NSC

Norfolk Southern Corp. Q1 2003 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2003 for Norfolk Southern Corporation, a major freight railroad operator. The company operates its own rail system and jointly owns Conrail Inc. (58% economic interest) with CSX Corporation. The financial statements are unaudited but have been reviewed by independent accountants.

Key Financial Metrics

Note: Net Income for Q1 2003 includes a $114 million non-cash gain from accounting changes and a $10 million gain from discontinued operations.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 4% ($63 million) driven by a 2% increase in traffic volume and a 3% increase in revenue per unit/mix. General merchandise revenues rose 6%, while coal revenues declined 1% due to export shortfalls and weather delays.
• Expense Increases: Operating expenses rose 5% ($69 million). Diesel fuel expenses increased 28% ($23 million) due to higher prices, though hedging provided a $26 million benefit. Casualty and claims expenses surged 46% ($16 million) due to derailments and personal injury claims.
• Accounting Changes: The adoption of SFAS No. 143 (Asset Retirement Obligations) and FIN No. 46 (Variable Interest Entities) resulted in a cumulative net adjustment of $114 million to net income. This change lowered depreciation expense but increased other operating expenses.
• Cash Flow: Operating cash flow improved significantly to $133 million from $63 million, largely due to a smaller reduction in accounts receivable sold compared to the prior year.

Guidance, Outlook, and Risks

• Outlook: Management expects coal revenues to strengthen in Q2 as utility stockpiles deplete, with H2 2003 coal revenues comparable to 2002. General merchandise revenues are expected to weaken in Q2 due to lower vehicle production but remain comparable to 2002 for the remainder of the year. Intermodal revenues are expected to benefit from service improvements and truck-to-rail conversion.
• Liquidity: The company maintains a working capital deficit of $840 million, primarily due to current debt maturities. Significant debt payments of $250 million are due in July 2003 and February 2004. Management expects to meet obligations via operating cash flow, cash on hand, and borrowings from the Conrail subsidiary.
• Market Risks:
  • Fuel: 68% of 2003 diesel fuel requirements are hedged at an average cost of 75 cents per gallon. A 10% drop in fuel prices would reduce the asset value of swaps by approximately $30 million.
  • Interest Rates: $917 million of debt is subject to interest rate fluctuations. A 1% rate increase would raise annual interest expense by approximately $9 million.
• Contingencies:
  • Legal: A $36 million judgment against codeveloper Williams Communications is on appeal; collection is uncertain due to the defendant's financial condition. Labor arbitration regarding "New York Dock" benefits could result in losses up to $75 million if NS does not prevail.
  • Environmental: Liabilities for environmental exposures are estimated at $28 million across 113 known locations.

Investor Verification Checklist

• Accounting Adjustments: Verify the impact of the $114 million cumulative effect of accounting changes (SFAS 143) on future depreciation and expense recognition.
• Debt Maturities: Confirm the company's ability to refinance or repay the $500 million in debt due in July 2003 and February 2004.
• Conrail Exposure: Review the $6.2 billion investment in Conrail and the associated "Conrail rents and services" expense structure.
• Legal Outcomes: Monitor the appeal of the $36 million Williams Communications judgment and the status of labor arbitration claims.
• Fuel Hedging: Assess the effectiveness of the fuel hedging program given the 28% increase in diesel fuel costs despite the hedge benefit.