BURLINGTON NORTHERN RAILROAD CO - 10-Q Quarterly 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. Yes ü No

	Three Months Ended June 30,						Six Months Ended June 30,
	2002			2001			2002			2001
Revenues	$	2,206		$	2,269		$	4,366		$	4,561
Operating expenses:
Compensation and benefits		696			694			1,410			1,423
Purchased services		279			274			553			536
Depreciation and amortization		231			230			461			458
Equipment rents		179			190			355			377
Fuel		207			246			391			503
Materials and other		210			209			427			420

Total operating expenses		1,802			1,843			3,597			3,717

Operating income		404			426			769			844
Interest expense		38			42			79			87
Interest (income) expense, related parties		(4	)		(4	)		(9	)		(11	)
Other (income) expense, net		(18	)		(3	)		(39	)		33

Income before income taxes		388			391			738			735
Income tax expense		148			143			280			273

Net income	$	240		$	248		$	458		$	462

	June 30, 2002		December 31, 2001
ASSETS
Current assets:
Cash and cash equivalents	$	154	$	78
Accounts receivable, net		197		227
Materials and supplies		217		191
Current portion of deferred income taxes		327		306
Other current assets		165		21

Total current assets		1,060		823
Property and equipment, net		23,450		23,056
Other assets		889		853
Intercompany notes receivable, net		722		708

Total assets	$	26,121	$	25,440


LIABILITIES AND STOCKHOLDER’S EQUITY
Current liabilities:
Accounts payable and other current liabilities	$	1,851	$	1,857
Long-term debt due within one year		291		288

Total current liabilities		2,142		2,145
Long-term debt		2,063		2,076
Deferred income taxes		7,003		6,723
Casualty and environmental liabilities		368		423
Employee merger and separation costs		184		216
Other liabilities		1,052		1,032

Total liabilities		12,812		12,615

Commitments and contingencies (see notes 2 and 7)
Stockholder’s equity:
Common stock, $1 par value (1,000 shares authorized, issued and outstanding) and paid-in capital		6,286		6,286
Retained earnings		7,007		6,549
Accumulated other comprehensive income (deficit)		16		(10	)

Total stockholder’s equity		13,309		12,825

Total liabilities and stockholder’s equity	$	26,121	$	25,440

	Six Months Ended June 30,
	2002			2001
Operating Activities:
Net income	$	458		$	462
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		461			458
Deferred income taxes		243			139
Employee merger and separation costs paid		(31	)		(27	)
Other, net		(104	)		23
Changes in current assets and liabilities:
Accounts receivable, net		30			26
Materials and supplies		(15	)		6
Other current assets		(108	)		37
Accounts payable and other current liabilities		(31	)		(175	)

Net cash provided by operating activities		903			949

Investing Activities:
Capital expenditures		(641	)		(637	)
Other, net		(103	)		(14	)

Net cash used for investing activities		(744	)		(651	)

Financing Activities:
Payments on long-term debt		(70	)		(68	)
Net (increase) decrease in intercompany notes receivables, net		(14	)		270
Cash dividends paid		—			(358	)
Other, net		1			1

Net cash used for financing activities		(83	)		(155	)

Increase in cash and cash equivalents		76			143
Cash and cash equivalents:
Beginning of period		78			123

End of period	$	154		$	266

Supplemental cash flow information:
Interest paid, net of amounts capitalized	$	83		$	89
Income taxes paid, net of refunds		129			161

The consolidated financial statements should be read in conjunction with The Burlington Northern and Santa Fe Railway Company (BNSF Railway or Company) Annual Report on Form 10-K for the year ended December 31, 2001, including the financial statements and notes thereto. BNSF Railway is a wholly-owned subsidiary of Burlington Northern Santa Fe Corporation (BNSF), and is the principal operating subsidiary of BNSF. The consolidated financial statements include the accounts of BNSF Railway and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for the entire year. In the opinion of management, all adjustments (consisting of only normal recurring adjustments, except as disclosed) necessary to present fairly BNSF Railway’s consolidated financial position as of June 30, 2002 and the results of operations for the three and six month periods ended June 30, 2002 and 2001 have been included.

In December 2001, a wholly-owned subsidiary of BNSF, Burlington Northern Santa Fe British Columbia, Ltd. (BNSF BC) was transferred to BNSF Railway. For accounting purposes, the transfer of BNSF BC to BNSF Railway was treated as a combination of subsidiaries for the periods BNSF Railway and BNSF BC were under common control. Accordingly, the consolidated statements of income and cash flows for the quarter and six months ended June 30, 2001 have been adjusted to include the results of BNSF BC.

On January 1, 2001, BNSF Railway adopted Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, and recorded a cumulative transition benefit of $56 million, net of tax, to Accumulated Other Comprehensive Income (AOCI). The standard requires that all derivatives be recorded on the balance sheet at fair value and establishes criteria for documentation and measurement of hedging activities.

The Company currently uses derivatives to hedge against increases in diesel fuel prices and to convert a portion of its fixed-rate long-term debt to floating-rate debt. The Company formally documents the relationship between the hedging instrument and the hedged item, as well as the risk management objective and strategy for the use of the hedging instrument. This documentation includes linking the derivatives that are designated as fair value or cash flow hedges to specific assets or liabilities on the balance sheet, commitments or forecasted transactions. The Company assesses at the time a derivative contract is entered into, and at least quarterly, whether the derivative item is effective in offsetting the changes in fair value or cash flows. Any change in fair value resulting from ineffectiveness, as defined by SFAS No. 133, is recognized in current period earnings. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is recorded in AOCI as a separate component of stockholder’s equity and reclassified into earnings in the period during which the hedge transaction affects earnings.

Fuel costs for the first six months of 2002 and 2001 represented 11 percent and 14 percent, respectively, of total operating expenses. Due to the significance of diesel fuel expenses to the operations of BNSF Railway and the historical volatility of fuel prices, the Company maintains a program to hedge against fluctuations in the price of its diesel fuel purchases. The intent of the program is to protect the Company’s operating margins and overall profitability from adverse fuel price changes by entering into fuel-hedge instruments based on management’s evaluation of current and expected diesel fuel price trends. However, to the extent the Company hedges portions of its fuel purchases, it may not realize the impact of decreases in fuel prices. Conversely, to the extent the Company does not hedge portions of its fuel purchases, it may be adversely affected by increases in fuel prices. Based on annualized fuel consumption during the first six months of 2002 and excluding the impact of the hedging program, each one-cent increase in the price of fuel would result in approximately $11 million of additional fuel expense on an annual basis.

The fuel-hedging program includes the use of derivatives that are accounted for as cash flow hedges. As of June 30, 2002, BNSF Railway had entered into fuel swap agreements utilizing Gulf Coast #2 heating oil to hedge the equivalent of approximately 296 million gallons of diesel fuel for the second half of 2002, at an average price of approximately 58 cents per gallon. The Company also entered into fuel swap agreements utilizing West Texas Intermediate (WTI) crude oil to hedge the equivalent of approximately 101 million and 88 million gallons (2.4 million and 2.1 million barrels) of diesel fuel for 2003 and 2004, respectively, at an average price of $20.58 per barrel. Additionally, as of June 30, 2002, BNSF Railway had entered into costless collar agreements, effective through 2002, utilizing Gulf Coast #2 heating oil to hedge the equivalent of approximately 32 million gallons of diesel fuel at an average cap price of approximately 64 cents per gallon and an average floor price of approximately 56 cents per gallon. The above prices do not include taxes, transportation costs, certain other fuel handling costs, and any differences which may occur between the prices of commodities hedged and the purchase price of BNSF Railway’s diesel fuel, which typically range between 10 and 20 cents per gallon. As of June 30, 2002, BNSF Railway’s fuel-hedging program covered approximately 58 percent, 8 percent and 7 percent of estimated fuel purchases for the remainder of 2002, 2003 and 2004, respectively. Hedge positions are closely monitored to ensure that they will not exceed actual fuel requirements in any period.

As a result of adopting SFAS No. 133, the Company recorded a cumulative transition benefit of $56 million, net of tax, to AOCI related to deferred gains on fuel hedging transactions as of January 1, 2001. Subsequent changes in fair value for the effective portion of derivatives qualifying as hedges are recognized in Other Comprehensive Income (OCI) until the purchase of the related hedged item is recognized in earnings, at which time changes in fair value previously recorded in OCI are reclassified to earnings and recognized in fuel expense. During the second quarter of 2002, the Company recognized a gain of approximately $400 thousand related to the ineffective portion of derivatives in fuel expense. At June 30, 2002, AOCI includes a pretax gain of $38 million, all of which relates to derivative transactions that will expire through 2004. Settled fuel-hedging contracts are a $9 million receivable and a $3 million payable at June 30, 2002 and December 31, 2001, respectively, recorded in working capital.

BNSF Railway measures the fair value of swaps from data provided by various external counterparties. To value a swap, the Company uses a three-month average of forward Gulf Coast #2 heating oil prices or WTI crude oil prices for the period hedged. The fair value of costless collars is calculated and provided by the corresponding counterparties.

From time to time, the Company enters into various interest rate hedging transactions for the purpose of converting a portion of its fixed-rate long-term debt to floating-rate debt. The Company uses interest rate swaps as part of its interest rate risk management strategy. These swaps are accounted for as fair value hedges under SFAS 133. They qualify for the short cut method of recognition and, therefore, no portion of these swaps is treated as ineffective.

As of June 30, 2002, BNSF Railway had entered into one swap on a notional amount of $100 million in which it pays a floating rate, which fluctuates quarterly, based on LIBOR. The floating rate to be paid by BNSF Railway as of June 30, 2002, was 6.19 percent and the fixed rate BNSF Railway is to receive is 8.63 percent. This swap will expire in 2004. The fair value of this swap at June 30, 2002, was $2 million.

BNSF Railway’s comprehensive income, net of tax, was $258 million and $484 million for the three and six months ended June 30, 2002, respectively, compared with $247 million and $495 million for the three and six months ended June 30, 2001, respectively. BNSF Railway’s comprehensive income includes net income and adjustments to the minimum pension liability, as well as changes related to derivatives that qualify for cash flow hedge accounting. The change in Accumulated Other Comprehensive Income, net of tax, for the three and six months ended June 30, was as follows:

Delaware		41-6034000
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Class		Shares Outstanding at June 30, 2002
Common stock, $1.00 par value		1,000 shares