NSC

Norfolk Southern Corporation 2007 Annual Report (10-K) Summary

Business Context and Reporting Period

Company: Norfolk Southern Corporation (NS)
Reporting Period: Fiscal year ended December 31, 2007
Business Overview: NS is a major freight railroad operating approximately 21,000 miles of road in 22 eastern states and the District of Columbia. It transports raw materials, intermediate products, and finished goods, with a significant focus on coal, general merchandise, and intermodal traffic. NS also jointly owns Conrail Inc. (58% economic interest) with CSX Corporation.

Key Financial Metrics (2007)

Material Changes vs. Prior Period

• Revenue Growth: Railway operating revenues increased slightly by $25 million (0.3%) compared to 2006. This increase was driven by higher average revenue per unit, which offset a decline in traffic volumes across most commodity groups.
• Profitability: Net income decreased by $17 million (1%) to $1.464 billion. The decline was primarily due to higher income taxes and lower non-operating items, despite a modest increase in income from railway operations.
• EPS Improvement: Diluted earnings per share increased by 3% to $3.68, driven by a reduction in shares outstanding due to aggressive share repurchases.
• Operating Efficiency: The operating ratio improved to 72.6% from 72.8% in 2006. Railway operating expenses remained flat ($6.847 billion), as lower volume-related costs offset higher fuel expenses.
• Shareholder Returns: NS repurchased and retired 23.6 million shares in 2007 at a cost of $1.2 billion. Dividends per share increased significantly from $0.68 in 2006 to $0.96 in 2007.

Guidance, Outlook, and Risks

Outlook: Management expects revenues to continue growing in 2008, reflecting higher average revenue per unit and modestly higher traffic volumes, contingent on overall economic improvement. Capital expenditures for 2008 are budgeted at $1.43 billion.

Key Risks and Contingencies:

• Regulatory Environment: Risks include potential economic re-regulation by Congress and new safety/security regulations regarding hazardous materials transportation, which could increase costs.
• Legal Proceedings: NS is defending 28 consolidated antitrust class actions regarding fuel surcharges. Additionally, the DOJ is preparing an action regarding the 2005 Graniteville, SC derailment; NS does not believe these will have a material adverse effect.
• Labor Relations: Approximately 85% of employees are unionized. Negotiations with the International Association of Machinists (IAM) are ongoing under federal mediation; a strike could significantly disrupt operations.
• Environmental Liabilities: NS maintains a liability of $46 million for environmental remediation at 155 identified locations. While management believes this is adequate, future costs could vary.
• Fuel Costs: Fuel expenses increased 7% in 2007 due to higher prices. NS no longer hedges fuel costs as the program ended in 2006.

Investor Verification Checklist

• Share Repurchase Program: Verify the remaining authorized shares under the program (29.7 million shares remaining as of Dec 31, 2007) and the impact on future EPS.
• Operating Ratio Trend: Monitor the operating ratio closely; while it improved slightly, rising fuel costs and labor agreements could pressure margins in 2008.
• Coal Traffic Volume: Confirm trends in utility and metallurgical coal shipments, which represent 25% of revenues and are sensitive to economic conditions and environmental regulations.
• Legal Exposure: Track the status of the fuel surcharge antitrust litigation and the DOJ environmental action regarding the Graniteville derailment.
• Capital Allocation: Assess the balance between the $1.43 billion 2008 capital budget (infrastructure and equipment) and continued share buybacks/dividends.