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 number 1-8339
NORFOLK SOUTHERN CORPORATION
- --------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 52-1188014
- ----------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
Three Commercial Place
Norfolk, Virginia 23510-2191
- ----------------------------------- ---------------------------------
(Address of principal Zip Code
executive offices)
Registrant's telephone number, including area code (757) 629-2680
----------------------
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 $1.00) 388,088,216 (excluding 21,169,125
shares held by registrant's
consolidated subsidiaries)
2
TABLE OF CONTENTS
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Page
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Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Statements of Income
Three Months Ended March 31, 2002 and 2001 3
Consolidated Balance Sheets
March 31, 2002 and Dec. 31, 2001 4
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures
About Market Risks 21
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
3
PART I. FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements.
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NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
($ in millions except per share amounts)
(Unaudited)
Three Months Ended
March 31,
------------------
2002 2001
---- ----
Railway operating revenues:
Coal $ 359 $ 393
General merchandise 869 871
Intermodal 270 276
------ ------
TOTAL RAILWAY OPERATING REVENUES 1,498 1,540
------ ------
Railway operating expenses:
Compensation and benefits 523 519
Materials, services and rents 339 372
Conrail rents and services (Note 4) 113 105
Depreciation 127 127
Diesel fuel 81 117
Casualties and other claims 35 37
Other 43 58
------ ------
TOTAL RAILWAY OPERATING EXPENSES 1,261 1,335
------ ------
Income from railway operations 237 205
Other income - net 34 27
Interest expense on debt (134) (141)
------ ------
Income from continuing operations
before income taxes 137 91
Provision for income taxes 51 30
------ ------
Income from continuing operations 86 61
Discontinued operations - gain on sale of
motor carrier, net of taxes (Note 3) -- 13
------ ------
NET INCOME $ 86 $ 74
====== ======
Per share amounts (Note 8):
Income from continuing operations,
basic and diluted $ 0.22 $ 0.16
Net income, basic and diluted $ 0.22 $ 0.19
Dividends $ 0.06 $ 0.06
See accompanying notes to Consolidated Financial Statements.
4
Item 1. Financial Statements. (continued)
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NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
($ in millions)
(Unaudited)
March 31, Dec. 31,
2002 2001
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 164 $ 204
Accounts receivable, net (Note 6) 615 475
Due from Conrail (Note 4) 5 8
Materials and supplies 94 90
Deferred income taxes 169 162
Other current assets 95 108
------ ------
Total current assets 1,142 1,047
Investment in Conrail (Note 4) 6,167 6,161
Properties less accumulated depreciation 11,280 11,208
Other assets 1,052 1,002
------ ------
TOTAL ASSETS $19,641 $19,418
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 828 $ 848
Income and other taxes 271 312
Due to Conrail (Note 4) 83 373
Other current liabilities 291 248
Current maturities of long-term debt 410 605
------ ------
Total current liabilities 1,883 2,386
Long-term debt (Note 5) 7,246 7,027
Other liabilities 1,061 1,089
Due to Conrail (Note 4) 367 --
Minority interests 45 45
Deferred income taxes 2,828 2,781
------ ------
TOTAL LIABILITIES 13,430 13,328
------ ------
Stockholders' equity:
Common stock $1.00 per share par value, 1,350,000,000
shares authorized; issued 409,257,341 and
407,000,871 shares, respectively 409 407
Additional paid-in capital 465 423
Accumulated other comprehensive loss (Note 9) (40) (55)
Retained income 5,397 5,335
Less treasury stock at cost, 21,169,125 shares (20) (20)
------ ------
TOTAL STOCKHOLDERS' EQUITY 6,211 6,090
------ ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $19,641 $19,418
====== ======
See accompanying notes to Consolidated Financial Statements.
5
Item 1. Financial Statements. (continued)
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NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
($ in millions)
(Unaudited)
Three Months Ended
March 31,
------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 86 $ 74
Reconciliation of net income to net cash
provided by operating activities:
Depreciation 131 130
Deferred income taxes 28 (36)
Equity in earnings of Conrail (8) (12)
Gains and losses on properties and investments (28) (9)
Income from discontinued operations -- (13)
Changes in assets and liabilities affecting operations:
Accounts receivable (140) (28)
Materials and supplies (4) (2)
Other current assets and due from Conrail 28 68
Current liabilities other than debt 25 --
Other - net (55) (54)
------ ------
Net cash provided by operating activities 63 118
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (189) (294)
Property sales and other transactions (7) 10
Investments, including short-term (21) (35)
Investment sales and other transactions 11 2
------ ------
Net cash used for investing activities (206) (317)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends (23) (23)
Common stock issued - net 35 4
Proceeds from borrowings 133 1,275
Debt repayments (42) (1,003)
------ ------
Net cash provided by financing activities 103 253
------ ------
Net increase (decrease) in cash and
cash equivalents (40) 54
CASH AND CASH EQUIVALENTS:
At beginning of year 204 --
------ ------
At end of period $ 164 $ 54
====== ======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of amounts capitalized) $ 79 $ 82
Income taxes $ 27 $ 62
See accompanying notes to Consolidated Financial Statements.
6
Item 1. Financial Statements. (continued)
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NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES
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 Corporation'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 Corporation's latest
Annual Report on Form 10-K and (b) any Current Reports on Form 8-K.
2. Commitments and Contingencies
Lawsuits
--------
Norfolk Southern 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 two cases, one involving labor issues and the
other involving contractual obligations of a fiber optic codeveloper,
where the aggregated range of loss could be from nothing to $75 million.
Management believes that NS will prevail in these cases. The ability
to collect the $37 million receivable from the codeveloper, Williams
Communications, LLC, may be limited due to its declining financial
condition; however, the shortfall, if any, cannot now be determined.
Its parent, Williams Communications Group, Inc., filed in April 2002
a voluntary petition for reorganization under Chapter 11 of the U.S.
Bankruptcy Code. However, Williams Communications, LLC, was not
included in the bankruptcy petition. Unfavorable outcomes on these
cases could result in accruals that could be significant to results of
operations in a particular year or quarter.
Casualty Claims
---------------
NS 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 payment 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 is subject to various jurisdictions' environmental laws and
regulations. It is NS' 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 are reflected as receivables in the
balance sheet and are not netted against the associated NS liability.
Environmental engineers regularly participate in ongoing evaluations
of all identified sites and in determining any necessary adjustments
to initial liability estimates. NS also has established an
Environmental Policy Council, composed of senior managers, to oversee
and interpret its environmental policy.
NS' 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
7
Item 1. Financial Statements. (continued)
- ------ --------------------
liability for each period). At March 31, 2002, the liability
represented NS' 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 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 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'
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' traffic mix, particularly those classified as
hazardous materials, can pose special risks that NS and its subsidiaries
work diligently to minimize. In addition, several NS 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 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 assessment 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' financial position, results of
operations or liquidity.
Purchase Commitments
--------------------
At March 31, 2002, NS had outstanding purchase commitments of
approximately $60 million in connection with its 2002 capital program.
NS 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. Discontinued Operations
On March 28, 1998, NS sold all the common stock of North American Van
Lines, Inc., its motor carrier subsidiary. First-quarter 2001 results
include an additional after-tax gain of $13 million, or 3 cents per
share, that resulted from the expiration of certain indemnities
contained in the sales agreement.
8
Item 1. Financial Statements. (continued)
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4. Investment in Conrail and Operations Over Its Lines
Overview
--------
Norfolk Southern and CSX Corporation (CSX) jointly own Conrail Inc.
(Conrail), whose primary subsidiary is Consolidated Rail Corporation
(CRC), the major freight railroad in the Northeast. From time to time,
Norfolk Southern and CSX, as the indirect owners of Conrail, may need
to make capital contributions, loans or advances to Conrail.
Operations of Conrail's Lines
-----------------------------
Norfolk Southern's railroad subsidiary, Norfolk Southern Railway Company
(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 access, NSR and CSXT pay, based on usage, the costs
incurred by CRC to operate the Shared Assets Areas.
Investment in Conrail
---------------------
NS is applying the equity method of accounting to its investment in
Conrail in accordance with APB Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock." NS is amortizing the
excess of the purchase price over Conrail's net equity using the
principles of purchase accounting, based primarily on the estimated
remaining useful lives of Conrail's property and equipment, including
the related deferred tax effect of the differences in tax and
accounting bases for certain assets. At March 31, 2002, the difference
between NS' investment in Conrail and its share of Conrail's
underlying net equity was $3.8 billion.
NS' Consolidated Balance Sheet at March 31, 2002 includes $73 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 has paid $116 million of these costs.
Related-Party Transactions
--------------------------
NS 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: (1) expenses for amounts due to
PRR and CRC for use by NSR of operating properties and equipment and
operation of the Shared Assets Areas and (2) NS' equity in the earnings
of Conrail, net of amortization.
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
9
Item 1. Financial Statements. (continued)
- ------ --------------------
discussed above. At Dec. 31, 2001, the current balance "Due to
Conrail" included $72 million of such amounts and $301 million of
advances owed under the previous demand note.
Summary Financial Information - Conrail
---------------------------------------
The following summary financial information should be read in
conjunction with Conrail's audited financial statements, included
as Exhibit 99 with NS' 2001 Annual Report on Form 10-K.
Summarized Consolidated Statements of Income - Conrail
------------------------------------------------------
Three Months Ended
March 31,
------------------
2002 2001
---- ----
($ in millions)
(Unaudited)
Operating revenues $ 225 $ 233
Operating expenses 164 169
------ ------
Operating income 61 64
Other income (expense) - net (5) (8)
------ ------
Income before income taxes 56 56
Provision for income taxes 20 11
------ ------
Net income $ 36 $ 45
====== ======
Summarized Consolidated Balance Sheets - Conrail
------------------------------------------------
March 31, Dec. 31,
2002 2001
---- ----
($ in millions)
(Unaudited)
Assets:
Current assets $ 325 $ 846
Noncurrent assets 7,788 7,236
------- -------
Total assets $ 8,113 $ 8,082
======= =======
Liabilities and stockholders' equity:
Current liabilities $ 449 $ 408
Noncurrent liabilities 3,523 3,569
Stockholders' equity 4,141 4,105
------- -------
Total liabilities and stockholders' equity $ 8,113 $ 8,082
======= =======
10
Item 1. Financial Statements. (continued)
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5. Long-Term Debt
At March 31, 2002, $200 million of Notes that mature May 1, 2002, was
classified as long term because NS had the ability and the intent to
refinance that amount of that obligation on a long-term basis.
6. Sales of Accounts Receivable
A bankruptcy-remote special purpose subsidiary of NS sells without
recourse undivided ownership interests in a pool of accounts receivable.
The buyers have a priority collection interest in the entire pool of
receivables, and as a result, NS has retained credit risk to the extent
the pool of receivables exceeds the amount sold. NS services and
collects the 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 for its
responsibilities. Payments collected from sold receivables can be
reinvested in new accounts receivable on behalf of the buyers.
Should NS' credit rating drop below investment grade, the buyers have
the right to discontinue this reinvestment.
Accounts receivable sold under this arrangement, and therefore not
included in "Accounts receivable, net" on the Consolidated Balance
Sheets, were $150 million at March 31, 2002, and $300 million at
Dec. 31, 2001. The fees associated with the sale, which are based on
the buyers' financing costs, are included in "Other income - net."
NS' retained interest, which is included in "Accounts receivable, net"
is recorded at fair value using estimates of dilution based on NS'
historical experience. These estimates are adjusted regularly based on
NS' actual experience with the pool, including defaults and credit
deterioration. NS has experienced very low levels of default, and as
a result, little dilution. If historical dilution percentages were to
increase one percentage point, the value of NS' retained interest
would be reduced by approximately $6 million.
NS' allowance for doubtful accounts was $5 million at March 31, 2002
and Dec. 31, 2001.
7. Derivative Financial Instruments
NS 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 does not engage in the trading
of derivatives. NS' 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 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' aggregate risk exposure to fuel price
fluctuations, which can significantly affect NS' 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' operating expenses for first quarter 2002 and
2001, respectively. The program provides that NS 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' average monthly fuel
consumption will be hedged for each month within any thirty-six
month period.
11
Item 1. Financial Statements. (continued)
- ------ --------------------
NS' 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 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' 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 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 had $243 million, or
3.4 percent, and $251 million, or 3.5 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' 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 loss," a component of
"Stockholders' equity," includes $10 million (pretax) of unrealized gains
at March 31, 2002, and $15 million (pretax) of unrealized losses at
Dec. 31, 2001, related to the fair value of derivative fuel hedging
transactions that will terminate within twelve months of the respective
dates.
The asset and liability positions of NS' outstanding derivative
financial instruments at March 31, 2002 and Dec. 31, 2001 were
as follows:
March 31, Dec. 31,
2002 2001
---- ----
($ 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)
==== ====
12
Item 1. Financial Statements. (continued)
- ------ --------------------
8. Earnings Per Share
The following table sets forth the reconciliation of the number of
weighted-average shares outstanding used in the calculations of basic
and diluted earnings per share:
Three Months Ended
March 31,
------------------
2002 2001
---- ----
(In millions)
Weighted-average shares
outstanding 387.2 384.5
Dilutive effect of outstanding options
and performance share units (as
determined by the application of the
treasury stock method) 2.5 0.3
----- -----
Diluted weighted-average
shares outstanding 389.7 384.8
===== =====
The calculations exclude options on 24 million shares in 2002 and
28 million shares in 2001 because their exercise price exceeded the
average market price of Common Stock for the period. There are no
adjustments to "Net income" or "Income from continuing operations" for
the diluted earnings per share computations.
9. Comprehensive Income
NS' total comprehensive income was as follows:
Three Months Ended
March 31,
------------------
2002 2001
---- ----
($ in millions)
Net income $ 86 $ 74
Other comprehensive income (loss) 15 (1)
------ ------
Total comprehensive income $ 101 $ 73
====== ======
For NS, "Other comprehensive income (loss)" includes amounts related to
cash flow hedges and unrealized gains and losses on certain investments
in debt and equity securities. "Other comprehensive income (loss)" in
2002 includes a $6 million net-of-tax reclassification adjustment
related to the gain realized on the sale of an investment.
13
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations.
-------------------------
NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
RESULTS OF OPERATIONS
Net Income
- ----------
First-quarter net income was $86 million in 2002, up $12 million, or
16 percent, compared with first quarter last year. Results in 2001 included
a $13 million gain related to the 1998 sale of NS' former motor carrier
subsidiary (see Note 3). Excluding that gain, which is reported as
"Discontinued operations," net income increased $25 million, or 41 percent.
The improvement was primarily the result of a 16 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
$42 million, or 3 percent, compared with 2001. As shown in the following
table, the decline was the result of lower traffic volume.
First Quarter
2002 vs. 2001
Increase (Decrease)
-------------------
($ in millions)
Traffic volume (carloads) $ (44)
Revenue per unit/mix 2
-------
$ (42)
=======
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 270 276 549 543
------ ------ ------ ------
Total $ 1,498 $ 1,540 1,606 1,654
====== ====== ====== ======
14
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 $6 million, or 2 percent,
in 2002, compared with the first quarter of 2001. Revenue per unit declined
3 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
$74 million, or 6 percent, compared with first quarter 2001.
Compensation and benefits expenses increased $4 million, or 1 percent,
in the first quarter, as higher health and welfare benefit costs, lower
pension income, higher wage rates and higher stock-based incentive
compensation more than offset lower payrolls and reduced payroll taxes.
15
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Materials, services and rents decreased $33 million, or 9 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 $8 million, or 8 percent, in
the first quarter, reflecting lower Conrail earnings that were largely
attributable to the absence of a favorable adjustment to Conrail's state
tax liabilities that benefited 2001.
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 26 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 - Net
- ------------------
Other income - net was $7 million higher in the first quarter of 2002,
compared with the same period of 2001. The increase was the result of a
$10 million gain from the sale of an investment, more gains from property
sales and lower accounts receivable sales fees. These favorable items more
than offset the absence of a $13 million gain from a nonrecurring settlement
that benefited 2001.
Provision for Income Taxes
- --------------------------
The effective income tax rate was 37.2 percent in the first quarter,
compared with 33.0 percent for the same period last year. Excluding NS'
equity in Conrail's after-tax earnings, the first-quarter effective rates
were 39.5 percent in 2002 and 38.0 percent in 2001.
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities, NS' principal source of liquidity, was
$63 million in the first quarter of 2002, compared with $118 million in the
first quarter of 2001. The decline was the result of a reduction in the
amount of accounts receivable sold, which was offset, in part, by lower tax
payments (2001 included the settlement of federal tax years 1995 and 1996)
and the timing of payrolls and Conrail payments. The amount of accounts
receivable sold was reduced $150 million in the first quarter of 2002 versus
a $6 million reduction in the first quarter of 2001. NS expects to increase
the amount sold to generate some of the funds needed to repay debt maturing
in May. 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' 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' working capital deficit was $741 million at March 31, 2002, compared with
$1.3 billion at Dec. 31, 2001. The improvement was principally the result of
the change in the terms of the global note under which NS borrows funds from
the PRR subsidiary (see Note 4) and the reduction in current maturities of
long-term debt (see Note 5). The debt that matures May 1, 2002, is expected
to be paid using proceeds from new borrowings and the sale of accounts
receivable and cash on hand. NS has issued only $250 million of debt under
its $1 billion shelf registration that became effective in April 2001.
16
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
NS currently has the capability to increase the amount of accounts
receivable being sold under the revolving sale program to meet its more
immediate working capital needs. 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.
NS 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 provided by financing activities declined in the first quarter of 2002,
compared with the first quarter of 2001, reflecting a decrease in equipment
financing. 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 the
issuance of Notes and the pay-down of commercial paper, each amounting to
approximately $1 billion, $174 million of proceeds from the sale of equipment
trust certificates and $79 million of net borrowings from the PRR subsidiary.
NS' debt-to-total capitalization ratio (excluding the notes payable to the
PRR subsidiary) was 55.2 percent at March 31, 2002, and 55.6 percent at
Dec. 31, 2001.
CONRAIL'S RESULTS OF OPERATIONS, FINANCIAL CONDITION AND LIQUIDITY
Conrail's first-quarter net income was $36 million in 2002, down $9 million,
or 20 percent, compared with the same period last year. The decline
reflected a favorable adjustment to state tax reserves that benefited
results in 2001.
Conrail's first-quarter operating revenues were $225 million, down $8 million,
or 3 percent, compared with the same period last year. The decline reflected
lower operating fees, largely a result of reduced operating costs in the
Shared Assets Areas and lower revenues at Conrail's Indiana Harbor Belt
subsidiary.
Conrail's first-quarter operating expenses were $164 million, down $5 million,
or 3 percent, compared with the same period last year, reflecting lower
expenses for compensation and benefits and materials, services and rents.
Conrail's working capital deficit was $124 million at March 31, 2002,
compared with working capital of $438 million at Dec. 31, 2001. The change
was largely the result of the exchange of the demand notes receivable from
NS and CSX for new long-term notes. Conrail is expected to have sufficient
cash flow to meet its ongoing obligations.
NS' first-quarter equity in earnings of Conrail, net of amortization, was
$8 million in 2002 and $12 million in 2001.
17
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
OTHER MATTERS
Telecommunications Subsidiary
- -----------------------------
NS' subsidiary, Thoroughbred Technology and Telecommunications, Inc.
(T-Cubed), is codeveloping fiber optic infrastructure with members of the
telecommunications industry. This industry has experienced a severe
downturn. During 2001, one of T-Cubed's codevelopers filed for protection
under Chapter 11 of the U.S. Bankruptcy Code and foreign laws. This
codeveloper owes T-Cubed amounts for work performed on joint projects;
however, based on known facts and circumstances, management believes that
such amounts ultimately will be realized. T-Cubed is engaged in contract
litigation with a second codeveloper concerning the latter's obligation to
purchase fiber optic infrastructure installed by T-Cubed between Cleveland,
Ohio, and northern Virginia. Management expects to prevail in this
litigation. The ability to collect a judgment against the codeveloper,
Williams Communications, LLC, may be limited due to its declining financial
condition; however, the shortfall, if any, cannot now be determined. Its
parent, Williams Communications Group, Inc., filed in April 2002 a voluntary
petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code.
However, Williams Communications, LLC, was not included in the bankruptcy
petition.
As a result of changes in the values of telecommunications assets, T-Cubed
is monitoring its carrying amount of these assets, as required by
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." To date, based on the known facts and circumstances, management
believes that its ultimate investment in these assets will be recovered and,
accordingly, no impairment has been recognized.
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' 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
- ----------------
Approximately 85 percent of NS' railroad 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 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.
As of March 31, 2002, through swap transactions and advance purchases, NS
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.
18
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
A 10 percent decrease in diesel fuel prices would reduce NS' asset related
to the swaps by approximately $21 million.
NS 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.
Of NS' total debt outstanding at March 31, 2002, all is fixed-rate debt, except
for most capital leases, $250 million of notes due in 2003 and $215 million of
equipment obligations. As a result, NS' debt subject to interest rate exposure
totaled $707 million at March 31, 2002. A 1 percent increase in interest rates
would increase NS' total annual interest expense related to all its variable
debt by approximately $7 million. Management considers it unlikely that
interest rate fluctuations applicable to these instruments will result in a
material adverse effect on NS' 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 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
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 is subject to various jurisdictions' environmental laws and regulations.
It is NS' 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 are
reflected as receivables (when collection is probable) in the balance
sheet and are not netted against the associated NS liability. Environmental
engineers regularly participate in ongoing evaluations of all identified
sites and in determining any necessary adjustments to initial liability
estimates. NS 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' 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' 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
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 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.
19
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
With respect to known environmental sites (whether identified by NS or by
the EPA or comparable state authorities), estimates of NS' 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' traffic mix, particularly those classified as
hazardous materials, can pose special risks that NS and its subsidiaries
work diligently to minimize. In addition, several NS 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 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' 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' financial condition and results of
operations and require management to exercise significant judgments.
NS' critical accounting policies include those addressing the
recoverability and useful lives of assets and the estimation of
liabilities and loss exposures for litigation, environmental
remediation, casualty claims, income taxes, pensions and
postretirement benefits.
NS' 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. NS' amortization of its investment in
Conrail is based principally on estimates of the expected remaining
useful lives of Conrail's property and equipment. Actual results
could differ from these estimates due to changes in retirement or
maintenance patterns, the introduction of new technology, or other
changes in the expected usage of certain assets. In addition,
NS 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
20
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
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' estimates of liabilities and loss exposures 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 records income tax expense and the associated liabilities 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 operates.
The accounting for NS' 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' 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.
21
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 17 under the heading "Market Risks and
Hedging Activities."
22
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K.
- ------ --------------------------------
None
23
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 CORPORATION
----------------------------------
(Registrant)
Date: April 24, 2002 /s/ Dezora M. Martin
-------------- -----------------------------------
Dezora M. Martin
Corporate Secretary (Signature)
Date: April 24, 2002 /s/ John P. Rathbone
-------------- -----------------------------------
John P. Rathbone
Senior Vice President and Controller
(Principal Accounting Officer) (Signature)