NSC

Norfolk Southern Corp. Q1 2006 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2006 for Norfolk Southern Corporation (NS), a Class I railroad operating in the eastern United States. The filing includes unaudited consolidated financial statements and management's discussion and analysis. NS is a large accelerated filer with 414,692,476 shares of common stock outstanding as of the period end.

Key Financial Metrics

Note: Operating ratio calculated as Total Railway Operating Expenses ($1,752M) divided by Total Railway Operating Revenues ($2,303M). Total Debt includes current maturities ($348M) and long-term debt ($6,550M).

Material Changes vs. Prior Period

• Revenue Growth: Railway operating revenues increased 17% ($342 million) driven by a 12% increase in revenue per unit (due to higher rates and fuel surcharges) and a 5% increase in traffic volume.
• Profitability: Net income rose 57% ($111 million). Income from railway operations increased 37% ($148 million) despite a 12% rise in operating expenses.
• Expense Drivers: Operating expenses increased $194 million. Key factors included:
  • Compensation & Benefits: Up $117 million (19%), significantly impacted by the adoption of SFAS 123(R) requiring immediate expensing of stock-based awards ($31 million total impact).
  • Diesel Fuel: Up $81 million (54%) due to higher prices and reduced hedging benefits ($15M benefit in 2006 vs. $40M in 2005).
  • Casualties: Down $25 million (32%) primarily due to the absence of the Graniteville, SC derailment costs recorded in Q1 2005.
• Tax Rate: The effective income tax rate increased to 34.5% from 30.0%, largely due to a reduction in tax credits from synthetic fuel investments caused by high oil prices.

Guidance, Outlook, and Risks

• Outlook: Management expects business levels to continue growing for the remainder of 2006, though potentially at a more modest rate. Capital expenditures for the full year are expected to be approximately $1.2 billion, funded by internally generated cash.
• Strategic Initiatives: NS announced a joint venture with Kansas City Southern to improve the "Meridian Speedway" rail line, with a $300 million cash contribution expected to close in Q2 2006.
• Fuel Surcharge Revision: NS announced a revision to its fuel surcharge program effective July 1, 2006, raising the trigger price for West Texas Intermediate Crude Oil from $23 to $64 per barrel.
• Risks & Contingencies:
  • Labor: Approximately 85% of employees are covered by collective bargaining agreements. Negotiations are ongoing with seven rail unions; a strike is possible if mediation fails, though an Emergency Board could delay action.
  • Environmental: Liabilities for environmental exposures totaled $58 million across 182 known locations. Management believes recorded liabilities are adequate.
  • Legal: NS is a defendant in numerous lawsuits. A settlement regarding 2001 West Virginia flooding was reached in Q1 2006 with no material effect on operations.

Investor Verification Checklist

• Accounting Change Impact: Verify the specific impact of SFAS 123(R) adoption on Q1 2006 compensation expenses ($31 million additional expense) and future quarters.
• Fuel Hedging Exposure: Confirm that no new fuel hedges have been entered since May 2004 and assess exposure to rising diesel prices as existing hedges expire in Q2 2006.
• Tax Credit Phase-out: Monitor the "Reference Price" of crude oil for 2006 to determine the final phase-out percentage of synthetic fuel tax credits (estimated at 45% reduction).
• Joint Venture Dilution: Review the financial impact of the $300 million cash contribution to the Kansas City Southern joint venture, which is expected to be modestly dilutive in early years due to lost interest income.
• Labor Negotiations: Track the status of mediation with the Rail Labor Bargaining Coalition and the United Transportation Union regarding potential strikes.