NSC

Norfolk Southern Corp. Q1 2004 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2004. Norfolk Southern Corporation (NS) is a Class I railroad operating in the eastern United States. The company jointly owns Conrail Inc. (58% economic interest) with CSX Corporation. NS operates Conrail's Pennsylvania Lines (PRR) under a long-term operating agreement while seeking a corporate reorganization to directly own these assets.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 8% ($132 million) driven by a 7% rise in traffic volume and a 1% increase in revenue per unit. Coal revenues rose 12%, General Merchandise 5%, and Intermodal 13%.
• Profitability: Income from continuing operations before accounting changes surged 86% to $158 million (from $85 million in Q1 2003). This growth was fueled by higher revenues and improved operational efficiency (higher train speeds, lower dwell times) which kept operating expenses flat (up only 1%).
• Net Income Decline: Reported Net Income decreased to $158 million from $209 million in Q1 2003. This decline is primarily due to the absence of a $114 million one-time gain from accounting changes (SFAS 143) and a $10 million gain from discontinued operations recorded in 2003.
• Cash Flow: Operating cash flow improved significantly to $258 million, up from $133 million, reflecting stronger operating income.
• Debt Reduction: The company repaid $303 million in debt during the quarter, including a $250 million maturity, reducing long-term debt.

Guidance, Outlook, and Risks

• Outlook: Management expects coal revenues to grow for the remainder of 2004 due to utility stockpile replenishment and favorable export conditions. General merchandise and intermodal revenues are expected to remain favorable, though Q4 comparisons may be challenging due to strong prior-year performance.
• Conrail Reorganization: NS, CSX, and Conrail are working to consummate a reorganization in 2004 to allow direct ownership of PRR and NYC assets. This requires IRS rulings, STB approval, and debt holder consent. Upon completion, NS's investment in Conrail will be adjusted, and "Conrail rents and services" expenses will decrease.
• Regulatory Risks: Ongoing Surface Transportation Board (STB) proceedings regarding coal rate reasonableness (Duke Energy and CP&L cases) remain stayed or subject to appeal. Future adjustments could significantly impact results.
• Market Risks: NS hedges 67% of its 2004 diesel fuel consumption at an average price of 80 cents/gallon. A 10% drop in fuel prices would reduce asset value by approximately $38 million. Interest rate risk is managed via swaps; a 1% rate increase would raise annual interest expense by ~$6 million.
• Environmental & Legal: NS maintains a $24 million liability for environmental remediation at 112 known sites. Management believes recorded liabilities are adequate, though future claims could be significant.

Investor Verification Checklist

• Conrail Transaction Status: Verify progress on the IRS ruling, STB approval, and debt holder consent required for the Conrail reorganization.
• Coal Rate Cases: Monitor the status of the Duke Energy and CP&L rate reasonableness proceedings at the STB for potential revenue adjustments.
• Capital Expenditures: Confirm adherence to the capital program, noting $270 million in outstanding purchase commitments for locomotives and equipment.
• Labor Negotiations: Track the status of collective bargaining agreements, specifically the failed ratification of the tentative agreement with the IBEW.
• Working Capital: Review the company's ability to manage its working capital deficit through operating cash flow and the revolving accounts receivable sale program.