NSC

Norfolk Southern Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 1998, and the nine-month period ended on the same date. Norfolk Southern Corporation (NS) is a Class I railroad operating in the eastern United States. A primary focus of the filing is the joint acquisition of Conrail Inc. with CSX Corporation, which received regulatory approval effective August 22, 1998. The final closing of the transaction, allowing NS to operate specific Conrail assets, is anticipated in the first quarter of 1999.

Key Financial Metrics

Liquidity and Capital Structure:

• Cash and Cash Equivalents: $107 million (Sept 30, 1998) vs. $34 million (Dec 31, 1997).
• Working Capital: Deficit of $133 million (Sept 30, 1998) vs. surplus of $10 million (Dec 31, 1997), primarily due to accrued interest on term notes.
• Debt to Total Capitalization: 56.5% (Sept 30, 1998) vs. 57.9% (Dec 31, 1997).
• Long-Term Debt: $7,508 million.

Material Changes vs. Prior Period

• Revenue Stability: Total railway operating revenues remained flat at $1,048 million for the third quarter compared to 1997. Year-to-date revenue increased 1% to $3,193 million, driven by a 113 million dollar increase in traffic volume that offset an $81 million decrease in revenue per unit.
• Profitability Decline (Continuing Ops): Income from continuing operations decreased 11% in Q3 and 2% for the nine months. This decline is largely attributed to Conrail-related costs, including $384 million in interest expense on debt for the nine months and integration expenses.
• Discontinued Operations Impact: Net income for the nine months increased 15% year-over-year, primarily due to a $105 million after-tax gain from the sale of the motor carrier subsidiary, North American Van Lines (NAVL).
• Expense Increases: Railway operating expenses rose 5% in Q3 and 6% year-to-date. Key drivers included Conrail integration costs, higher wage rates, and increased costs for automotive mixing centers. "Materials, services and rents" increased 19% in Q3.
• Coal Segment: Coal revenues declined 2% year-to-date despite a 1% increase in carloads, reflecting a shift toward lower-revenue utility coal and a decrease in export/metallurgical coal shipments.

Guidance, Outlook, and Risks

• Conrail Transaction: NS expects to begin operating leased Conrail assets in Q1 1999 (targeting March 1). The transaction is subject to contingencies including labor agreements and system integration. Future financial results will be significantly impacted by the realization of synergies and the costs of operating the new assets.
• Revenue Outlook:
  • Coal: Q4 revenues expected to be below 1997 levels due to softness in export and domestic metallurgical markets.
  • General Merchandise: Q4 revenues expected to be slightly ahead of 1997, supported by automotive mixing center traffic.
  • Intermodal: Q4 revenues expected to be below 1997 levels due to a network redesign implemented in August.
• Year 2000 Compliance: NS is actively remediating systems, with business-critical systems expected to be implemented by mid-1999. Total costs are estimated at approximately $25 million. Risks include potential failures of third-party systems (suppliers, customers, other railroads) which could materially affect operations.
• Market Risk: NS has capital lease obligations payable in Japanese yen, hedged via yen deposits. One bank holding these deposits was placed under special public management in Japan, though the government intends to protect liabilities.

Investor Verification Checklist

• Conrail Closing Date: Verify if the anticipated Q1 1999 closing date is met, as delays could postpone revenue synergies and increase integration costs.
• Operating Ratio Exclusions: Review the "adjusted" operating ratio (72.1% for Q3 excluding Conrail costs) to assess core operational efficiency versus transaction-related drag.
• Coal Traffic Mix: Monitor the shift from high-revenue export/metallurgical coal to lower-revenue utility coal and its long-term impact on revenue per unit.
• Year 2000 Progress: Track the completion of testing and implementation for business-critical systems to ensure no operational disruption in 1999.
• Working Capital: Monitor the working capital deficit and the company's ability to fund accrued interest payments via commercial paper or other liquidity sources.