NSC

Norfolk Southern Corp. 2004 Annual Report (10-K) Summary

Business Context and Reporting Period

Company: Norfolk Southern Corporation (NS)
Reporting Period: Fiscal year ended December 31, 2004
Business Overview: NS is a Class I railroad operating approximately 21,300 miles of track across 22 states, the District of Columbia, and parts of Canada. The company transports raw materials, intermediate products, and finished goods, with major commodity groups including coal (24% of revenue), general merchandise (55%), and intermodal (21%).
Key Event: On August 27, 2004, NS completed the "Conrail Corporate Reorganization," establishing direct ownership of Pennsylvania Lines LLC (PRR) assets previously held by Conrail, while retaining a joint venture with CSX for the Shared Assets Areas.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased $844 million (13%) driven by a 9% rise in carloadings (603,000 units) and higher average revenue per unit. Intermodal revenue grew 24%, coal revenue grew 15%, and general merchandise revenue grew 9%.
• Profitability: Net income surged 73% to $923 million. This was aided by a $53 million non-cash gain from the Conrail Corporate Reorganization and the absence of a $107 million voluntary separation program charge and an $84 million telecommunications asset impairment charge that impacted 2003 results.
• Operating Efficiency: The operating ratio improved significantly to 76.7% from 83.5% in 2003. Operating expenses grew only 4% despite a 9% increase in volume, reflecting improved productivity and the absence of 2003 separation costs.
• Balance Sheet: Total assets increased by $4.1 billion, primarily due to the fair value recording of PRR assets ($8.3 billion) acquired in the Conrail reorganization. Long-term debt increased slightly, but the debt-to-total capitalization ratio improved to 48.5%.

Guidance, Outlook, and Risks

• Outlook: Management expects business levels to continue growing in 2005 but at a more modest pace than 2004. Capital spending is budgeted at $938 million for 2005.
• Rate Cases: NS is involved in ongoing proceedings with Duke Energy and Carolina Power & Light regarding coal tariff rates. While the Surface Transportation Board (STB) found rates reasonable in October 2004, customers have appealed and requested phasing constraints. Management estimates the ultimate resolution but notes uncertainty regarding potential retroactive or prospective adjustments.
• Subsequent Event: A derailment occurred in Graniteville, SC, on January 6, 2005. NS expects operating expenses related to this incident to be between $30 million and $40 million (pretax) in the first quarter of 2005.
• Market Risks: Diesel fuel costs remain a significant variable. NS has hedged 36% of its 2005 diesel fuel requirements at an average price of 83 cents per gallon. No new hedges have been entered since May 2004 due to high market prices.
• Accounting Changes: NS will adopt SFAS No. 123 (revised) in the third quarter of 2005, requiring the expensing of stock options, which will impact future net income.

Investor Verification Checklist

• Conrail Reorganization Impact: Verify the long-term operational and financial integration of the PRR assets and the ongoing status of the Shared Assets Areas joint venture with CSX.
• Coal Rate Litigation: Monitor the status of the Duke Energy and CP&L rate cases and any potential retroactive rate adjustments or phasing constraints ordered by the STB or courts.
• Graniteville Derailment: Track the actual costs incurred in Q1 2005 related to the Graniteville incident and any potential fines or penalties not covered by insurance.
• Fuel Hedging Strategy: Assess the impact of rising diesel prices on margins given that NS has not entered new hedges since May 2004 and has limited coverage for the remainder of 2005.
• Stock-Based Compensation: Review the pro forma impact of the upcoming adoption of SFAS 123(R) on future earnings per share.