: Net income fell 51% year-over-year. This decline is largely attributable to the absence of a $98 million after-tax gain from the sale of the motor carrier subsidiary (North American Van Lines) recorded in Q1 1998. Income from continuing operations decreased 15% ($20 million).
• Expense Management: Railway operating expenses decreased 3% ($22 million). Savings were driven by lower compensation (due to reduced stock-based compensation and union welfare refunds) and lower diesel fuel costs. These were partially offset by higher casualty claims and materials costs.
• Cash Flow: Operating cash flow decreased $42 million due to higher accounts receivable and lower operating income. Investing cash outflows increased significantly ($224 million increase) due to property additions financed via equipment trust certificates rather than capital leases used in the prior year.

Outlook, Risks, and Management Commentary

• Conrail Integration: Management expects significant revenue increases immediately following the June 1, 1999, Closing Date. Coal revenues are projected to rise by one-third, General Merchandise by nearly one-half, and Intermodal revenues to double. However, operating expenses will also increase due to lease payments (estimated $325-$350 million annually) and the integration of 11,500 Conrail employees.
• Year 2000 Compliance: NS is actively remediating systems, with business-critical systems expected to be completed by Q3 1999. Total incremental costs are estimated at $25 million. Risks include potential system failures if third-party vendors or Conrail systems are not compliant.
• Liquidity: The company maintains a working capital deficit of $193 million, which includes $124 million of accrued interest payable in May. NS utilizes commercial paper to manage short-term liquidity and recently issued $400 million in 10-year term notes in April 1999 to reduce commercial paper obligations.
• Market Risks: Coal revenues remain vulnerable to global economic conditions and the strength of the U.S. dollar. General merchandise faces competition from lower-priced imported steel.

Investor Verification Checklist

• Conrail Closing Date: Verify the June 1, 1999, integration timeline and the specific lease payment obligations ($325-$350 million annually) that will impact future operating expenses.
• Coal Market Exposure: Assess the sustainability of the 34% decline in export coal traffic and the impact of the strong U.S. dollar on future revenue projections.
• Year 2000 Readiness: Confirm the status of Conrail's core transportation system remediation, which is scheduled for completion in September 1999, and the potential for operational disruption if delays occur.
• Liquidity Position: Monitor the repayment of commercial paper and the utilization of the $400 million term note proceeds to ensure the working capital deficit does not constrain operations.
• Discontinued Operations: Note that the high net income in Q1 1998 included a one-time gain from the sale of the motor carrier; future comparisons should focus on "Income from Continuing Operations."