NSC

Norfolk Southern Corp. 10-Q Summary: Period Ended September 30, 2002

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2002, and the nine-month period ended on that date. Norfolk Southern Corporation (NS) operates as a major freight railroad in the eastern United States. The company holds a 58% economic interest in Conrail Inc., a joint venture with CSX Corporation, and operates Conrail lines under lease agreements. The financial statements are unaudited but include all normal recurring accruals.

Key Financial Metrics

Debt and Liquidity: Total long-term debt remained stable at $7.027 billion. Current maturities of long-term debt decreased from $605 million to $356 million. The company maintains a $1 billion credit facility and a revolving accounts receivable sale program to manage working capital.

Material Changes vs. Prior Period

• Revenue Growth: Third-quarter revenues increased 6% ($90 million) driven by a 7% increase in traffic volume. Nine-month revenues rose 1% ($49 million). General merchandise and intermodal segments saw volume gains, while coal revenues declined year-to-date due to lower utility and export tonnage.
• Expense Management: Nine-month operating expenses decreased 2% ($89 million). Diesel fuel expenses dropped 22% ($70 million) due to lower average prices and favorable hedge settlements. Casualty and other claims expenses increased 18% ($20 million) due to adverse claims development.
• Profitability: Net income for the third quarter surged 59% ($47 million) compared to the prior year. Year-to-date net income increased 27% ($71 million). Excluding a $13 million discontinued operations gain in 2001, the year-to-date increase was 34%.
• Conrail Investment: NS's equity in Conrail earnings increased to $13 million for the quarter (from $5 million) and $32 million for the nine months (from $31 million), aided by lower shared asset costs and tax settlements.

Outlook, Risks, and Contingencies

• Guidance and Outlook: Management expects coal volumes to weaken in the fourth quarter due to planned utility outages. General merchandise growth is expected to moderate compared to the strong fourth quarter of 2001. Intermodal growth may be tempered by economic uncertainty.
• Legal and Labor Contingencies: NS faces labor arbitration claims regarding "New York Dock" income protection benefits and a contract dispute with Williams Communications, LLC. The potential loss range for these matters is estimated between zero and $75 million. Management believes it will prevail but notes collection risks regarding Williams Communications.
• Environmental Liabilities: Recorded environmental liabilities totaled $30 million at September 30, 2002, covering 124 known locations. Management believes these accruals are adequate, though future costs for unidentified sites cannot be estimated.
• Market Risks: NS hedges approximately 62% of its diesel fuel requirements for the remainder of 2002. A 10% decrease in fuel prices would reduce the asset value of swaps by approximately $28 million. Interest rate exposure on variable debt is managed via swaps; a 1% rate increase would raise annual interest expense by roughly $8 million.
• Debt Redemption: Holders of $719 million in 7.05% notes due 2037 may require redemption on May 1, 2004. NS expects to fund this via operations, cash on hand, or new borrowings.

Investor Verification Checklist

• Coal Volume Trends: Verify the impact of utility outages and export demand on fourth-quarter coal revenue projections.
• Claims Development: Monitor the actuarial study results regarding personal injury and derailment costs, which drove a 78% increase in casualty expenses for the quarter.
• Conrail Joint Venture: Review Conrail's specific operating performance and the status of the Shared Assets Areas cost-sharing agreements.
• Debt Maturity Profile: Confirm the company's liquidity strategy for the potential 2004 redemption of the 2037 notes.
• Legal Exposure: Track the resolution of the Williams Communications litigation and labor arbitration claims to assess potential accruals up to $75 million.