NSC

Norfolk Southern Corp. 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report (Form 10-Q) for Norfolk Southern Corporation (NS) for the period ended September 30, 2008. NS is a large accelerated filer operating as a Class I railroad. The report covers the three and nine months ended September 30, 2008, comparing results to the same periods in 2007.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Railway operating revenues increased 23% ($541 million) in Q3 and 17% ($1.2 billion) for the nine months compared to 2007. This was driven by higher average revenue per unit, including significant fuel surcharges, which offset a decline in traffic volume.
• Profitability: Net income rose 35% ($134 million) in Q3 and 19% ($199 million) for the nine months. Income from railway operations increased $213 million in Q3.
• Expense Increases: Operating expenses rose 20% in Q3 and 16% for the nine months. Fuel expenses surged 64% in Q3 and 68% year-to-date due to higher oil prices. Compensation and benefits increased due to a new labor agreement with the Brotherhood of Locomotive Engineers and Trainmen (BLET) and higher incentive payouts.
• Traffic Volume: Overall traffic volume declined. Automotive volumes dropped 30% in Q3 and 20% year-to-date. Conversely, coal export tonnage increased 55% in Q3 and 60% year-to-date.

Guidance, Outlook, and Risks

• Outlook: Management expects coal revenues to remain higher for the remainder of the year due to pricing and export strength. General merchandise and intermodal revenues are also expected to be higher, driven by pricing improvements offsetting lower volumes.
• Liquidity: NS maintains a working capital deficit of $221 million but expects cash on hand and operating cash flows to meet obligations. The company has a $1 billion credit facility available (none outstanding) and recently renewed its accounts receivable securitization facility.
• Capital Allocation: NS repurchased 6.2 million shares in Q3 at a cost of $405 million. Total share repurchases for the first nine months were $899 million. Capital expenditures were $1.1 billion for the nine months, with budget increases approved for coal cars and locomotives.
• Risks and Contingencies:
  • Legal Proceedings: NS is defending antitrust class actions regarding fuel surcharges and a DOJ action regarding the 2005 Graniteville, SC derailment. Management does not believe these will have a material adverse effect.
  • Insurance Disputes: NS is in arbitration with an insurance carrier regarding a $100 million recovery related to the Graniteville settlement.
  • Environmental: Liabilities for environmental exposures are estimated at $39 million. Risks include potential cleanup costs at 148 known locations and latent liabilities on owned properties.
  • Market Risks: Fluctuations in oil prices impact both revenue (via surcharges) and expenses. Interest rate risk is managed via hedging, with $122 million of debt subject to rate fluctuations.

Investor Verification Checklist

• Fuel Surcharges vs. Costs: Verify the sustainability of the margin benefit from fuel surcharges given the volatility of crude oil prices and the lag in surcharge adjustments.
• Automotive Sector Exposure: Monitor the impact of continued automotive production cuts and plant closures on general merchandise traffic volumes.
• Insurance Recovery: Track the status of the arbitration regarding the $100 million insurance claim related to the Graniteville derailment settlement.
• Share Repurchases: Confirm the remaining capacity under the share repurchase program (approx. 14.5 million shares remaining as of Sept 30, 2008) and future buyback intent.
• Environmental Liabilities: Review updates on the 148 known environmental sites and potential for additional accruals beyond the current $39 million estimate.