NSC

Norfolk Southern Corp. 2003 Annual Report (10-K) Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2003. Norfolk Southern Corporation (NS) is a holding company engaged principally in the rail transportation business, operating approximately 21,500 route miles across 22 states, the District of Columbia, and Ontario, Canada. NS operates as a major freight carrier in the Southeast, East, and Midwest, serving key industrial centers and Atlantic/Gulf Coast ports. The company holds a 58% economic interest in Conrail Inc., a joint venture with CSX Corporation, and operates a significant portion of Conrail's assets under long-term agreements.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total railway operating revenues increased 3% to $6.47 billion, driven by a 4% increase in coal revenues, a 5% increase in intermodal revenues, and a 2% increase in general merchandise revenues.
• Operating Expenses: Expenses rose 6% to $5.4 billion. This increase was significantly impacted by a $107 million charge for a voluntary separation program and an $84 million impairment charge related to telecommunications assets.
• Operating Ratio: The operating ratio (expenses as a percentage of revenue) increased to 83.5% from 81.5%. The voluntary separation program added 1.6 percentage points to this ratio.
• Accounting Changes: Net income included a $114 million benefit from the cumulative effect of changes in accounting principles (SFAS No. 143 regarding asset retirement obligations and FIN No. 46 regarding consolidation of variable interest entities).
• Coal Traffic: Coal tonnage increased 1% to 172 million tons. Export coal tonnage rose 9%, while domestic metallurgical coal volumes decreased 5% due to mine closures and steel industry consolidation.

Guidance, Outlook, and Risks

• Conrail Reorganization: NS, CSX, and Conrail are proceeding with a corporate reorganization to establish direct ownership of Conrail's assets (PRR and NYC). The IRS has ruled the transaction tax-free, and the Surface Transportation Board (STB) has granted authorization pending debt holder consent. Completion is targeted for 2004.
• Rate Regulation: Significant coal rate reasonableness proceedings with Duke Energy and Carolina Power & Light (CP&L) remain active. While the STB initially found rates reasonable in the Duke case, technical corrections were issued in early 2004. Future developments could impact quarterly results.
• Capital Spending: NS has budgeted $810 million for capital expenditures in 2004, focusing on roadway projects ($517 million) and equipment ($220 million).
• Market Risks:
  • Fuel Costs: Diesel fuel costs represented 7% of operating expenses. NS has hedged approximately 63% of its 2004 diesel fuel requirements at an average price of 78 cents per gallon.
  • Interest Rates: NS manages exposure through a mix of fixed and floating-rate debt and interest rate swaps.
  • Environmental: NS has recorded $25 million in liabilities for environmental exposures across 113 sites. Management believes these are adequate but notes that future costs could be significant.
• Labor: Approximately 85% of employees are covered by collective bargaining agreements. Agreements have been reached with most major unions, including a contract extension with the Brotherhood of Locomotive Engineers through 2009.

Investor Verification Checklist

• Accounting Adjustments: Verify the impact of the $114 million accounting change benefit on the reported net income versus core operating performance.
• One-Time Charges: Assess the sustainability of earnings by excluding the $107 million voluntary separation charge and the $84 million telecommunications asset impairment.
• Conrail Transaction: Monitor the progress of the Conrail reorganization and the potential impact on NS's balance sheet and debt structure upon completion.
• Coal Rate Litigation: Track the status of the Duke Energy and CP&L rate reasonableness cases, as outcomes could materially affect future coal revenue.
• Debt Maturities: Review the $717 million of 7.05% notes due in 2037, which holders can require NS to redeem on May 1, 2004, and confirm refinancing plans.
• Operating Ratio Trend: Analyze the 83.5% operating ratio against industry peers and historical performance, considering the impact of rising compensation and fuel costs.