UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2001
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file numbers 1-743; 1-3744; 1-4793; 1-546-2
NORFOLK SOUTHERN RAILWAY COMPANY
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(Exact name of registrant as specified in its charter)
Virginia 53-6002016
- ----------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
Three Commercial Place
Norfolk, Virginia 23510-2191
- ----------------------------------- ---------------------------------
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (757) 629-2680
- ---------------------
No Change
- --------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. (X) Yes ( ) No
The number of shares outstanding of each of the registrant's classes of
Common Stock, as of the last practicable date:
Class Outstanding as of July 31, 2001
----- --------------------------------
Common Stock (par value $1.00) 16,668,997
2
TABLE OF CONTENTS
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Page
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Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Statements of Income
Three Months and Six Months Ended
June 30, 2001 and 2000 3
Consolidated Balance Sheets
June 30, 2001, and December 31, 2000 4
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2001 and 2000 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures
About Market Risks 15
Signatures 16
3
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements.
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Income
($ in millions)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2001 2000 2001 2000
---- ---- ---- ----
Railway operating revenues:
Coal $ 395 $ 377 $ 788 $ 724
General merchandise 922 942 1,793 1,857
Intermodal 233 235 471 445
------ ------ ------ ------
TOTAL RAILWAY OPERATING REVENUES 1,550 1,554 3,052 3,026
------ ------ ------ ------
Railway operating expenses:
Compensation and benefits (Notes 3 and 4) 372 486 766 1,137
Materials, services and rents (Note 4) 483 347 969 691
Conrail rents and services (Note 4) 120 124 237 255
Depreciation 124 121 247 242
Diesel fuel 106 106 223 221
Casualties and other claims 40 34 77 66
Other 71 87 147 171
------ ------ ------ ------
TOTAL RAILWAY OPERATING EXPENSES 1,316 1,305 2,666 2,783
------ ------ ------ ------
Income from railway operations 234 249 386 243
Other income (expense) - net (87) (50) (132) (83)
Interest expense on debt (10) (11) (18) (21)
------ ------ ------ ------
Income before income taxes 137 188 236 139
Provision for income taxes 54 73 91 54
------ ------ ------ ------
NET INCOME $ 83 $ 115 $ 145 $ 85
====== ====== ====== ======
See accompanying notes to Consolidated Financial Statements.
4
Item 1. Financial Statements. (continued)
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NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Balance Sheets
($ in millions)
(Unaudited)
June 30, 2001 Dec. 31, 2000
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 25 $ --
Short-term investments -- 1
Accounts receivable, net (Note 4) 161 146
Due from Conrail (Note 4) 8 31
Materials and supplies 94 89
Deferred income taxes 165 173
Other current assets 47 125
------ ------
Total current assets 500 565
Investments (Note 6) 692 486
Properties less accumulated depreciation 10,647 10,483
Other assets 550 483
------ ------
TOTAL ASSETS $12,389 $12,017
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 825 $ 902
Income and other taxes 238 221
Due to NS - net (Note 4) 111 26
Notes and accounts payable to Conrail (Note 4) 285 155
Other current liabilities 140 159
Current maturities of long-term debt 88 80
------ ------
Total current liabilities 1,687 1,543
Long-term debt 818 691
Other liabilities 1,048 1,061
Minority interests 3 3
Deferred income taxes 3,670 3,613
------ ------
TOTAL LIABILITIES 7,226 6,911
------ ------
Stockholders' equity:
Serial preferred stock 55 55
Common stock 167 167
Additional paid-in capital 695 695
Accumulated other comprehensive income (Note 6) 254 157
Retained income 3,992 4,032
------ ------
TOTAL STOCKHOLDERS' EQUITY 5,163 5,106
------ ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $12,389 $12,017
====== ======
See accompanying notes to Consolidated Financial Statements.
5
Item 1. Financial Statements. (continued)
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Cash Flows
($ in millions)
(Unaudited)
Six Months Ended
June 30,
----------------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 145 $ 85
Reconciliation of net income to net cash
provided by operating activities:
Depreciation 248 243
Deferred income taxes (10) (8)
Nonoperating gains on properties and investments (8) (6)
Changes in assets and liabilities affecting operations:
Accounts receivable (15) 57
Materials and supplies (5) (36)
Other current assets and due from Conrail 102 109
Income tax liabilities 43 55
Other short-term liabilities (108) 100
Other - net (96) 3
----- -----
Net cash provided by operating activities 296 602
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (420) (333)
Property sales and other transactions 14 43
Investments, including short-term (55) (39)
Investment sales and other transactions 11 38
----- -----
Net cash used for investing activities (450) (291)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends (1) (1)
Advances to NS (106) (194)
Advances and repayments from NS 8 34
Proceeds from borrowings 340 125
Debt repayments (62) (254)
----- -----
Net cash provided by (used for)
financing activities 179 (290)
----- -----
Net increase in cash and cash equivalents 25 21
CASH AND CASH EQUIVALENTS:
At beginning of year -- --
----- -----
At end of period $ 25 $ 21
===== =====
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of amounts capitalized) $ 49 $ 81
Income taxes $ 64 $ 6
See accompanying notes to Consolidated Financial Statements.
6
Item 1. Financial Statements. (continued)
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NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NS RAIL)
(A Majority-Owned Subsidiary of Norfolk Southern Corporation [NS])
Notes to Consolidated Financial Statements
1. In the opinion of Management, the accompanying unaudited interim
financial statements contain all adjustments (consisting of normal
recurring accruals) necessary to present fairly the Company's
financial position as of June 30, 2001, its results of operations
for the three and six months ended June 30, 2001 and 2000, and its
cash flows for the six months ended June 30, 2001 and 2000.
Although Management believes that the disclosures presented are
adequate to make the information not misleading, these Consolidated
Financial Statements should be read in conjunction with: (a) the
financial statements and notes included in the Company's latest
Annual Report on Form 10-K and in any subsequent Quarterly Report
on Form 10-Q and (b) any Current Reports on Form 8-K.
2. Commitments and Contingencies
There have been no significant changes since year-end 2000 in the
matters as discussed in NOTE 15, COMMITMENTS AND CONTINGENCIES,
appearing in the NS Rail Annual Report on Form 10-K for 2000,
Notes to Consolidated Financial Statements, beginning on page 61.
3. Work-Force Reduction Costs in 2000
"Compensation and benefits" expenses for the six months ended
June 30, 2000, include $101 million of costs recorded in the
first quarter related to actions taken to reduce the size of
the work force, which reduced net income by $62 million.
These costs resulted principally from a voluntary early
retirement program, accepted by 919 of 1,180 eligible employees.
The retirements were effective March 1, 2000, and most of the
related benefits are being paid from the overfunded pension plan.
The resulting noncash reduction to NS Rail's pension plan asset
is included in "Other - net" in the Consolidated Statements of
Cash Flows. In addition, an accrual was made for certain
postemployment benefits due to some union employees who were
furloughed.
4. Related Parties
General
-------
NS is the parent holding company of NSR. Rail operations are
coordinated at the holding company level by the NS Vice Chairman
and Chief Operating Officer. Effective June 1, 2000, NS charges
NS Rail a fee for management services it performs for NS Rail
(which totaled $137 million in the second quarter of 2001,
including an $8 million mark-up, and $281 million for the first
six months, including a $17 million mark-up). Previously, the
costs of functions performed by NS were charged to NS Rail.
As a result, costs that were previously included in "Compensation
and benefits" and "Other" are reflected in "Materials, services
and rents." In addition, NS charges NS Rail a revenue-based
licensing fee (which totaled $24 million in each of the second
quarters of 2001 and 2000 and $45 million in each of the six-month
periods) for use of certain intangible assets owned by NS.
NS Rail owns 21,363,974 shares of NS common stock.
Operations Over Conrail's Lines
-------------------------------
Overview -- NS and CSX Corporation (CSX) jointly own Conrail Inc.
(Conrail), whose primary subsidiary is Consolidated Rail Corporation
(CRC), the major freight railroad in the Northeast. NS has a
58 percent economic and 50 percent voting interest in the jointly
owned entity, and CSX has the remainder of the economic and voting
interests.
7
Item 1. Financial Statements. (continued)
- ------ --------------------
Operations of Conrail's Lines -- NSR operates as a part of its rail
system the routes and assets of Pennsylvania Lines LLC (PRR), a wholly
owned subsidiary of CRC, pursuant to operating and lease agreements.
Costs necessary to operate and maintain the PRR assets, including
leasehold improvements, are borne by NSR. CSX Transportation, Inc.
(CSXT) operates the routes and assets of another CRC subsidiary under
comparable terms. Certain other Conrail routes and assets (the
"Shared Assets Areas") continue to be operated by CRC for the joint
and exclusive benefit of NSR and CSXT. In addition to a fee paid for
such access, NSR and CSXT pay, based on usage, the costs incurred by
CRC to operate the Shared Assets Areas.
NS Rail's Consolidated Balance Sheet at June 30, 2001, includes
$97 million of liabilities related to the Conrail transaction,
principally for contractual obligations to Conrail employees imposed
by the Surface Transportation Board when it approved the transaction.
Through June 30, 2001, NS Rail has paid $70 million of these costs.
NS Rail provides certain general and administrative support functions
to Conrail, the fees for which are billed in accordance with several
service-provider arrangements. Any unpaid balance is included in
"Due from Conrail."
"Conrail rents and services" includes expenses for amounts due to PRR
and CRC for use by NSR of operating properties and equipment and
operation of the Shared Assets Areas.
"Notes and accounts payable to Conrail" includes $194 million at
June 30, 2001, and $51 million at Dec. 31, 2000, of interest-bearing
loans made to NS Rail by a PRR subsidiary, payable on demand. The
interest rate for these loans is variable and was 4.1 percent at
June 30, 2001. Also included is $91 million at June 30, 2001, and
$104 million at Dec. 31, 2000, due to PRR and CRC related to expenses
included in "Conrail rents and services," as discussed above.
Sales of Accounts Receivable
----------------------------
From Dec. 1, 1999, through April 30, 2000, NS Rail sold certain of
its rail accounts receivable, on a nonrecourse basis, to NS. Based
on the terms of the sale agreement, these sales were accounted for as
secured borrowings. The discount is included in "Other income
(expense) - net" in the Consolidated Statements of Income.
Effective May 2000, NS and NS Rail sold, without recourse, to a
bankruptcy-remote special-purpose NS subsidiary, a pool of accounts
receivable totaling approximately $700 million. The pool consisted
of receivables NS earlier had purchased from NS Rail (as described
above), and certain additional NS Rail receivables. NS Rail
services and collects all of the sold receivables on behalf of the
buyers; however, no servicing asset or liability has been recognized
because the benefits of servicing are estimated to be just adequate
to compensate NS Rail for its responsibilities. Payments collected
from sold receivables are remitted to the special-purpose NS
subsidiary, which, in turn, reinvests the amounts by purchasing new
receivables from NS Rail. NS Rail has no retained interest in the
sold receivables.
Under the terms of the new sale agreement, the receivables are
treated as sold and, accordingly, $615 million at June 30, 2001,
and $607 million at Dec. 31, 2000, of sold receivables are not
included on the NS Rail Consolidated Balance Sheets. Fees
associated with the sale, which are based on historical dilution
and prevailing interest rates, are included in "Other income
(expense) - net."
8
Item 1. Financial Statements. (continued)
- ------ --------------------
Intercompany Accounts
- ---------------------
June 30, 2001 Dec. 31, 2000
------------- -------------
Average Average
Interest Interest
Balance Rate Balance Rate
------- -------- ------- --------
($ in millions)
Due from NS:
Advances $ 184 4% $ 261 6%
Due to NS:
Notes (295) 5% (287) 8%
----- -----
Due to NS - net $ (111) $ (26)
===== =====
Interest is applied to certain advances at the average NS yield on
short-term investments and to the notes at specified rates. NS Rail's
results for the six months ended June 30 include interest income of
$13 million in 2001 and $7 million in 2000 and interest expense of
$8 million in 2001 and $60 million in 2000 (which includes the
discount on the sales of accounts receivable accounted for as
secured borrowings, as discussed under the heading "Sales of
Accounts Receivable," above) related to these intercompany accounts.
These amounts are included in "Other income (expense) - net."
Noncash Dividend
----------------
In May 2001, NS Rail declared and issued to NS a noncash dividend of
$183 million, which was settled by reduction of NS Rail's interest-
bearing advances due from NS. Noncash dividends are excluded from
the Consolidated Statements of Cash Flows.
Intercompany Federal Income Tax Accounts
----------------------------------------
In accordance with the NS Tax Allocation Agreement, intercompany
federal income tax accounts are recorded between companies in the
NS consolidated group. NS Rail had long-term intercompany federal
income tax payables (which are included in "Deferred income taxes"
in the Consolidated Balance Sheets) of $839 million at June 30, 2001,
and $819 million at Dec. 31, 2000.
5. Derivative Financial Instruments
On Jan. 1, 2001, NS Rail adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities" (SFAS 133), as amended by Statement of Financial
Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" (SFAS 138). The
Statements establish accounting and reporting standards for
derivative instruments and hedging activities, requiring that all
derivatives be recognized in the financial statements as either
assets or liabilities and that they be measured at fair value.
Changes in fair value are recorded as adjustments to the assets
or liabilities being hedged in "Other comprehensive income", or
in current earnings, depending on whether the derivative is
designated and qualifies for hedge accounting, the type of hedge
transaction represented and the effectiveness of the hedge. The
adoption of SFAS 133 and SFAS 138 resulted in the recognition of a
$5 million asset and a $5 million increase in long-term debt as of
Jan. 1, 2001.
NS Rail uses derivative financial instruments to reduce the risk of
volatility in its diesel fuel costs and to manage its overall
9
Item 1. Financial Statements. (continued)
- ------ --------------------
exposure to fluctuations in interest rates. NS Rail does not engage
in the trading of derivatives. NS Rail's management has determined
that its derivative financial instruments qualify as either fair-value
or cash-flow hedges, having values which highly correlate with the
underlying hedged exposures, and has designated such instruments as
hedging transactions. Credit risk related to the derivative financial
instruments is considered to be minimal and is managed by requiring
high credit standards for counterparties and periodic settlements.
Diesel Fuel Hedging
-------------------
During April 2001, NS Rail began a program to hedge a portion of its
diesel fuel consumption. Fuel costs in the second quarter represented
approximately 8 percent of NS Rail's operating expenses, and as a
result, fluctuations in the price of diesel fuel can significantly
affect its operating margins and profitability. The intent of the
program is to assist in the management of NS Rail's aggregate risk
exposure to fuel price fluctuations through the use of one or more
types of derivative instruments. The program provides that NS Rail
will not enter into any fuel hedges with a duration of more than
thirty-six months, and that no more than eighty percent of NS Rail's
average monthly fuel consumption will be hedged for each month within
any thirty-six month period.
NS Rail entered into two types of diesel fuel derivative transactions
during the second quarter of 2001. NS Rail's management has designated
these derivative instruments as cash-flow hedges of the exposure to
variability in expected future cash flows attributable to fluctuations
in diesel fuel prices. In April, NS Rail purchased eight monthly
options at a strike price of $0.84 per gallon of Nymex No. 2 heating
oil. The cost of the monthly options, which expire serially through
Dec. 31, 2001, is being amortized as a component of diesel fuel
expense, and because the price of diesel fuel did not reach the strike
price at any time during the second quarter, NS Rail has not recorded
any benefit related to these transactions. NS Rail also entered into
78 fuel swaps for approximately 163 million gallons at an average
price of approximately $0.74 per gallon of Nymex No. 2 heating oil.
As of June 30, 2001, outstanding swaps covered approximately 16 percent,
10 percent, and 4 percent of estimated fuel purchases for the remainder
of 2001 and for the years 2002 and 2003, respectively.
NS Rail has not recorded any ineffectiveness related to its use of
diesel fuel hedges through June 30, 2001. NS Rail's fuel hedging
activity resulted in a net increase in diesel fuel expense of
$0.6 million for the second quarter of 2001.
Interest Rate Hedging
---------------------
NS Rail manages its overall exposure to fluctuations in interest
rates by issuing both fixed and floating-rate debt instruments,
and by entering into interest rate hedging transactions. NS Rail
had $273 million, or 3.8 percent, and $294 million, or 4.5 percent,
of its fixed rate debt portfolio hedged at June 30, 2001 and
June 30, 2000, respectively, using interest rate swaps that qualify
for and are designated as fair-value hedge transactions. These swaps
have been effective in hedging the changes in fair value of the
related debt arising from changes in interest rates, and accordingly,
there has been no impact on earnings resulting from ineffectiveness
associated with these derivative transactions.
Fair Values
-----------
The fair values of NS Rail's diesel fuel derivative instruments at
June 30, 2001, were determined based upon current fair market values
as quoted by third party dealers. Fair values of interest rate swaps
were determined based upon the present value of expected future cash
flows discounted at the appropriate implied spot rate from the spot
rate yield curve. Fair value adjustments are noncash transactions,
and accordingly, are excluded from the Consolidated Statement of Cash
Flows. At June 30, 2001, Accumulated other comprehensive income, a
component of Stockholder's equity, includes $2 million relating to
the decrease in the fair value of the derivative fuel hedging
transactions that will terminate in 2001.
10
Item 1. Financial Statements. (continued)
- ------ --------------------
The asset and liability positions of NS Rail's outstanding derivative
financial instruments at June 30, 2001 and Dec. 31, 2000 were as follows:
June 30, Dec. 31,
2001 2000
---- ----
($ in millions)
Interest rate hedges:
Gross fair market asset position $ 7 $ --
Gross fair market (liability) position -- --
Fuel hedges:
Gross fair market asset position -- --
Gross fair market (liability) position (2) --
---- ----
Total net asset position $ 5 $ --
==== ====
6. Comprehensive Income
NS Rail's total comprehensive income was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2001 2000 2001 2000
---- ---- ---- ----
($ in millions)
Net income $ 83 $ 115 $ 145 $ 85
Other comprehensive income (loss) 51 6 97 (78)
----- ----- ----- -----
Total comprehensive income $ 134 $ 121 $ 242 $ 7
===== ===== ===== =====
For NS Rail, "Other comprehensive income (loss)" is the unrealized
gains and losses on certain investments in debt and equity securities,
principally NS common stock, and fair value adjustments to derivative
financial instruments.
11
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations.
-------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Management's Discussion and Analysis of Financial Condition
and Results of Operations
RESULTS OF OPERATIONS
Net Income
- ----------
Second-quarter net income was $83 million in 2001, down $32 million, or
28 percent, compared with the same period last year, reflecting higher
nonoperating expenses and lower income from railway operations. For the
first six months of 2001, net income was $145 million, compared with
$85 million for the first half of last year. Results in 2000 included
$62 million of after-tax costs related to actions taken to reduce the
size of the work force (see Note 3). Excluding the effects of last
year's work-force reduction costs, year-to-date net income decreased
$2 million, or 1 percent, as higher income from railway operations
largely offset higher nonoperating expenses.
Railway Operating Revenues
- --------------------------
Second-quarter railway operating revenues were $1.6 billion in 2001,
down $4 million, compared with last year. For the first six months,
railway operating revenues were $3.1 billion, up $26 million, or
1 percent, compared with last year. For both periods, the effects
of higher revenue per unit were offset, entirely for the quarter and
in part for the first six months, by lower traffic volume.
Second Quarter First Six Months
2001 vs. 2000 2001 vs. 2000
Increase (Decrease) Increase (Decrease)
------------------ ------------------
($ in millions) ($ in millions)
Traffic volume (carloads) $ (61) $ (82)
Revenue per unit/mix 57 108
------ ------
$ (4) $ 26
====== ======
Revenues and carloads for the commodity groups were as follows (prior year
data has been reclassified to conform to the current presentation):
Revenues
----------------------------------------------
Second Quarter Six Months
2001 2000 2001 2000
---- ---- ---- ----
($ in millions)
Coal $ 395 $ 377 $ 788 $ 724
General merchandise:
Automotive 244 249 458 490
Chemicals 191 195 379 380
Metals/construction 177 184 342 359
Paper/clay/forest 162 162 316 317
Agr./consumer prod./govt. 148 152 298 311
------ ------ ------ ------
General merchandise 922 942 1,793 1,857
Intermodal 233 235 471 445
------ ------ ------ ------
Total $ 1,550 $ 1,554 $ 3,052 $ 3,026
====== ====== ====== ======
12
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Carloads
----------------------------------------------
Second Quarter Six Months
2001 2000 2001 2000
---- ---- ---- ----
(In thousands)
Coal 437 436 876 858
General merchandise:
Automotive 173 189 325 372
Chemicals 111 116 218 230
Metals/construction 185 206 351 396
Paper/clay/forest 117 126 234 252
Agr./consumer prod./govt. 126 128 256 263
----- ----- ----- -----
General merchandise 712 765 1,384 1,513
Intermodal 538 555 1,081 1,062
----- ----- ----- -----
Total 1,687 1,756 3,341 3,433
===== ===== ===== =====
Coal
- ----
Coal revenues increased $18 million, or 5 percent, in the second quarter
and $64 million, or 9 percent, in the first six months, compared with the
same periods last year. Total tonnage handled increased 1 percent for the
quarter and 4 percent year-to-date, principally due to higher utility coal
volume that was somewhat offset by lower volume for domestic metallurgical
coal, coke and iron ore and export coal. Utility coal volume increased
9 percent in the quarter and 13 percent year-to-date. Growth moderated in
the quarter, reflecting milder weather and production problems at some mines.
Domestic metallurgical coal, coke and iron ore volume declined 21 percent
for the quarter and 25 percent for the first six months, principally due to
continued weakness in the steel-production industry. Export coal volume
decreased 19 percent in the quarter and 17 percent year-to-date, due in
part to high domestic prices, which is diverting coal from the export market.
Coal revenue per unit increased 4 percent in the quarter and 7 percent year-
to-date, reflecting utilization of higher capacity cars and longer hauls.
In addition, higher export rates resulting from the annual contract
negotiations began to take effect late in the quarter.
For the remainder of the year, coal revenues are expected to continue to
benefit from increased demand for electricity; however, milder weather in
NS Rail's service region has negated this favorable outlook early in the
third quarter.
General Merchandise
- -------------------
General merchandise revenues decreased $20 million, or 2 percent, in the
second quarter, and $64 million, or 3 percent, for the first six months,
compared with the same periods last year. Traffic volume (carloads)
declined 7 percent in the quarter and 9 percent year-to-date, as all
commodity groups posted decreases for both periods. Automotive traffic
volume was 9 percent lower in the quarter and 13 percent lower year-to-
date, reflecting continued production cutbacks in the face of the slow
economy. Metals and construction traffic volume declined 10 percent in
the quarter and 11 percent for the first six months, principally due to
the effects of the automotive slowdown and continued weakness in the steel
industry. Paper, clay and forest products traffic volume decreased
7 percent in both the quarter and year-to-date, largely due to production
cutbacks by paper producers, which were mitigated by increased lumber volume.
Chemicals traffic volume declined 4 percent for the quarter and 5 percent
year-to-date, reflecting continued weak demand. For both periods, higher
revenue per unit, largely the result of higher rates and favorable changes
in the mix of traffic, offset much of the effects of the traffic volume
decreases. Revenue per unit for the automotive group benefited from
13
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
improved yield associated with the redesign of the mixing center network
and changes in the type of equipment used on certain movements.
In spite of new business initiatives, general merchandise revenues are
expected to continue to post year-over-year declines in 2001 in view of
the very weak manufacturing and industrial sectors of the economy.
Intermodal
- ----------
Intermodal revenues decreased $2 million, or 1 percent, in the second
quarter, but increased $26 million, or 6 percent, for the first six months,
compared with the same periods last year. Growth in traffic volume (units)
weakened in the second quarter, declining 3 percent compared with last year,
as a 23 percent decrease in trailer volume more than offset a 3 percent
increase in container shipments. Second-quarter traffic volume was
uncharacteristically lower than that of the first quarter, reflecting the
continuation of weak economic conditions and an abundance of competing
truck capacity. For the year-to-date, shipments remained ahead of last year,
supported by a 10 percent increase in container traffic volume, which was
mitigated by a 20 percent decline in trailer traffic volume. Revenue per
unit increased for both periods, largely due to rate increases.
For the remainder of the year, intermodal revenues are expected to benefit
from new business and facility improvements; however, continued softness in
the economy could temper this positive outlook.
Railway Operating Expenses
- --------------------------
Second-quarter railway operating expenses were $1.3 billion, up $11 million,
or 1 percent, compared with last year. For the first six months, expenses
were $2.7 billion, down $117 million, or 4 percent. Expenses in 2000
included $101 million of work-force reduction costs in the first quarter
(see Note 3); excluding these costs, year-to-date 2001 expenses were down
$16 million, or 1 percent.
"Compensation and benefits" expenses decreased $114 million, or 23 percent,
in the second quarter and $270 million, or 26 percent, year-to-date,
excluding the first-quarter 2000 work-force reduction costs. Both
declines were primarily due to the effects of the management fee charged
by NS (see Note 4) and lower wages that resulted from last year's work-
force reductions. These decreases were somewhat offset by higher wage
rates and benefit costs for union employees and a lower pension credit.
"Materials, services and rents" expenses increased $136 million, or
39 percent, in the quarter and $278 million, or 40 percent, year-to-date,
principally due to the effects of the management fee. In addition,
higher mechanical and engineering costs and higher expenses for intermodal-
related purchased services were partially offset by lower equipment rents
and joint facility expenses.
"Conrail rents and services" expenses decreased $4 million, or 3 percent,
in the second quarter and $18 million, or 7 percent, year-to-date.
Both declines reflected lower costs in the Shared Assets Areas and lower
expenses for the rental of Conrail equipment.
"Diesel fuel" expenses were unchanged in the second quarter, but increased
$2 million, or 1 percent, for the first six months. For both periods,
consumption was lower (5 percent) and price per gallon was higher
(5 percent for the quarter and 7 percent for the year-to-date).
"Casualties and other claims" expenses increased $6 million, or
18 percent, in the second quarter and $11 million, or 17 percent, for the
first six months. Both comparisons reflected the absence of a premium
refund that benefited last year and adverse claims development. The
year-to-date also reflected higher costs related to derailments.
"Other" expenses decreased $16 million, or 18 percent, in the second
quarter and $24 million, or 14 percent, for the first six months.
Both declines reflected the effects of the management fee charged by NS,
14
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
lower property and sales and use taxes, and lower travel and relocation
costs.
The second-quarter railway operating ratio was 84.9 percent in 2001,
compared with 84.0 percent in 2000. For the first six months, the ratio
was 87.4 percent in 2001, compared with 88.6 percent in 2000 (excluding
the work-force reduction costs, which added 3.4 percentage points to
the ratio).
Other Income (Expense) - Net
- ----------------------------
"Other income (expense) - net" was an expense of $87 million in the second
quarter and $132 million for the first six months of 2001, compared with
expenses of $50 million for the second quarter and $83 million for the
first six months of 2000. The increases principally resulted from the
sales of accounts receivable (see Note 4).
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities, NS Rail's principal source of
liquidity, decreased significantly in the first six months of 2001,
compared with the same period last year. The decline resulted from:
(1) the absence of the proceeds received May 1, 2000, from the sales of
accounts receivable (see Note 4); (2) higher tax payments this year,
including the settlement of federal tax years 1995 and 1996; (3) the
timing of payments to Conrail, coupled with the absence of significant
one-time receipts that occurred in 2000; (4) the absence of bonus payments
in 2000; and (5) a litigation settlement payment this year. These items
were somewhat offset by higher operating income (excluding last year's
largely noncash work-force reduction costs) and the receipt of cash from a
non-recurring settlement. NS Rail's working capital deficit was
$1.2 billion at June 30, 2001, compared with $1.0 billion at Dec. 31,
2000. A working capital deficit is not unusual for NS Rail; it is expected
that NS Rail will continue to generate sufficient cash to meet its ongoing
obligations. In addition, NS currently has the capability to issue
commercial paper, the proceeds of which could be advanced to NS Rail, if
necessary, to meet its more immediate working capital needs.
Cash used for investing activities increased significantly in the first
six months of 2001, compared with the same period last year. The increase
resulted from a 26 percent rise in property additions, reflecting the
purchase of locomotives as compared to the absence of such a purchase in
the first half of 2000, somewhat offset by less track program work and
fewer freight car purchases.
Cash provided by financing activities in the first six months of 2001
included $174 million of proceeds from the sale of equipment trust
certificates. In addition, it reflected a $144 million net increase in
borrowings from PRR.
OTHER MATTERS
Labor Arbitration
- -----------------
Several hundred claims have been filed on behalf of NSR employees furloughed
after June 1, 1999, for various periods of time, alleging that the furloughs
were a result of the Conrail transaction and seeking "New York Dock" income
protection benefits. One labor organization has initiated arbitration on
behalf of approximately one hundred of these claimants. These claims likely
will be arbitrated in the fall of 2001. Management believes, based
on known facts and circumstances, including the availability of legal
defenses, that the amount of liability for claims currently in arbitration
should not have a material adverse effect on NS Rail's financial position,
results of operations or liquidity. Depending on the outcome of
the arbitration, other claims may be filed or progressed to arbitration.
Should all such claimants prevail, there could be a significant effect on
results of operations in a particular quarter.
15
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Labor Agreements
- ----------------
Substantially all of NS Rail's employees are covered by collective
bargaining agreements with 15 different labor unions. These agreements
remain in effect until changed pursuant to the Railway Labor Act.
Moratorium provisions in these agreements permitted NS Rail and
the unions to propose such changes in late 1999; negotiations at the
national level commenced shortly thereafter. The outcome of these
negotiations is uncertain. However, an agreement was reached with
the Brotherhood of Locomotive Engineers, which represents about 5,000
NS Rail employees, and a national agreement has been reached with the
Brotherhood of Maintenance of Way Employes, which represents about 4,500
NS Rail employees. In addition, tentative national agreements (subject
to ratification) have been reached with the International Brotherhood of
Electrical Workers, which represents about 1,000 NS Rail employees, and the
United Transportation Union, which represents about 7,500 NS Rail employees.
REQUIRED ACCOUNTING CHANGES
Effective Jan. 1, 2001, NS Rail adopted Statement of Financial Accounting
Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging
Activities and SFAS No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities" (see Note 5).
Effective April 1, 2001, NS Rail adopted SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," which replaced SFAS No. 125 of the same name. SFAS No. 140
revises the standards for accounting for securitizations and other transfers
of financial assets and requires certain disclosures, but carries over most
of the provisions of SFAS No. 125. NS Rail adopted the disclosure
requirements with its 2000 Annual Report; the remaining provisions of
SFAS No. 140 did not have a material effect on NS Rail's financial
statements.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements that may be identified by
the use of words like "believe," "expect," "anticipate" and "project."
Forward-looking statements reflect Management's good-faith evaluation of
information currently available. However, such statements are dependent on
and, therefore, can be influenced by, a number of external variables over
which Management has little or no control, including: domestic and
international economic conditions; the business environment in industries
that produce and consume rail freight; competition and consolidation within
the transportation industry; fluctuation in prices of key materials, in
particular diesel fuel; labor difficulties, including strikes and work
stoppages; legislative and regulatory developments; changes in securities
and capital markets; and natural events such as severe weather, floods and
earthquakes. Forward-looking statements are not, and should not be relied
upon as, a guaranty of future performance or results. Nor will they
necessarily prove to be accurate indications of the times at or by which
any such performance or results will be achieved. As a result, actual
outcomes and results may differ materially from those expressed in
forward-looking statements. The Company undertakes no obligation to update
or revise forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risks.
- ------ -----------------------------------------------------------
There has been no material change to the disclosures made under the
heading "Market Risks and Hedging Activities" on page 32 of the Company's
2000 Annual Report on Form 10-K. Additional information required by this
item is included in Part I, Item I, "Financial Statements" in Note 5 on
page 8.
16
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORFOLK SOUTHERN RAILWAY COMPANY
--------------------------------
(Registrant)
Date: Aug. 9, 2001 /s/ Reginald J. Chaney
------------ ------------------------------------------
Reginald J. Chaney
Corporate Secretary (Signature)
Date: Aug. 9, 2001 /s/ John P. Rathbone
------------ -------------------------------------------
John P. Rathbone
Vice President and Controller
(Principal Accounting Officer) (Signature)