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 MARCH 31, 2002
( ) 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
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(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (757) 629-2680
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No Change
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(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 March 31, 2002
----- --------------------------------
Common Stock (par value $1.00) 16,668,997
2
TABLE OF CONTENTS
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Page
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Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Statements of Income
Three Months Ended March 31, 2002 and 2001 3
Consolidated Balance Sheets
March 31, 2002, and December 31, 2001 4
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures
About Market Risks 19
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
3
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements.
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NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Income
($ in millions)
(Unaudited)
Three Months Ended
March 31,
------------------
2002 2001
---- ----
Railway operating revenues:
Coal $ 359 $ 393
General merchandise 869 871
Intermodal 229 238
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TOTAL RAILWAY OPERATING REVENUES 1,457 1,502
------- -------
Railway operating expenses:
Compensation and benefits 383 394
Materials, services and rents 453 486
Conrail rents and services (Note 3) 121 117
Depreciation 123 123
Diesel fuel 81 117
Casualties and other claims 35 37
Other 61 76
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TOTAL RAILWAY OPERATING EXPENSES 1,257 1,350
------- -------
Income from railway operations 200 152
Other income (expense) - net (52) (45)
Interest expense on debt (9) (8)
------- -------
Income before income taxes 139 99
Provision for income taxes 54 37
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NET INCOME $ 85 $ 62
======= =======
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)
March 31, 2002 Dec. 31, 2001
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 120 $ 167
Accounts receivable net of allowance for doubtful
accounts of $5 million (Note 3) 126 152
Due from Conrail (Note 3) 5 8
Materials and supplies 91 87
Deferred income taxes 155 153
Other current assets 85 98
------- -------
Total current assets 582 665
Investments (Note 5) 775 631
Properties less accumulated depreciation 10,742 10,672
Other assets 608 573
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TOTAL ASSETS $ 12,707 $ 12,541
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 788 $ 819
Income and other taxes 202 236
Due to NS - net (Note 3) 407 517
Notes and accounts payable to Conrail (Note 3) 83 373
Other current liabilities 123 134
Current maturities of long-term debt 92 88
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Total current liabilities 1,695 2,167
Long-term debt 798 780
Other liabilities 1,002 1,024
Due to Conrail (Note 3) 367 --
Minority interests 3 3
Deferred income taxes 3,842 3,746
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TOTAL LIABILITIES 7,707 7,720
------- -------
Stockholders' equity:
Serial preferred stock 55 55
Common stock 167 167
Additional paid-in capital 706 706
Accumulated other comprehensive income (Note 5) 310 215
Retained income 3,762 3,678
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TOTAL STOCKHOLDERS' EQUITY 5,000 4,821
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,707 $ 12,541
======= =======
See accompanying notes to Consolidated Financial Statements.
5
Item 1. Financial Statements. (continued)
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NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Cash Flows
($ in millions)
(Unaudited)
Three Months Ended
March 31,
------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 85 $ 62
Reconciliation of net income to net cash
provided by operating activities:
Depreciation 124 123
Deferred income taxes 29 (39)
Nonoperating gains on properties and investments (10) (7)
Changes in assets and liabilities affecting operations:
Accounts receivable 26 (1)
Materials and supplies (4) (1)
Other current assets and due from Conrail 27 69
Income tax liabilities (1) 23
Other short-term liabilities (43) (106)
Other - net (52) (52)
----- -----
Net cash provided by operating activities 181 71
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (179) (273)
Property sales and other transactions (9) 2
Investments, including short-term (22) (33)
Investment sales and other transactions -- 2
----- -----
Net cash used for investing activities (210) (302)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends (1) (1)
Advances to NS (112) --
Advances and repayments from NS 2 21
Proceeds from borrowings 133 258
Debt repayments (40) (20)
----- -----
Net cash provided by (used for)
financing activities (18) 258
----- -----
Net increase (decrease) in cash
and cash equivalents (47) 27
CASH AND CASH EQUIVALENTS:
At beginning of year 167 --
----- -----
At end of period $ 120 $ 27
===== =====
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of amounts capitalized) $ 13 $ 34
Income taxes $ 27 $ 60
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 March 31, 2002, and its results of operations
and cash flows for the three months ended March 31, 2002 and 2001.
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 (b) any Current Reports on Form 8-K.
2. Commitments and Contingencies
Lawsuits
--------
NSR and certain subsidiaries are defendants in numerous lawsuits and
other claims relating principally to railroad operations. When
management concludes that it is probable that a liability has been
incurred and the amount of the liability can be reasonably estimated,
it is accrued through a charge to expenses.
Presently, there are cases involving labor issues where the aggregated
range of loss could be from nothing to $40 million. Management believes
that NS Rail will prevail in these cases; however, an unfavorable
outcome could result in accruals that could be significant to results
of operations in a particular year or quarter.
Casualty Claims
---------------
NS Rail is generally self-insured for casualty claims. Claims in
excess of self-insurance levels are insured up to excess coverage
limits. The casualty claims liability is determined actuarially, based
upon claims filed and an estimate of claims incurred but not yet
reported. While the ultimate amount of claims incurred is dependent
on future developments, in management's opinion, the recorded
liability is adequate to cover the future payments of claims. However,
it is possible that the recorded liability may not be adequate to cover
the future payments of claims. Adjustments to the recorded liability
will be reflected in operating expenses in the periods in which such
adjustments are known.
Environmental Matters
---------------------
NS Rail is subject to various jurisdictions' environmental laws and
regulations. It is NS Rail's policy to record a liability where such
liability or loss is probable and its amount can be estimated
reasonably. Claims, if any, against third parties for recovery of
cleanup costs incurred by NS Rail are reflected as receivables in the
balance sheet and are not netted against the associated NS Rail
liability. Environmental engineers regularly participate in ongoing
evaluations of all identified sites and in determining any necessary
adjustments to initial liability estimates. NS Rail also has
established an Environmental Policy Council, composed of senior
managers, to oversee and interpret its environmental policy.
NS Rail's balance sheets included liabilities for environmental
exposures in the amount of $30 million at March 31, 2002, and
$33 million at Dec. 31, 2001 (of which $8 million was accounted for as
a current liability for each period). At March 31, 2002, the
liability represented NS Rail's estimate of the probable cleanup and
remediation costs based on available information at 123 identified
locations. On that date, 10 sites accounted for $16 million of the
liability, and no individual site
7
Item 1. Financial Statements. (continued)
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was considered to be material. NS Rail anticipates that much of this
liability will be paid out over five years; however, some costs will be
paid out over a longer period.
At some of the 123 locations, certain NS Rail subsidiaries, usually in
conjunction with a number of other parties, have been identified as
potentially responsible parties by the Environmental Protection Agency
(EPA) or similar state authorities under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980, or
comparable state statutes, which often impose joint and several
liability for cleanup costs.
With respect to known environmental sites (whether identified by
NS Rail or by the EPA or comparable state authorities), estimates of
NS Rail's ultimate potential financial exposure for a given site or
in the aggregate for all such sites are necessarily imprecise because
of the widely varying costs of currently available cleanup techniques,
the likely development of new cleanup technologies, the difficulty of
determining in advance the nature and full extent of contamination and
each potential participant's share of any estimated loss (and that
participant's ability to bear it) and evolving statutory and regulatory
standards governing liability.
The risk of incurring environmental liability - for acts and omissions,
past, present and future - is inherent in the railroad business. Some
of the commodities in NS Rail's traffic mix, particularly those
classified as hazardous materials, can pose special risks that NS Rail
and its subsidiaries work diligently to minimize. In addition, several
NS Rail subsidiaries own, or have owned, land used as operating
property, or which is leased or may have been leased and operated by
others, or held for sale. Because environmental problems may exist on
these properties that are latent or undisclosed, there can be no
assurance that NS Rail will not incur environmentally related
liabilities or costs with respect to one or more of them, the amount
and materiality of which cannot be estimated reliably at this time.
Moreover, lawsuits and claims involving these and other now-
unidentified environmental sites and matters are likely to arise from
time to time. The resulting liabilities could have a significant
effect on financial condition, results of operations or liquidity in
a particular year or quarter.
However, based on its assessments of the facts and circumstances now
known, Management believes that it has recorded the probable costs
for dealing with those environmental matters of which the Corporation
is aware. Further, Management believes that it is unlikely that any
identified matters, either individually or in the aggregate, will
have a material adverse effect on NS Rail's financial position,
results of operations or liquidity.
Purchase Commitments
--------------------
At March 31, 2002, NS Rail had outstanding purchase commitments of
approximately $60 million in connection with its 2002 capital program.
NS Rail had forward fuel purchase commitments for the remainder of 2002
covering 51 million gallons of fuel at an average cost of 63 cents per
gallon, which includes federal taxes.
3. 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. NS charges NS Rail a fee for management
services it performs for NS Rail (which totaled $146 million and
included a $9 million mark-up in the first quarter of 2002 and totaled
$144 million and included a $9 million markup in the first quarter of
2001). In addition, NS charges NS Rail a revenue-based
8
Item 1. Financial Statements. (continued)
- ------ --------------------
licensing fee (which totaled $21 million in each of the first quarters
of 2002 and 2001) for use of certain intangible assets owned by NS.
NS Rail owns 21,169,125 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.
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 CRXT. 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 March 31, 2002, included $70
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
March 31, 2002, NS Rail has paid $99 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 and amount to approximately $6 million
annually.
"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.
A significant portion of payments made to PRR is borrowed back from a
PRR subsidiary. Previously, these loans were made under a global demand
note; however, in the first quarter of 2002, the PRR subsidiary
exchanged this demand note for a new global note due in 2032. As a
result, borrowings owed to the PRR subsidiary now comprise the
noncurrent balance "Due to Conrail." The interest rate for these loans
is variable and was 2.66 percent at March 31, 2002. The current
balance "Due to Conrail" at March 31, 2002, is composed of amounts
related to expenses included in "Conrail rents and services," as
discussed above. At Dec. 31, 2001, the current balance "Due to
Conrail" included $72 million of such amounts and $301 million of
advances owed under the previous demand note.
Sales of Accounts Receivable
----------------------------
NS Rail sells, without recourse, to a bankruptcy-remote special-purpose
NS subsidiary, a pool of accounts receivable. 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 sale agreement, the receivables are treated as
sold and, accordingly, $562 million at March 31, 2002, and $534 million
at Dec. 31, 2001, of sold receivables are not included on the NS Rail
Consolidated Balance
9
Item 1. Financial Statements. (continued)
- ------ --------------------
Sheets. Fees associated with the sale, which totaled $67 million and
$68 million in each of the first quarters of 2002 and 2001,
respectively, are based on historical dilution and prevailing interest
rates and are included in "Other income (expense) - net."
Intercompany Accounts
---------------------
March 31, 2002 Dec. 31, 2001
-------------- -------------
Average Average
Interest Interest
Balance Rate Balance Rate
------- -------- ------- --------
($ in millions)
Due from NS:
Advances $ 68 2% $ 68 2%
Due to NS:
Notes (475) 3% (585) 3%
----- -----
Due to NS - net $ (407) $ (517)
===== =====
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
first quarter results include interest income of $3 million in each of
2002 and 2001 and interest expense of $3 million in 2002 and $4 million
in 2001 related to these intercompany accounts. These amounts are
included in "Other income (expense) - net."
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 $876 million at March 31, 2002, and
$871 million at Dec. 31, 2001.
4. Derivative Financial Instruments
NS Rail uses derivative financial instruments to reduce the risk of
volatility in its diesel fuel costs and to manage its overall 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
-------------------
In second quarter 2001, NS Rail began a program to hedge a portion of
its diesel fuel consumption. The intent of the program is to assist in
the management of NS Rail's aggregate risk exposure to fuel price
fluctuations, which can significantly affect NS Rail's operating margins
and profitability, through the use of one or more types of derivative
instruments. Diesel fuel costs represented approximately 6 percent and
9 percent of NS Rail's operating expenses for first quarter 2002 and
2001, respectively. 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.
10
Item 1. Financial Statements. (continued)
- ------ --------------------
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. During first
quarter 2002 NS Rail entered into 72 fuel swaps for approximately
101 million gallons at an average price of approximately $0.61 per
gallon of Nymex No. 2 heating oil. As of March 31, 2002, outstanding
swaps covered approximately 42 percent, 32 percent, and 2 percent of
estimated fuel purchases for the remainder of 2002 and for the years
2003 and 2004, respectively.
NS Rail's fuel hedging activity resulted in a net increase in diesel
fuel expense of $4 million for the first quarter 2002. Ineffectiveness
related to the use of diesel fuel hedges was approximately $1 million
for the quarter.
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 $243
million, or 36.3 percent, and $251 million, or 36.7 percent, of its
fixed rate debt portfolio hedged at March 31, 2002 and Dec. 31, 2001,
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
March 31, 2002 and Dec. 31, 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. "Accumulated other comprehensive
income," a component of "Stockholders' equity," includes $10 million
(pretax) of unrealized gains at March 31, 2002, and $15 million (pretax)
of unrealized losses at Dec. 31, 2001, related to the fair value of
derivative fuel hedging transactions that will terminate within twelve
months of the respective dates.
The asset and liability positions of NS Rail's outstanding derivative
financial instruments at March 31, 2002 and Dec. 31, 2001 were as
follows:
March 31, Dec. 31,
2002 2001
---- ----
($ in millions)
Interest rate hedges:
Gross fair market asset position $ 10 $ 12
Fuel hedges:
Gross fair market asset position 16 --
Gross fair market (liability) position (1) (19)
---- ----
Total net asset (liability) position $ 25 $ (7)
==== ====
11
Item 1. Financial Statements. (continued)
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5. Comprehensive Income
NS Rail's total comprehensive income was as follows:
Three Months Ended
March 31,
------------------
2002 2001
---- ----
($ in millions)
Net income $ 85 $ 62
Other comprehensive income 95 46
----- -----
Total comprehensive income $ 180 $ 108
===== =====
For NS Rail, "Other comprehensive income" is the unrealized gains and
losses on certain investments in debt and equity securities,
principally NS common stock, and amounts related to cash flow hedges.
12
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations.
-------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
RESULTS OF OPERATIONS
Net Income
- ----------
First-quarter net income was $85 million in 2002, up $23 million, or
37 percent, compared with first quarter last year. The improvement was
primarily the result of a 32 percent increase in income from railway
operations, which was driven by lower railway operating expenses.
Railway Operating Revenues
- --------------------------
First-quarter railway operating revenues were $1.5 billion in 2002, down
$45 million, or 3 percent, compared with 2001. As shown in the following
table, the decline was primarily the result of lower traffic volume.
First Quarter
2002 vs. 2001
Increase (Decrease)
------------------
($ in millions)
Traffic volume (carloads) $ (43)
Revenue per unit/mix (2)
------
$ (45)
======
Revenues and carloads for the commodity groups were as follows:
Revenues Carloads
2002 2001 2002 2001
---- ---- ---- ----
($ in millions) (In thousands)
Coal $ 359 $ 393 398 439
General merchandise:
Automotive 228 214 163 152
Chemicals 186 188 104 107
Metals/construction 160 165 162 166
Paper/clay/forest 141 154 105 117
Agr./consumer prod./govt. 154 150 125 130
----- ----- ----- -----
General merchandise 869 871 659 672
Intermodal 229 238 549 543
----- ----- ----- -----
Total $1,457 $1,502 1,606 1,654
===== ===== ===== =====
13
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Coal
- ----
Coal revenues decreased $34 million, or 9 percent, in the first quarter,
compared with the same period of last year. Total tonnage handled declined
9 percent, reflecting lower utility volume, compared with a strong first
quarter of 2001, and continued weakness in export coal traffic. Lower
utility volume principally resulted from reduced demand that reflected a
mild winter, higher stockpiles and lower natural gas prices (resulting in
more power generation at gas-fired plants). The decline in export volume
was primarily the result of high coal prices and weak demand.
In the near term, coal revenues are expected to be comparable to those of
last year and to post year-over-year increases later in the year as utilities
deplete their stockpiles.
General Merchandise
- -------------------
First-quarter general merchandise revenues decreased $2 million in 2002,
compared with the first quarter of 2001. Traffic volume (carloads) declined
2 percent, as all commodity groups except automotive posted decreases.
Paper/clay/forest traffic volume was 10 percent lower, reflecting continued
weakness in the paper market. Agriculture/consumer products/government
traffic volume dropped 4 percent, primarily a result of fewer shipments of
fertilizers, grains and feed. Chemicals traffic volume decreased 3 percent,
largely because of reduced industrial demand. Metals/construction traffic
volume fell 3 percent, reflecting less construction shipments. Automotive
posted the only increase in traffic volume, up 7 percent, a result of
stronger-than-expected light vehicle production. General merchandise
revenue per unit increased 2 percent, driven by a 7 percent increase in the
agriculture/consumer products/government commodity group that reflected a
favorable change in the mix of traffic (more longer-haul shipments).
General merchandise revenues are not expected to post year-over-year
improvements until later in the year, when a stronger economy is
anticipated.
Intermodal
- ----------
First-quarter intermodal revenues decreased $9 million, or 4 percent, in
2002, compared with the first quarter of 2001. Revenue per unit declined
5 percent, reflecting the absence of fuel surcharges that were in place in
2001, market-driven rate reductions (largely a result of excess truck
capacity) and a change in the mix of traffic (less trailer shipments, which
have a higher revenue per unit). Intermodal traffic volume increased
1 percent, as a 4 percent increase in container shipments and a 6 percent
gain in Triple Crown volume more than offset a 14 percent decline in
trailer shipments, which reflects the conversion of trailer traffic to
containers. Traffic volume continued to benefit from new business supported
by the recently completed expansion of the intermodal network and service
improvements.
Intermodal revenues are expected to continue to benefit from continued
improvements in service and the terminal capacity added in 2001.
Railway Operating Expenses
- --------------------------
First-quarter railway operating expenses were $1.3 billion in 2002, down
$93 million, or 7 percent, compared with first quarter 2001.
Compensation and benefits expenses decreased $11 million, or 3 percent, in
the first quarter, as lower payrolls and reduced payroll taxes more than
offset higher health and welfare benefit costs, lower pension income and
higher wage rates.
14
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Materials, services and rents decreased $33 million, or 7 percent, in the
first quarter, reflecting lower equipment rents and reduced expenses for
materials, primarily for locomotive and car repairs. These lower costs were
partially offset by higher expenses for volume-related purchased services.
Conrail rents and services expenses increased $4 million, or 3 percent, in
the first quarter, reflecting a slight increase in operating fees and
lease rentals.
Depreciation expense was unchanged in the first quarter, as lower rates
implemented as a result of a recently completed depreciation study offset the
effects of property additions.
Diesel fuel expenses decreased $36 million, or 31 percent, in the first
quarter, a result of a 27 percent drop in the average price per gallon and a
6 percent reduction in consumption.
Other expense decreased $15 million, or 20 percent, in the first quarter,
due to a reduction to prior years' property tax accruals, reflecting a
first-quarter settlement, and a favorable bad debt settlement.
Other Income (Expense) - Net
- ----------------------------
Other income (expense) - net was an expense of $52 million in the first
quarter of 2002, $7 million higher than in the first quarter of 2001. The
increase was principally the result of the absence of a $13 million gain
from a nonrecurring settlement that benefited 2001.
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities, NS Rail's principal source of
liquidity, was $181 million in the first quarter of 2002, compared with
$71 million in the first quarter of 2001. The increase was principally the
result of lower tax payments (2001 included the settlement of federal tax
years 1995 and 1996) and the timing of payrolls and Conrail payments. A
significant portion of payments made to PRR (which are included in
"Conrail rents and services" and, therefore, are a use of cash in "Cash
provided by operating activities") are borrowed back from a PRR subsidiary
and, therefore, are a source of cash in "Proceeds from borrowings."
NS Rail's net cash flow from these borrowings amounted to $66 million in
the first quarter of 2002 and $79 million in the first quarter of 2001.
NS Rail's working capital deficit was $1.1 billion at March 31, 2002,
compared with $1.5 billion at Dec. 31, 2001. The improvement was
principally the result of the change in the terms of the global note under
which NS Rail borrows funds from the PRR subsidiary (see Note 3) and a
reduction in the net amount due to NS.
NS Rail looks to NS to provide needed funding. NS currently has the
capability to increase the amount of accounts receivable being sold under
its revolving sale program. Over the last twelve months, the amount of
receivables NS could sell under this program ranged from $359 million to
$468 million. Moreover, NS has a $1 billion credit facility, which expires
in 2006, that it can borrow under or use to support commercial paper debt.
However, any reduction in its credit rating could limit NS' ability to
access the commercial paper markets.
15
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
As the major NS subsidiary, NS Rail provides funding to service NS' debt.
NS' debt at March 31, 2002, totaled $6.7 billion. Of this debt,
$1.5 billion is due between 2002 and 2006.
NS Rail expects to generate sufficient cash flow from operations to meet its
ongoing obligations. This expectation is based on the view that the economy
will remain flat in the second quarter and resume growth in the third and
fourth quarters.
Cash used for investing activities decreased significantly in the first
quarter of 2002, compared with the first quarter of 2001. The decline was
principally the result of lower capital expenditure driven by fewer
locomotive purchases.
Cash flows from financing activities were a use of $18 million quarter of
2002, compared with a source of $258 million in the first quarter of 2001,
reflecting a decrease in equipment financing and an increase in advances to
NS. First-quarter 2002 financing activities included loan transactions with
a PRR subsidiary that resulted in net borrowings of $66 million and proceeds
from the sale of equipment trust certificates that amounted to $52 million.
Financing activities in the first quarter of 2001 included $174 million of
proceeds from the sale of equipment trust certificates and $79 million of net
borrowings from the PRR subsidiary. Advances to NS typically account for
most of the cash used for financing requirements and reflect NS' requirements.
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 100 of these claimants. Management believes, based
on known facts and circumstances, including the availability of legal
defenses, that the amount of liability for these claims 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.
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 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 at this time. However, agreements
have been reached with the Brotherhood of Maintenance of Way Employes, which
represents about 4,400 NS employees, and with the Brotherhood of Locomotive
Engineers, which represents about 5,000 NS employees. In addition, a
tentative national agreement (subject to ratification) has been reached with
the United Transportation Union, which represents about 7,000 NS employees.
Market Risks and Hedging Activities
- -----------------------------------
NS Rail uses derivative financial instruments to reduce the risk of volatility
in its diesel fuel costs and to manage its overall exposure to fluctuations in
interest rates.
16
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
As of March 31, 2002, through swap transactions and advance purchases, NS Rail
has hedged approximately 56 percent of expected diesel fuel requirements for
the remainder of 2002. The effect of the hedges is to yield an average cost
of 70 cents per hedged gallon, including federal taxes and transportation.
A 10 percent decrease in diesel fuel prices would reduce NS Rail's asset
related to the swaps by approximately $21 million.
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 to achieve an appropriate mix within its
debt portfolio. NS Rail's debt subject to interest rate exposure totaled
$457 million at March 31, 2002. A 1 percent increase in interest rates
would increase NS Rail's total annual interest expense related to all its
variable debt by approximately $5 million. Management considers it unlikely
that interest rate fluctuations applicable to these instruments will result
in a material adverse effect on NS Rail's financial position, results of
operations or liquidity.
The capital leases, which carry an average fixed rate of 7.1 percent, were
effectively converted to variable rate obligations using interest rate swap
agreements. On March 31, 2002, the average pay rate under these agreements
was 2.7 percent, and the average receive rate was 7.1 percent. A portion of
the lease obligations is payable in Japanese yen. NS Rail eliminated the
associated exchange rate risk at the inception of each lease with a yen
deposit sufficient to fund the yen-denominated obligation. Most of these
deposits are held by foreign banks, primarily Japanese. As a result, NS Rail
is exposed to financial market risk relative to Japan. Counterparties to the
interest rate swaps and Japanese banks holding yen deposits are major
financial institutions believed by management to be creditworthy.
Environmental Matters
- ---------------------
NS Rail is subject to various jurisdictions' environmental laws and
regulations. It is NS Rail's policy to record a liability where such
liability or loss is probable and its amount can be estimated reasonably.
Claims, if any, against third parties for recovery of cleanup costs incurred
by NS Rail are reflected as receivables (when collection is probable) in the
balance sheet and are not netted against the associated NS Rail liability.
Environmental engineers regularly participate in ongoing evaluations of all
identified sites and in determining any necessary adjustments to initial
liability estimates. NS Rail also has established an Environmental Policy
Council, composed of senior managers, to oversee and interpret its
environmental policy.
Operating expenses for environmental matters totaled approximately $2 million
and $3 million in first quarter 2002 and 2001, respectively. Capital
expenditures totaled approximately $2 million in each quarter.
NS Rail's balance sheets included liabilities for environmental exposures in
the amount of $30 million at March 31, 2002, and $33 million at Dec. 31, 2001
(of which $8 million was accounted for as a current liability in each period).
At March 31, 2002, the liability represented NS Rail's estimate of the
probable cleanup and remediation costs based on available information at
123 identified locations. On that date, 10 sites accounted for $16 million
of the liability, and no individual site was considered to be material. NS
Rail anticipates that much of this liability will be paid out over five years;
however, some costs will be paid out over a longer period.
17
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
At some of the 123 locations, certain NS Rail subsidiaries, usually in
conjunction with a number of other parties, have been identified as
potentially responsible parties by the Environmental Protection Agency (EPA)
or similar state authorities under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, or comparable state statutes, which
often impose joint and several liability for cleanup costs.
With respect to known environmental sites (whether identified by NS or by
the EPA or comparable state authorities), estimates of NS Rail's ultimate
potential financial exposure for a given site or in the aggregate for all
such sites are unavoidably imprecise because of the widely varying costs of
currently available cleanup techniques, the likely development of new cleanup
technologies, the difficulty of determining in advance the nature and full
extent of contamination and each potential participant's share of any
estimated loss (and that participant's ability to bear it), and evolving
statutory and regulatory standards governing liability.
The risk of incurring environmental liability -- for acts and omissions,
past, present and future -- is inherent in the railroad business. Some of
the commodities in NS Rail's traffic mix, particularly those classified as
hazardous materials, can pose special risks that NS Rail and its
subsidiaries work diligently to minimize. In addition, several NS Rail
subsidiaries own, or have owned, land used as operating property, or which
is leased or may have been leased and operated by others, or held for sale.
Because environmental problems that are latent or undisclosed may exist on
these properties, there can be no assurance that NS Rail will not incur
environmental liabilities or costs with respect to one or more of them, the
amount and materiality of which cannot be estimated reliably at this time.
Moreover, lawsuits and claims involving these and other unidentified
environmental sites and matters are likely to arise from time to time. The
resulting liabilities could have a significant effect on financial condition,
results of operations or liquidity in a particular year or quarter.
However, based on an assessment of known facts and circumstances, management
believes that it is unlikely that any known matters, either individually or
in the aggregate, will have a material adverse effect on NS Rail's financial
position, results of operations or liquidity.
Critical Accounting Policies
- ----------------------------
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, the disclosure
of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
Management reviews these estimates and assumptions based on historical
experience, changes in the business environment and other factors that
management believes to be reasonable under the circumstances. Actual results
could differ materially from these estimates and assumptions.
Critical accounting policies are defined as those that are both important to
the portrayal of NS Rail's financial condition and results of operations and
require management to exercise significant judgments. NS Rail's critical
accounting policies included those addressing the recoverability and useful
lives of assets and the estimation of liabilities and loss expenses for
litigation, environmental remediation, casualty claims, income taxes,
pensions and postretirement benefits.
NS Rail's investment in rail and other track material is depreciated
primarily on the basis of use as measured by gross-ton miles. Other assets
are depreciated using straight-line rates. The assumptions supporting
these depreciation rates, including those of expected useful lives and
salvage values, are based on a periodic review of historical retirement
patterns and experience, taking into account any change in operations.
Actual results could differ from these estimates due to changes in
18
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
retirement or maintenance patterns, the introduction of new technology, or
other changes in the expected usage of certain assets. In addition, NS Rail
reviews the carrying amount of properties whenever events or changes in
circumstances indicate that such carrying amount may not be recoverable
based on estimates of future undiscounted cash flows or net realizable
value. These estimates may change based on changes in circumstances,
including actual cash flows generated, changes in market conditions and
recent asset sales.
NS Rail's estimates of liabilities and loss expenses related to lawsuits and
environmental remediation are evaluated on a case by case basis. These
estimates are based on known facts and circumstances and reflect
management's best estimate of loss. Future developments could materially
change these estimates. Casualty reserves are established using an
actuarial review of historical loss experience and expected exposure
information. Changes in either could materially affect the recorded
liability.
NS Rail is included in the consolidated federal tax return of NS. NS Rail
records income tax expense and the associated liabilities on a separate
company basis based upon estimates of current tax exposure together with
an assessment of the effect of differing treatments of certain items for
tax and accounting purposes, which result in deferred tax assets and
liabilities. The valuation of these assets includes an assessment of the
likelihood that they will be recovered from future taxable income. Changes
in these assessments and estimates may occur from the passage of new tax
laws, resolution of audit issues, changes in the level of taxable income
and changes in the tax jurisdictions in which NS Rail operates.
The accounting for NS Rail's pension and postretirement benefit programs
is based on a number of assumptions that are reviewed periodically.
These include a weighted average discount rate, a health care cost trend
rate, a long-term rate of return on benefit plan assets and the rate of
increase to future compensation levels. These assumptions are affected
by changes in interest rates, actual health care cost experience and
projected cost trends, the actual performance of plan assets and changes
in compensation levels or policies.
REQUIRED ACCOUNTING CHANGE
NS Rail's adoption of Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which was
effective Jan. 1, 2002, did not have a material effect on its 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.
19
Item 3. Quantitative and Qualitative Disclosures About Market Risks.
- ------ -----------------------------------------------------------
The information required by this item is included in Part I, Item 2,
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" on page 15 under the heading "Market Risks and Hedging
Activities."
20
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K.
- ------ --------------------------------
None
21
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: April 24, 2002 /s/ Reginald J. Chaney
-------------- ------------------------------------------
Reginald J. Chaney
Corporate Secretary (Signature)
Date: April 24, 2002 /s/ John P. Rathbone
-------------- ------------------------------------------
John P. Rathbone
Vice President and Controller
(Principal Accounting Officer) (Signature)