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, 2007. NS is a Class I railroad operating in the eastern United States. The report covers the third quarter and the first nine months of 2007, comparing results to the same periods in 2006. The company reported a large accelerated filer status with 387,240,494 shares of common stock outstanding as of the reporting date.

Key Financial Metrics

Liquidity and Capital Structure:

• Cash and Short-term Investments: $418 million (Sept 30, 2007) vs. $918 million (Dec 31, 2006).
• Working Capital: Deficit of $171 million (Sept 30, 2007) vs. Surplus of $307 million (Dec 31, 2006).
• Long-term Debt: $5,764 million (Sept 30, 2007) vs. $6,109 million (Dec 31, 2006).
• Debt-to-Total Capitalization: 38.4% (Sept 30, 2007) vs. 40.7% (Dec 31, 2006).
• Cash Flow from Operations (9M): $1.811 billion (2007) vs. $1.717 billion (2006).

Material Changes vs. Prior Period

• Revenue Decline: Operating revenues decreased 2% in Q3 and 2% for the first nine months. This was driven by a 4% reduction in traffic volume, partially offset by a 2.5% increase in average revenue per unit.
• Profitability: Net income decreased 7% in Q3 ($30 million) and 3% for the first nine months ($31 million). The decline was attributed to lower railway operating income and nonoperating income, partially offset by reduced interest expense.
• Operating Ratio: The operating ratio worsened to 71.1% in Q3 2007 from 70.1% in Q3 2006, indicating higher operating costs relative to revenue.
• Commodity Performance:
  • Coal: Revenues down 3% (Q3) and 1% (9M) due to lower utility shipments (high stockpiles) and metallurgical coal declines, despite a 44% increase in export coal volume.
  • General Merchandise: Revenues up 1% (Q3) and down 1% (9M). Volume declines in metals/construction and paper were offset by pricing increases.
  • Intermodal: Revenues down 6% (Q3) and 4% (9M) due to lower truckload and domestic intermodal volumes linked to housing and automotive sector weakness.
• Expense Trends: Diesel fuel expense was flat in Q3 but down 3% for the first nine months due to lower consumption, despite higher prices. Casualty and other claims expenses decreased significantly (34% in Q3) due to favorable claim development.

Guidance, Outlook, and Risks

• Outlook: Management expects Q4 coal revenues to be slightly higher than the prior year due to export strength. General merchandise revenues are expected to trend modestly higher due to pricing. Intermodal revenues are expected to be flat year-over-year.
• Tax Rate: The effective tax rate for the full year 2007 is projected to be approximately 34%, supported by synthetic fuel tax credits which expire at the end of 2007. The rate is expected to increase thereafter.
• Capital Expenditures: Expected to be approximately $1.4 billion for 2007, including a commitment to purchase 50 locomotives.
• Share Repurchases: NS repurchased 6.7 million shares in Q3 at a cost of $341 million. The program authorizes up to 75 million shares through 2010.
• Key Risks and Contingencies:
  • Regulatory: The Surface Transportation Board (STB) prohibited fuel surcharges on regulated traffic, requiring a transition to market-based pricing. NS does not expect a material financial impact.
  • Legal/Environmental: NS settled a Pennsylvania derailment case (June 2006) for approximately $7.6 million in restitution and fines. NS is also facing 26 antitrust class actions regarding fuel surcharges, which it intends to vigorously defend.
  • Labor: Negotiations with the United Transportation Union (UTU) and International Association of Machinists (IAM) are ongoing under federal mediation. A strike is not imminent but remains a risk.
  • Synthetic Fuel Investments: Net benefits from these investments are sensitive to crude oil prices. A $1 change in the average oil price changes the net benefit by nearly $2 million.

Investor Verification Checklist

• Traffic Volume vs. Pricing: Verify the sustainability of the 2.5% revenue-per-unit increase given the 4% volume decline and the STB's removal of fuel surcharges.
• Coal Market Dynamics: Monitor utility coal stockpile levels and export demand, as these are the primary drivers of the largest revenue segment.
• Operating Ratio Trajectory: Assess whether the widening operating ratio (71.1%) is a temporary anomaly or a structural shift due to rising fuel and labor costs.
• Environmental Liabilities: Review the $47 million recorded environmental liability and the status of the 155 known locations, particularly regarding the Pennsylvania settlement.
• Synthetic Fuel Credit Phase-out: Confirm the impact of the 43% phase-out of synthetic fuel tax credits on the 2007 effective tax rate and the projected increase in 2008.
• Labor Negotiations: Track the status of negotiations with UTU and IAM, as a work stoppage would materially disrupt operations.