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(Exact name of registrant as specified in its charter)
iVirginia
i52-1188014
(State
or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
iThree Commercial Place
i23510-2191
iNorfolk,
iVirginia
(Address
of principal executive offices)
(Zip Code)
i(757)
i629-2680
(Registrant’s telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
iNorfolk Southern Corporation Common Stock (Par Value $1.00)
iNSC
iNew
York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. iYes☒ No ☐
Indicate
by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐iNo☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.iYes☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period
that the registrant was required to submit such files). iYes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large
accelerated filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.
iLarge accelerated filer☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company i☐ Emerging
growth company i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes i☐ No ☒
The aggregate market value of the voting common equity held by non-affiliates at June 30, 2019 was $i52,456,511,032
(based on the closing price as quoted on the New York Stock Exchange on June 28, 2019).
GENERAL – Our company, Norfolk Southern Corporation (Norfolk Southern), is a Norfolk, Virginia-based company that owns a major freight railroad, Norfolk Southern Railway Company (NSR). We were incorporated on July 23, 1980, under the laws of the Commonwealth of Virginia. Our common stock (Common Stock) is listed on the New York Stock Exchange (NYSE)
under the symbol “NSC.”
Unless indicated otherwise, Norfolk Southern Corporation and its subsidiaries, including NSR, are referred to collectively as NS, we, us, and our.
We are primarily engaged in the rail transportation of raw materials, intermediate products, and finished goods primarily in the Southeast, East, and Midwest and, via interchange with rail carriers, to and from the rest of the United States. We also transport overseas freight through several Atlantic and Gulf Coast ports. We offer the most extensive intermodal network in the eastern half of the United States.
We make available free of charge through our website,
www.norfolksouthern.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the U.S. Securities and Exchange Commission (SEC). In addition, the following documents are available on our website and in print to any shareholder who requests them:
•Corporate Governance Guidelines
•Charters of the Committees of the Board of Directors
•The Thoroughbred Code
of Ethics
•Code of Ethical Conduct for Senior Financial Officers
RAILROAD OPERATIONS – At December 31, 2019, our railroad operated approximately 19,500 route miles in 22 states and the District of Columbia.
Our
system reaches many manufacturing plants, electric generating facilities, mines, distribution centers, transload facilities, and other businesses located in our service area.
Corridors with heaviest freight volume:
•New York City area to Chicago (via Allentown and Pittsburgh)
•Chicago to Macon (via Cincinnati, Chattanooga, and Atlanta)
•Central Ohio to Norfolk (via Columbus and Roanoke)
•Birmingham to Meridian
•Cleveland
to Kansas City
•Memphis to Chattanooga
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The miles operated, which include major leased lines between Cincinnati, Ohio, and Chattanooga, Tennessee, and an exclusive operating agreement for trackage rights over property owned by North Carolina Railroad Company, were as follows:
We
operate freight service over lines with significant ongoing Amtrak and commuter passenger operations, and conduct freight operations over trackage owned or leased by Amtrak, New Jersey Transit, Southeastern Pennsylvania Transportation Authority, Metro-North Commuter Railroad Company, Maryland Department of Transportation, and Michigan Department of Transportation.
The following table sets forth certain statistics relating to our railroads’ operations for the past five years:
Revenue
ton miles (thousands) per railroad employee
7,939
7,822
7,474
6,838
6,645
Ratio of railway operating expenses to railway
operating
revenues (Railway operating ratio)
64.7
%
65.4
%
66.6
%
69.6
%
72.8
%
RAILWAY
OPERATING REVENUES– Total railway operating revenues were $11.3 billion in 2019. Following is an overview of our three commodity groups. See the discussion of merchandise revenues by major commodity group, intermodal revenues, and coal revenues and tonnage in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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MERCHANDISE– Our merchandise commodity group is composed of five groupings:
•Chemicals includes
sulfur and related chemicals, petroleum products (including crude oil), chlorine and bleaching compounds, plastics, rubber, industrial chemicals, and chemical wastes.
•Agriculture products includes soybeans, wheat, corn, fertilizer, livestock and poultry feed, food products, food oils, flour, sweeteners, and ethanol.
•Metals and construction includes steel, aluminum products, machinery, scrap metals, cement, aggregates, sand, minerals, transportation equipment, and items for the U.S. military.
•Automotive includes finished motor vehicles and automotive parts.
•Forest and consumer includes lumber and wood products, pulp board and paper products, wood fibers, wood pulp, scrap paper, clay, beverages,
canned goods, and consumer products
Merchandise carloads handled in 2019 were 2.4 million, the revenues from which accounted for 60% of our total railway operating revenues.
INTERMODAL– Our intermodal commodity group consists of shipments moving in domestic and international containers and trailers. These shipments are handled on behalf of intermodal marketing companies, international steamship lines, premium customers and asset owning companies. Intermodal units handled in 2019 were 4.2 million, the revenues from which accounted for 25% of our total railway operating revenues.
COAL– Revenues from coal accounted for 15% of our total railway operating revenues in 2019. We handled 102 million tons, or 0.9 million carloads, in 2019, most of which originated on our lines from major eastern coal basins, with the balance from major western coal basins received via the Memphis and Chicago gateways. Our coal franchise supports the electric generation market, serving approximately 60 coal generation plants, as well as the export, domestic metallurgical and industrial markets, primarily through direct rail and river, lake, and coastal facilities, including various terminals on the Ohio River, Lamberts Point in Norfolk, Virginia, the Port of Baltimore, and Lake Erie.
FREIGHT RATES– Our predominant pricing mechanisms, private
contracts and exempt price quotes, are not subject to regulation. In general, market forces are the primary determinant of rail service prices.
RAILWAY PROPERTY
Our railroad infrastructure makes us capital intensive with net property of approximately $32 billion on a historical cost basis.
Property Additions– Property additions for the past five years were as follows:
2019
2018
2017
2016
2015
($
in millions)
Road and other property
$
1,371
$
1,276
$
1,210
$
1,292
$
1,514
Equipment
648
675
513
595
658
Delaware
& Hudson acquisition
—
—
—
—
213
Total
$
2,019
$
1,951
$
1,723
$
1,887
$
2,385
Our
capital spending and replacement programs are and have been designed to assure the ability to provide safe, efficient, and reliable rail transportation services.
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Equipment– At December 31, 2019, we owned or leased the following units of equipment:
Owned
Leased
Total
Capacity
of Equipment
Locomotives:
(Horsepower)
Multiple purpose
3,711
—
3,711
14,234,300
Auxiliary
units
178
—
178
—
Switching
17
—
17
23,800
Total
locomotives
3,906
—
3,906
14,258,100
Freight cars:
(Tons)
Gondola
22,081
3,541
25,622
2,476,401
Hopper
9,877
—
9,877
1,109,777
Covered
hopper
6,320
—
6,320
699,985
Box
4,432
747
5,179
388,615
Flat
1,572
387
1,959
190,213
Other
1,592
4
1,596
73,203
Total
freight cars
45,874
4,679
50,553
4,938,194
Other:
Chassis
33,861
—
33,861
Containers
18,920
—
18,920
Work
equipment
5,754
258
6,012
Vehicles
3,349
59
3,408
Miscellaneous
2,391
—
2,391
Total
other
64,275
317
64,592
The following table indicates the number and year built for locomotives and freight cars owned at December 31, 2019:
2019
2018
2017
2016
2015
2010- 2014
2005- 2009
2004
& Before
Total
Locomotives:
No. of units
35
15
55
66
8
325
359
3,043
3,906
%
of fleet
1
%
—
%
2
%
2
%
—
%
8
%
9
%
78
%
100
%
Freight
cars:
No. of units
200
—
470
775
2,090
6,841
4,760
30,738
45,874
%
of fleet
—
%
—
%
1
%
2
%
5
%
15
%
10
%
67
%
100
%
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The
following table shows the average age of our owned locomotive and freight car fleets at December 31, 2019, and information regarding 2019 retirements:
Locomotives
Freight Cars
Average age – in service
25.7 years
27.0
years
Retirements
250 units
8,825 units
Average age – retired
29.8 years
42.6 years
Track Maintenance– Of the approximately 35,600 total miles of track on which we operate, we are responsible for maintaining approximately 28,400 miles, with the remainder being operated under trackage rights from other parties responsible for maintenance.
Over
84% of the main line trackage (including first, second, third, and branch main tracks, all excluding rail operated pursuant to trackage rights) has rail ranging from 131 to 155 pounds per yard with the standard installation currently at 136 pounds per yard. Approximately 44% of our lines, excluding rail operated pursuant to trackage rights, carried 20 million or more gross tons per track mile during 2019.
The following table summarizes several measurements regarding our track roadway additions and replacements during the past five years:
2019
2018
2017
2016
2015
Track
miles of rail installed
449
416
466
518
523
Miles of track surfaced
5,012
4,594
5,368
4,984
5,074
Crossties
installed (millions)
2.4
2.2
2.5
2.3
2.4
Traffic Control– Of the approximately 16,400 route miles we dispatch, about 11,300 miles are signalized, including 8,500 miles of centralized traffic control (CTC) and 2,800
miles of automatic block signals. Of the 8,500 miles of CTC, approximately 7,600 miles are controlled by data radio originating at 355 base station radio sites.
ENVIRONMENTAL MATTERS– Compliance with federal, state, and local laws and regulations relating to the protection of the environment is one of our principal goals. To date, such compliance has not had a material effect on our financial position, results of operations, liquidity, or competitive position. See Note 17 to the Consolidated Financial Statements.
EMPLOYEES– The following table shows the average number of employees
and the average cost per employee for wages and benefits:
2019
2018
2017
2016
2015
Average
number of employees
24,587
26,662
27,110
28,044
30,456
Average wage cost per employee
$
85,000
$
83,000
$
79,000
$
76,000
$
77,000
Average
benefit cost per employee
$
40,000
$
39,000
$
42,000
$
35,000
$
32,000
Approximately 80% of our railroad employees are covered
by collective bargaining agreements with various labor unions. See the discussion of “Labor Agreements” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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GOVERNMENT REGULATION– In addition to environmental, safety, securities, and other regulations generally applicable to all business, our railroads are subject to regulation by the U.S. Surface Transportation Board (STB). The STB has jurisdiction to varying extents over rates, routes, customer access provisions, fuel surcharges, conditions of service, and the extension or abandonment of rail lines. The STB
has jurisdiction to determine whether we are “revenue adequate” on an annual basis based on the results of the prior year. A railroad is “revenue adequate” on an annual basis under the applicable law when its return on net investment exceeds the rail industry’s composite cost of capital. This determination is made pursuant to a statutory requirement. The STB also has jurisdiction over the consolidation, merger, or acquisition of control of and by rail common carriers.
The relaxation of economic regulation of railroads, following the Staggers Rail Act of 1980, included exemption from STB regulation of the rates and most service terms for intermodal business (trailer-on-flat-car, container-on-flat-car), rail boxcar shipments, lumber, manufactured steel, automobiles, and certain bulk commodities such as sand, gravel, pulpwood, and wood chips for paper manufacturing. Further, all shipments
that we have under contract are effectively removed from commercial regulation for the duration of the contract. Approximately 90% of our revenues comes from either exempt shipments or shipments moving under transportation contracts; the remainder comes from shipments moving under public tariff rates.
Efforts have been made over the past several years to increase federal economic regulation of the rail industry, and such efforts are expected to continue in 2020. The Staggers Rail Act of 1980 substantially balanced the interests of shippers and rail carriers, and encouraged and enabled rail carriers to innovate, invest in their infrastructure,
and compete for business, thereby contributing to the economic health of the nation and to the revitalization of the industry. Accordingly, we will continue to oppose efforts to reimpose increased economic regulation.
Government regulations are further discussed within Item 1A “Risk Factors” and the safety and security of our railroads are discussed within the “Security of Operations” section contained herein.
COMPETITION–There is continuing strong competition among rail, water, and highway carriers. Price is usually only one factor of importance as shippers and receivers choose a transport mode and specific hauling company. Inventory carrying costs, service reliability,
ease of handling, and the desire to avoid loss and damage during transit are also important considerations, especially for higher-valued finished goods, machinery, and consumer products. Even for raw materials, semi-finished goods, and work-in-progress, users are increasingly sensitive to transport arrangements that minimize problems at successive production stages.
Ourprimary rail competitor is CSXCorporation (CSX); both NS and CSX operate throughout much of the same territory. Other railroads also operate in parts of the territory. Wealso compete with motor carriers, water carriers, and with shippers who have the additional options of handling their own goods in private carriage, sourcing products from different geographic areas, and using substitute products.
Certain
marketing strategies to expand reach and shipping options among railroads and between railroads and motor carriers enablerailroadsto compete more effectively in specific markets.
SECURITY OF OPERATIONS – We continue to enhance the security of our rail system. Our comprehensive security plan is modeled on and was developed in conjunction with the security plan prepared by the Association of American Railroads (AAR) post September 11, 2001. The AAR Security Plan defines four Alert Levels and details the actions and countermeasures that are being applied across the railroad industry to mitigate the risk of terrorist, violent extremist or seriously disruptive cyber-attack increases
or decreases. The Alert Level actions include countermeasures that will be applied in three general areas: (1) operations (including transportation, engineering, and mechanical); (2) information technology and communications; and, (3) railroad police. All of our Operations Division employees are advised by their supervisors or train dispatchers, as appropriate, of any change in Alert Level and any additional responsibilities they may incur due to such change.
Our security plan also complies with U.S. Department of Transportation (DOT) security regulations pertaining to training and security plans with respect to the transportation of hazardous materials. As part of the plan, security awareness training is given to all railroad employees who directly affect hazardous material transportation safety,
K9
and
is integrated into hazardous material training programs. Additionally, location-specific security plans are in place for rail corridors in certain metropolitan areas referred to as High Threat Urban Areas (HTUA). Particular attention is aimed at reducing risk in a HTUA by: (1) the establishment of secure storage areas for rail cars carrying toxic-by-inhalation (TIH) materials; (2) the expedited movement of trains transporting rail cars carrying TIH materials; (3) reducing the number of unattended loaded tank cars carrying TIH materials; and (4) cooperation with federal, state, local, and tribal governments to identify those locations where security risks are the highest.
We also operate six facilities that are under U.S. Coast Guard (USCG) Maritime Security Regulations. With respect to these facilities, each facility’s security plan has been approved by the applicable Captain of the Port and remains subject
to inspection by the USCG.
Additionally, we continue to engage in close and regular coordination with numerous federal and state agencies, including the U.S. Department of Homeland Security (DHS), the Transportation Security Administration, the Federal Bureau of Investigation, the Federal Railroad Administration (FRA), the USCG, U.S. Customs and Border Protection, the Department of Defense, and various state Homeland Security offices.
In 2019, through the Norfolk Southern Operation Awareness and Response Program as well as participation in the Transportation Community Awareness and Emergency Response Program, we provided rail accident response training to approximately 5,700 emergency responders, such as local police and fire personnel. Our other training efforts throughout 2019 included participation in tabletop and full scale exercises for
local, state, and federal agencies. We also have ongoing programs to sponsor local emergency responders at the Security and Emergency Response Training Course conducted at the AAR Transportation Technology Center in Pueblo, Colorado.
We also continually evaluate ourselves for appropriate business continuity and disaster recovery planning, with test scenarios that include cybersecurity attacks. Our risk-based information security program helps ensure our defenses and resources are aligned to address the most likely and most damaging potential attacks, to provide support for our organizational mission and operational objectives, and to keep us in the best position to detect, mitigate, and recover from a wide variety of potential attacks in a timely fashion.
Item 1A. Risk Factors
The
risks set forth in the following risk factors could have a materially adverse effect on our financial position, results of operations, or liquidity in a particular year or quarter, and could cause those results to differ materially from those expressed or implied in our forward-looking statements. The information set forth in this Item 1A “Risk Factors” should be read in conjunction with the rest of the information included in this annual report, including Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8 “Financial Statements and Supplementary Data.”
Significant governmental legislation and regulation over commercial, operating and environmental matters could affect us,
our customers, and the markets we serve. Congress can enact laws that could increase economic regulation of the industry. Railroads presently are subject to commercial regulation by the STB, which hasjurisdiction to varying extents over rates, routes, customer access provisions, fuel surcharges, conditions of service, and the extension or abandonment of raillines. The STB also has jurisdiction over the consolidation, merger, or acquisition of control of and by rail commoncarriers. Additional economic regulation of the rail industry by Congress or the STB, whether under new orexisting laws, could have a significant negative impact on our ability to negotiate prices for rail services, on railway operating
revenues, and on theefficiency of our operations. This potential material adverse effectcould also result in reduced capital spending on our rail network or abandonment of lines.
Railroads are also subject to the enactment of laws by Congress and regulation by the DOT and the DHS, which regulate most aspects of our operations related to safety and security. The Rail Safety Improvement Act of 2008, the Surface Transportation Extension Act of 2015, and the implementing regulations promulgated by the FRA (collectively “the PTC laws and regulations”) require us (and each other Class I railroad) to implement, on certain mainline track where intercity and commuter passenger railroads operate and where TIH hazardous materials are
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transported,
an interoperable positive train control system (PTC). PTC is a set of highly advanced technologies designed to prevent train-to-train collisions, speed-related derailments, and certain other accidents caused by human error, but PTC will not prevent all types of train accidents or incidents. We met the deadline under the PTC laws and regulations to install all hardware and to implement PTC on some of those rail lines, and we are required to fully implement PTC on the remainder of those rail lines by December 31, 2020. In addition, other railroads’ implementation schedules could impose additional interoperability requirements and accelerated timelines on us, which could impact our operations over other railroads if not met.
Full implementation of PTC will result in additional operating costs and capital expenditures, and PTC implementation
may result in reduced operational efficiency and service levels, as well as increased compensation and benefits expenses, and increased claims and litigation costs.
Our operations are subject to extensive federal and state environmental laws and regulations concerning, among other things, emissions to the air; discharges to waterways or groundwater supplies; handling, storage, transportation, and disposal of waste and other materials; and the cleanup of hazardous material or petroleum releases. The risk of incurring environmental liability, for acts and omissions, past, present, and future, is inherent in the railroad business. This risk includes property owned by us, whether currently or in the past, that is or has been subject to a variety of uses, including our railroad operations and other industrial activity by past owners or our past and present tenants.
Environmental
problems that are latent or undisclosed may exist on these properties, and we could incur environmental liabilities or costs, the amount and materiality of which cannot be estimated reliably at this time, with respect to one or more of these properties. Moreover, lawsuits and claims involving other unidentified environmental sites and matters are likely to arise from time to time.
Concern over climate change has led to significant federal, state, and international legislative and regulatory efforts to limit greenhouse gas (GHG) emissions. Restrictions, caps, taxes, or other controls on GHG emissions, including diesel exhaust, could significantly increase our operating costs, decrease the amount of traffic handled, and decrease the value of coal reserves we own.
In addition, legislation and regulation related to GHGs could negatively affect
the markets we serve and our customers. Even without legislation or regulation, government incentives and adverse publicity relating to GHGs could negatively affect the markets for certain of the commodities we carry and our customers that (1) use commodities that we carry to produce energy, including coal, (2) use significant amounts of energy in producing or delivering the commodities we carry, or (3) manufacture or produce goods that consume significant amounts of energy.
As a common carrier by rail, we must offer to transport hazardous materials, regardless of risk. Transportation of certain hazardous materials could create catastrophic losses in terms of personal injury andproperty (including environmental) damage, and compromise critical parts of our rail network. The cost of a catastrophic railaccident
involving hazardous materials could exceed our insurance coverage. We have obtained insurance for potential losses forthird-party liability and first-party property damages (see Note 17 to the Consolidated Financial Statements);however, insurance is available from a limited number of insurers and may not continue to be available or, ifavailable, may not be obtainable on terms acceptable to us.
We may be affected by general economic conditions. Prolonged negative changes in domestic and global economic conditions could affect the producers and consumers of the commodities we carry. Economic conditions could also result in bankruptcies of one or more large customers.
Significant
increases in demand for rail services could result in the unavailability of qualified personnel and locomotives. In addition, workforce demographics and trainingrequirements, particularly for engineers and conductors, could have anegative impact on our ability to meet short-term demand for rail service. Unpredicted increases in demand for rail servicesmay exacerbate such risks.
K11
We may be affected by energy prices. Volatility in energy prices could have a significant effect on a variety of items including, but not limited to: the economy; demand for transportation
services; business related to the energy sector, including crude oil, natural gas, and coal; fuel prices; and fuel surcharges.
We face competition from other transportation providers. We are subject to competition from motor carriers, railroads and, to a lesser extent, ships, barges, and pipelines, on the basis of transit time, pricing, and quality and reliability of service. While we have used primarily internal resources to build or acquire and maintain our rail system, trucks and barges have been able to use public rights-of-way maintained by public entities. Any future improvements, expenditures, legislation, or regulation materially increasing the quality or reducing the cost of alternative modes of transportation in the regions in which we operate (such as granting materially greater latitude for motor carriers with respect
to size or weight limitations or adoption of autonomous commercial vehicles) could have a material adverse effect on our operations.
The operations of carriers with which we interchange may adversely affect our operations. Our ability to provide rail service to customers in the U.S. and Canada depends in large part upon our ability to maintain collaborative relationships with connecting carriers (including shortlines and regional railroads) with respect to, among other matters, freight rates, revenue division, car supply and locomotive availability, data exchange and communications, reciprocal switching, interchange, and trackage rights. Deterioration in the operations of or service provided by connecting carriers, or in our relationship with those connecting carriers, could result in our inability to meet our customers’ demands or require us to use alternate
train routes, which could result in significant additional costs and network inefficiencies. Additionally, any significant consolidations, mergers or operational changes among other railroads may significantly redefine our market access and reach.
We rely on technology and technology improvements in our business operations. If we experience significant disruption or failure of one or more of our information technology systems, including computer hardware, software, and communications equipment, we could experience a service interruption, a security breach, or other operational difficulties. We also face cybersecurity threats which may result in breaches of systems, or compromises of sensitive data, which may result in an inability to access or operate systems necessary for conducting operations and providing customer service, thereby impacting our efficiency and/or damaging our
corporate reputation. Additionally, if we do not have sufficient capital to acquire new technology or we are unable to implement new technology, we may suffer a competitive disadvantage within the rail industry and with companies providing other modes of transportation service.
The vast majority of our employees belong to labor unions, and labor agreements, strikes, or work stoppages could adversely affect our operations. Approximately 80% of our railroad employees are covered by collectivebargaining agreements with various labor unions. If unionized workers were to engage in a strike, work stoppage,or other slowdown, we could experience a significant disruption of our operations. Additionally, future nationallabor
agreements, or renegotiation of labor agreements or provisions of labor agreements, could significantlyincrease our costs for health care, wages, and other benefits.
We may be subject to various claims and lawsuits that could result in significant expenditures. The nature of our business exposes us to the potential for various claims and litigation related to labor and employment, personal injury, commercial disputes, freight loss and other property damage, and other matters. Job-related personal injury and occupational claims are subject to the Federal Employer’s Liability Act (FELA), which is applicable only to railroads. FELA’s fault-based tort system produces results that are unpredictable and inconsistent as compared with a no-fault worker’s compensation system. The variability inherent in this system could result in actual costs
being different from the liability recorded.
Any material changes to current litigation trends or a catastrophic rail accident involving any or all of freight loss, property damage, personal injury, and environmental liability could have a material adverse effect on us to the extent not covered by insurance. We have obtained insurance for potential losses for third-party liability and first-party property damages; however, insurance is available from a limited number of insurers and may not continue to be available or, if available, may not be obtainable on terms acceptable to us.
K12
Severe weather could result in significant business interruptions and expenditures. Severe weather conditions and
other natural phenomena, including hurricanes, floods, fires, and earthquakes, may cause significant business interruptions and result in increased costs, increased liabilities, and decreased revenues.
We may be affected by terrorism or war. Any terrorist attack, or other similar event, any government response thereto, and war or risk of war could cause significant business interruption. Because we play a critical role in the nation’s transportation system, we could become the target of such an attack or have a significant role in the government’s preemptive approach or response to an attack or war.
Although we currently maintain insurance coverage for third-party liability arising out of war and acts of terrorism, we maintain only limited insurance coverage for first-party property damage and damage to property in our
care, custody, or control caused by certain acts of terrorism. In addition, premiums for some or all of our current insurance programs covering these losses could increase dramatically, or insurance coverage for certain losses could be unavailable to us in the future.
We may be affected by supply constraints resulting from disruptions in the fuel markets or the nature of some of our supplier markets. We consumed approximately 451 million gallons of diesel fuel in 2019. Fuelavailability could be affected by any limitation in the fuel supply or by any imposition of mandatory allocation orrationing regulations. A severe fuel supply shortage arising from production curtailments, increased demand inexisting or emerging foreign markets, disruption
of oil imports, disruption of domestic refinery production, damage
to refinery or pipeline infrastructure, political unrest, war or other factors could impact us as well as our customers and other transportation companies.
Due to the capital intensive nature, as well as the industry-specific requirements of the rail industry, high barriers of entry exist for potential new suppliers of core railroad items, such as locomotives and rolling stock equipment. Additionally, we compete with other industries for available capacity and raw materials used in the production of locomotives and certain track and rolling stock materials. Changes in the competitive landscapes of these limited supplier markets could result in increased prices or significant shortages of materials.
The state of capital markets could adversely
affect our liquidity. We rely on the capital markets to provide some of our capital requirements, including the issuance of debt instruments, as well as the sale of certain receivables. Significant instability or disruptions of the capital markets, including the credit markets, or deterioration of our financial position due to internal or external factors could restrict or eliminate our access to, and/or significantly increase the cost of, various financing sources, including bank credit facilities and issuance of corporate bonds. Instability or disruptions of the capital markets and deterioration of our financial position, alone or in combination, could also result in a reduction in our credit rating to below investment grade, which could prohibit or restrict us from accessing external sources of short- and long-term debt financing and/or significantly increase the associated costs.
Item
1B. Unresolved Staff Comments
None.
K13
Item 3. Legal Proceedings
In 2007, various antitrust class actions filed against us and other Class I railroads in various Federal district courts regarding fuel surcharges were consolidated in the District of Columbia by the Judicial Panel on Multidistrict Litigation. In 2012, the court certified the case as a class action. The defendant railroads appealed this certification, and the Court of Appeals for the District of Columbia vacated the District Court’s decision and remanded the case for further consideration. On October
10, 2017, the District Court denied class certification. The decision was upheld by the Court of Appeals on August 16, 2019. Since that decision, various individual cases have been filed in multiple jurisdictions. We believe the allegations in the complaints are without merit and intend to vigorously defend the cases. We do not believe the outcome of these proceedings will have a material effect on our financial position, results of operations, or liquidity.
Item 4. Mine Safety Disclosures
Not applicable.
K14
Information
About Our Executive Officers
Our executive officers generally are elected and designated annually by the Board of Directors at its first meeting held after the annual meeting of stockholders, and they hold office until their successors are elected. Executive officers also may be elected and designated throughout the year as the Board of Directors considers appropriate. There are no family relationships among our officers, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The following table sets forth certain information, at February 1, 2020, relating to our officers.
Prior to joining Norfolk Southern, served as Vice President, Finance and Chief Financial Officer at segments of United Technologies Corporation. The positions were Vice President Finance, Strategy, IT and Chief Financial Officer at Otis Elevator Company from October 2015 to May 2019, and Vice President Finance and Chief Financial Officer at Carrier Corporation from September 2008 until September 2015, and again June 2019 until joining Norfolk Southern.
John M. Scheib, 48, Executive Vice
President and Chief Strategy Officer
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
STOCK INFORMATION
Common Stock is owned by 23,273 stockholders of record as of December 31, 2019, and is traded on the New York Stock Exchange under the symbol “NSC.”
ISSUER
PURCHASES OF EQUITY SECURITIES
Period
Total Number
of Shares
(or Units)
Purchased(1)
Average Price
Paid per Share (or Unit)
Total
Number of
Shares (or Units)
Purchased as
Part of Publicly
Announced Plans
or Programs(2)
Maximum Number
(or Approximate
Dollar Value)
of Shares (or Units)
that may yet be
Purchased under
the Plans
or Programs(2)
October 1-31, 2019
1,024,028
$
178.89
1,020,083
29,956,368
November
1-30, 2019
923,726
192.84
922,109
29,034,259
December 1-31, 2019
987,478
191.40
987,478
28,046,781
Total
2,935,232
2,929,670
(1)Of
this amount, 5,562 represents shares tendered by employees in connection with the exercise of stock options under the stockholder-approved Long-Term Incentive Plan.
(2)On September 26, 2017, our Board of Directors authorized the repurchase of up to an additional 50 million shares of Common Stock through December 31, 2022. As of December 31, 2019, 28.0 million shares remain authorized for repurchase.
K16
Item 6. Selected Financial Data
FIVE-YEAR
FINANCIAL REVIEW
2019
2018
2017
2016
2015
($
in millions, except per share amounts)
RESULTS OF OPERATIONS
Railway
operating revenues
$
11,296
$
11,458
$
10,551
$
9,888
$
10,511
Railway operating expenses
7,307
7,499
7,029
6,879
7,656
Income
from railway operations
3,989
3,959
3,522
3,009
2,855
Other
income – net
106
67
156
136
132
Interest expense on debt
604
557
550
563
545
Income
before income taxes
3,491
3,469
3,128
2,582
2,442
Income
taxes
769
803
(2,276)
914
886
Net income
$
2,722
$
2,666
$
5,404
$
1,668
$
1,556
PER
SHARE DATA
Basic earnings per share
$
10.32
$
9.58
$
18.76
$
5.66
$
5.13
Diluted
earnings per share
10.25
9.51
18.61
5.62
5.10
Dividends
3.60
3.04
2.44
2.36
2.36
Stockholders’
equity at year-end
58.87
57.30
57.57
42.73
40.93
FINANCIAL
POSITION
Total assets
$
37,923
$
36,239
$
35,711
$
34,892
$
34,139
Total
debt
12,196
11,145
9,836
10,212
10,093
Stockholders’ equity
15,184
15,362
16,359
12,409
12,188
OTHER
Property
additions
$
2,019
$
1,951
$
1,723
$
1,887
$
2,385
Average
number of shares outstanding (thousands)
263,270
277,708
287,861
293,943
301,873
Number of stockholders at year-end
23,273
24,475
25,737
27,288
28,443
Average
number of employees:
Rail
24,442
26,512
26,955
27,856
30,057
Nonrail
145
150
155
188
399
Total
24,587
26,662
27,110
28,044
30,456
Note
1: In 2017, as a result of the enactment of tax reform, “Railway operating expenses” included a $151 million benefit and “Income taxes” included a $3,331 million benefit, which added $3,482 million to “Net income” and $12.00 to “Diluted earnings per share.”
Note 2: On January 1, 2019, we adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-02, “Leases (Topic 842),” which requires lessees to recognize right-of-use (ROU) assets and lease liabilities on the balance sheet for leases greater than twelve months. As a result of the adoption, the Consolidated Balance Sheets at December 31, 2019 includes the recognition of ROU assets of $539 million and corresponding lease liabilities
of $538 million.
See accompanying consolidated financial statements and notes thereto.
K17
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes.
OVERVIEW
We
are one of the nation’s premier transportation companies. Our Norfolk Southern Railway Company subsidiary operates approximately 19,500 route miles in 22 states and the District of Columbia, serves every major container port in the eastern United States, and provides efficient connections to other rail carriers. Norfolk Southern is a major transporter of industrial products, including chemicals, agriculture, and metals and construction materials. In addition, we operate the most extensive intermodal network in the East and are a principal carrier of coal, automobiles, and automotive parts.
The execution of the initiatives in our strategic plan allowed us to achieve records for income from railway operations and railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) for the year. We continued our focus on improving the efficiency of our operations and utilization
of our assets, allowing us to reduce our operating expenses by 3% in the face of a 1% revenue decline.
SUMMARIZED RESULTS OF OPERATIONS
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
($ in millions, except per share amounts)
(% change)
Income
from railway operations
$
3,989
$
3,959
$
3,522
1
%
12
%
Net income
$
2,722
$
2,666
$
5,404
2
%
(51
%)
Diluted
earnings per share
$
10.25
$
9.51
$
18.61
8
%
(49
%)
Railway operating ratio (percent)
64.7
65.4
66.6
(1
%)
(2
%)
Income
from railway operations rose in 2019 as a 3% reduction in railway operating expenses more than offset the impact of a 1% decline in railway operating revenues. In addition to higher income from railway operations, net income and diluted earnings per share growth in 2019 also benefited from a lower effective tax rate. Our continuing share repurchase program contributed to diluted earnings per share growth that exceeded that of net income.
On December 22, 2017, the Tax Cuts and Jobs Act (“tax reform”) was signed into law. The following table adjusts our 2017 U.S. Generally Accepted Accounting Principles (GAAP) financial results to exclude the effects of tax reform, specifically, the effects of remeasurement of net deferred tax liabilities related to the reduction of the federal tax rate from 35% to 21% (the “2017 tax adjustments”). We use these
non-GAAP financial measures internally and believe this information provides useful supplemental information to investors to facilitate making period-to-period comparisons by excluding the 2017 tax adjustments. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similar measures presented by other companies.
K18
Reconciliation of Non-GAAP Financial Measures
Reported
2017 (GAAP)
2017 tax adjustments
Adjusted 2017 (non-GAAP)
($ in millions, except per share amounts)
Income from railway operations
$
3,522
$
(151)
$
3,371
Net
income
$
5,404
$
(3,482)
$
1,922
Diluted earnings per share
$
18.61
$
(12.00)
$
6.61
Railway
operating ratio (percent)
66.6
1.5
68.1
In the table below and the paragraph following, references to 2017 results and related comparisons use the adjusted, non-GAAP results from the reconciliation in the table above.
2018
vs.
Adjusted
Adjusted
2017
2019
2017
2019
2018
(non-GAAP)
vs.
2018
(non-GAAP)
($ in millions, except per share amounts)
(% change)
Income
from railway operations
$
3,989
$
3,959
$
3,371
1
%
17
%
Net income
$
2,722
$
2,666
$
1,922
2
%
39
%
Diluted
earnings per share
$
10.25
$
9.51
$
6.61
8
%
44
%
Railway operating ratio (percent)
64.7
65.4
68.1
(1
%)
(4
%)
Income
from railway operations increased in 2018 as compared to 2017, as a 9% increase in railway operating revenues more than offset a 4% increase in adjusted operating expenses. In addition to higher income from railway operations, net income and diluted earnings per share growth in 2018 also benefited from a lower effective tax rate, primarily due to the enactment of tax reform. Finally, our share repurchase program resulted in diluted earnings per share growth that exceeded that of net income.
K19
DETAILED RESULTS OF OPERATIONS
Railway Operating Revenues
The following tables present
a three-year comparison of revenues, volumes (units), and average revenue per unit by major commodity group. At the beginning of 2019, we made changes in the categorization of certain commodity groups within Merchandise. Prior period railway operating revenues, units, and revenue per unit have been reclassified to conform to the current presentation (see Note 2).
Revenues
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
($ in millions)
(% change)
Merchandise:
Chemicals
$
1,874
$
1,858
$
1,710
1
%
9
%
Agriculture
products
1,567
1,514
1,416
4
%
7
%
Metals and construction
1,522
1,539
1,481
(1
%)
4
%
Automotive
994
991
955
—
%
4
%
Forest
and consumer
846
842
795
—
%
6
%
Merchandise
6,803
6,744
6,357
1
%
6
%
Intermodal
2,824
2,893
2,452
(2
%)
18
%
Coal
1,669
1,821
1,742
(8
%)
5
%
Total
$
11,296
$
11,458
$
10,551
(1
%)
9
%
Units
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
(in thousands)
(% change)
Merchandise:
Chemicals
514.9
523.3
488.6
(2
%)
7
%
Agriculture
products
528.5
538.9
524.8
(2
%)
3
%
Metals and construction
721.3
759.7
761.2
(5
%)
—
%
Automotive
394.7
403.9
423.1
(2
%)
(5
%)
Forest
and consumer
273.0
293.3
293.7
(7
%)
—
%
Merchandise
2,432.4
2,519.1
2,491.4
(3
%)
1
%
Intermodal
4,207.2
4,375.7
4,074.1
(4
%)
7
%
Coal
914.0
1,033.5
1,046.0
(12
%)
(1
%)
Total
7,553.6
7,928.3
7,611.5
(5
%)
4
%
Revenue
per Unit
2019
2018
2019
2018
2017
vs. 2018
vs. 2017
($ per unit)
(%
change)
Merchandise:
Chemicals
$
3,640
$
3,551
$
3,501
3
%
1
%
Agriculture
products
2,964
2,809
2,697
6
%
4
%
Metals and construction
2,110
2,026
1,946
4
%
4
%
Automotive
2,517
2,453
2,257
3
%
9
%
Forest
and consumer
3,101
2,870
2,706
8
%
6
%
Merchandise
2,797
2,677
2,552
4
%
5
%
Intermodal
671
661
602
2
%
10
%
Coal
1,826
1,762
1,665
4
%
6
%
Total
1,495
1,445
1,386
3
%
4
%
K20
Revenues
decreased $162 million in 2019 but increased $907 million in 2018 compared to the prior years. As reflected in the table below, lower 2019 revenues were the result of decreased volumes, partially offset by higher average revenue per unit, driven by pricing gains. The rise in 2018 revenues was the result of higher average revenue per unit, driven by pricing gains and higher fuel surcharge revenue, partially offset by the mix-related impacts of increased intermodal volume and decreased coal volume. In addition, overall volume also increased.
The table below reflects the components of the revenue change by major commodity group.
2019
vs. 2018
2018 vs. 2017
Increase (Decrease)
Increase (Decrease)
($ in millions)
Merchandise
Intermodal
Coal
Merchandise
Intermodal
Coal
Volume
$
(232)
$
(111)
$
(210)
$
71
$
182
$
(21)
Fuel
surcharge
revenue
(14)
(30)
(35)
119
159
20
Rate,
mix and
other
305
72
93
197
100
80
Total
$
59
$
(69)
$
(152)
$
387
$
441
$
79
Approximately
90% of our revenue base is covered by contracts that include negotiated fuel surcharges. These revenues totaled $578 million, $657 million, and $359 million in 2019, 2018, and 2017, respectively.
For 2020, merchandise and intermodal revenues are expected to increase, while coal revenues are anticipated to decline, resulting in overall revenues that are expected to be flat.
MERCHANDISE revenues increased in both 2019 and 2018 compared with the prior years. In 2019, revenues grew due to higher average revenue per unit, driven by pricing gains, which were partially offset by volume declines in all commodity groups. In 2018, revenues grew due to higher average revenue per unit,
driven by pricing gains and higher fuel surcharge revenue, as well as higher volumes. Volume gains in chemicals and agriculture products were partially offset by declines in automotive traffic.
Chemicals revenues rose in both 2019 and 2018 compared with the prior years. In 2019, the rise was the result of higher average revenue per unit, due to pricing gains, which were partially offset by volume declines. Volume declines in natural gas, petroleum products, organic and inorganic chemicals, and plastics were partially offset by gains in crude oil and municipal waste. In 2018, the rise was the result of higher volume and higher average revenue per unit, due to pricing gains and higher fuel surcharge revenue. Volumes grew due to increased shipments of crude oil, liquefied petroleum gas, plastics, and municipal waste shipments, partially offset by a decrease in coal ash shipments.
Agriculture products revenues rose in both 2019 and 2018 compared to the prior years. Growth in 2019 was due to higher average revenue per unit, a result of pricing gains, which more than offset volume declines. Volumes were down due to decreased shipments of ethanol, soybeans, and fertilizer, partially offset by increases in corn shipments. Growth in 2018 was due to higher average revenue per unit, a result of pricing gains and higher fuel surcharge revenues, and higher volume. Higher ethanol and fertilizer shipments more than offset declines in soybean and corn shipments.
Metals and construction revenues declined in 2019 but increased in 2018 compared to the prior years. In 2019, volume declines were largely offset by higher average revenue per unit, the result of pricing gains. Volume
declines in iron and steel, coil, sand, and scrap metal were partially offset by increases in aggregates shipments due to improved service and market strength. In 2018, higher average revenue per unit, the result of pricing gains and
K21
higher fuel surcharge revenue, drove the increase while volumes remained flat. Volume increases in frac sand shipments for use in natural gas drilling in the Marcellus and Utica regions were offset by declines in aggregates, cement, aluminum, and iron and steel.
Automotive revenues were flat in 2019 and increased in 2018 compared to the prior years. In 2019, higher average revenue per unit, driven by price increases, offset volume declines that were primarily
the result of decreases in U.S. light vehicle production and the United Automobile Workers strike in the fourth quarter. In 2018, higher average revenue per unit, driven by price increases and higher fuel surcharge revenues, more than offset volume declines. Traffic declines were the result of shortages of availability of multilevel equipment and scheduled automotive plant downtime.
Forest and consumer revenues were flat in 2019 and increased in 2018 compared to the prior years. In 2019, higher average revenue per unit, the result of pricing gains, offset volume declines. Volume declines were primarily driven by reduced shipments of pulpboard, lumber and wood, and kaolin. In 2018, higher average revenue per unit, the result of pricing gains and higher fuel surcharge revenue drove the increase while volumes remained flat. Gains in pulpboard, a result of tightened truck capacity,
were offset by decreases in pulp, woodchip, and graphic paper.
INTERMODAL revenues decreased in 2019, but increased considerably in 2018 compared to the prior years. The decline in 2019 was driven by lower volumes, which were partially offset by higher average revenue per unit, a result of pricing gains. The rise in 2018 was driven by higher average revenue per unit, a result of increased fuel surcharge revenue and pricing gains, and higher volume.
Intermodal units by market were as follows:
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
(units in thousands)
(% change)
Domestic
2,593.5
2,801.1
2,585.0
(7
%)
8
%
International
1,613.7
1,574.6
1,489.1
2
%
6
%
Total
4,207.2
4,375.7
4,074.1
(4
%)
7
%
Domestic
volume fell in 2019 but increased in 2018. Volume was challenged in 2019 by stronger over-the-road competition. The rise in 2018 benefited from continued highway conversions due to tighter capacity in the truck market, higher truckload pricing, and growth from existing accounts.
International volume increased in both periods reflecting increased demand from new and existing customers, despite 2019 volume being somewhat tempered by tariff concerns.
COAL revenues decreased in 2019, but increased in 2018 compared with the prior years. The decrease in 2019 was a result of lower volume, which was partially offset by higher average revenue per unit, driven by pricing gains. Revenue growth in 2018 was the result of higher average revenue
per unit, largely the result of pricing gains, which more than offset volume declines.
K22
As shown in the following table, total tonnage decreased in both periods.
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
(tons in thousands)
(% change)
Utility
60,278
65,688
67,899
(8
%)
(3
%)
Export
23,324
28,046
26,460
(17
%)
6
%
Domestic
metallurgical
13,562
15,500
15,675
(13
%)
(1
%)
Industrial
4,655
5,410
5,545
(14
%)
(2
%)
Total
101,819
114,644
115,579
(11
%)
(1
%)
Utility
coal tonnage declined in both periods from continued headwinds from low natural gas prices as well as additional natural gas and renewable energy generating capacity, that were slightly offset by our service improvements and customer inventory rebuilding.
Export coal tonnage decreased in 2019 but increased in 2018. The decline in 2019 was a result of weak thermal seaborne pricing and coal supply disruptions at certain mines. The increase in 2018 was due to strong seaborne pricing that resulted in higher demand for U.S. coal.
Domestic metallurgical coal tonnage was down in both years. The decline in 2019 was a reflection of challenging overall market conditions including softening domestic steel demand, customer sourcing changes, and plant outages. The decline in
2018 was a reflection of customer sourcing changes.
Industrial coal tonnage decreased in both years driven by customer sourcing changes and pressure from natural gas conversions.
Railway Operating Expenses
Railway operating expenses summarized by major classifications were as follows:
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
($ in millions)
(% change)
Compensation and benefits
$
2,751
$
2,925
$
2,979
(6
%)
(2
%)
Purchased
services and rents
1,725
1,730
1,414
—
%
22
%
Fuel
953
1,087
840
(12
%)
29
%
Depreciation
1,138
1,102
1,055
3
%
4
%
Materials
and other
740
655
741
13
%
(12
%)
Total
$
7,307
$
7,499
$
7,029
(3
%)
7
%
In
2019, expenses fell as our strategic initiatives to improve productivity resulted in lower compensation, equipment rents, and materials expense. These decreases along with lower fuel prices and consumption were partially offset by lower gains on property sales, increased depreciation, and a write-off of a $32 million receivable as a result of a legal dispute. In 2018, expenses rose due to higher fuel prices as well as volume-related increases and costs associated with overall lower network velocity, partially offset by higher gains on property sales.
K23
Compensation and benefits decreased in 2019, reflecting changes in:
•employment levels (down $117
million),
•incentive and stock-based compensation (down $83 million),
•overtime and recrews (down $45 million),
•higher capitalized labor ($9 million),
•2018 employment tax refund ($31 million unfavorable in 2019),
•pay rates (up $76 million), and
•other (down $27 million).
In 2018, compensation and benefits decreased, a result of changes in:
•employment levels (down $61 million),
•health
and welfare benefit rates for agreement employees (down $34 million),
•employment tax refund ($31 million benefit),
•incentive and stock-based compensation (down $7 million),
•pay rates (up $34 million),
•overtime and recrews (up $58 million), and
•other (down $13 million).
Our employment averaged 24,587 in 2019, compared with 26,662 in 2018, and 27,110 in 2017.
Purchased services and rents includes the costs of services purchased from outside contractors, including the
net costs of operating joint (or leased) facilities with other railroads and the net cost of equipment rentals. In 2017, this line item includes a $151 million benefit from the 2017 tax adjustments ($36 million in purchased services and $115 million in equipment rents) in the form of higher income of certain equity investees.
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
($ in millions)
(% change)
Purchased services
$
1,434
$
1,367
$
1,233
5
%
11
%
Equipment
rents
291
363
181
(20
%)
101
%
Total
$
1,725
$
1,730
$
1,414
—
%
22
%
The
increase in purchased services in 2019 was the result of increased technology-related expenses, expenses associated with our headquarters relocation, and increased intermodal-related costs partially offset by decreased transportation activities. The increase in purchased services in 2018 was largely the result of the absence of the benefit from the 2017 tax adjustments, higher intermodal volume-related costs, additional transportation and engineering activities as well as higher technology costs.
Equipment rents, which includes our cost of using equipment (mostly freight cars) owned by other railroads or private owners less the rent paid to us for the use of our equipment, decreased in 2019, but increased in 2018. In 2019, the decrease was largely due to improved network velocity and the absence of short-term locomotive resource costs incurred in the prior year. In 2018, the rise was due to the absence
of the benefits from the 2017 tax adjustments, the impact of slower network velocity, the cost of additional short-term locomotive resources as well as growth in volume.
Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, decreased in 2019, but increased in 2018. The change in both years was principally due to locomotive fuel prices (down 8% in 2019 and up 25% in 2018) which decreased expenses $82 million in 2019 but increased expenses $208 million in 2018. Locomotive fuel consumption decreased 4% in 2019, but increased 3% in 2018. We consumed
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approximately 451 million gallons of diesel fuel in 2019, compared with 472 million gallons in
2018 and 458 million gallons in 2017.
Depreciation expense increased in both periods, a reflection of growth in our roadway and equipment capital base as we continue to invest in our infrastructure and rolling stock, and technology.
Materials and other expenses increased in 2019 but decreased in 2018 as shown in the following table.
2019
2018
2019
2018
2017
vs.
2018
vs. 2017
($ in millions)
(% change)
Materials
$
327
$
362
$
348
(10
%)
4
%
Casualties
and other claims
193
176
145
10
%
21
%
Other
220
117
248
88
%
(53
%)
Total
$
740
$
655
$
741
13
%
(12
%)
Materials
expense decreased in 2019, due primarily to lower locomotive repair costs as a result of fewer locomotives in service. In 2018, the increase was primarily a result of higher locomotive repair costs.
Casualties and other claims expenses include the estimates of costs related to personal injury, property damage, and environmental matters. The 2019 expense increased, primarily the result of higher costs related to environmental remediation matters and higher personal injury costs. The 2018 expense increased, primarily the result of higher derailment-related costs.
Other expense increased in 2019 but decreased in 2018, largely a result of gains from sales of operating properties. Gains from operating property sales amounted to $64 million, $158 million, and $79 million in 2019, 2018, and 2017, respectively. In 2019, the increase was additionally
impacted by the write-off of a $32 million receivable as a result of a legal dispute. In 2018, the decline was also impacted by the inclusion of net rental income from operating property previously included in “Other income – net” of $78 million, partially offset by increased costs as a result of the relocation of our train dispatchers to Atlanta, Georgia.
Other income – net
Other income – net increased in 2019 but decreased in 2018. The increase in 2019 was driven by higher returns on corporate-owned life insurance (COLI) investments and increased gains on sales of non-operating property, which more than offset a $49 million impairment loss related to our natural resource assets that we are actively marketing to sell. The decline in 2018 was driven by the absence of net rental income as discussed above and unfavorable returns from COLI
investments.
Income Taxes
The effective income tax rate was 22.0% in 2019, compared with 23.1% in 2018 and negative 72.8% in 2017. Both 2019 and 2018 benefited from favorable reductions in deferred taxes for state tax law changes and certain business tax credits, while 2019 and 2017 benefited from higher returns from COLI. Income taxes in 2018 benefited from the effects of the enactment of tax reform in late 2017 that lowered the federal corporate income tax rate. Income taxes in 2017 included a benefit of $3,331 million related to the effects of the enactment of tax reform from the reduction in our net deferred tax liabilities driven by the change in the federal rate. All three years benefited from favorable tax benefits associated with stock-based compensation.
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For
2020, we expect the effective income tax rate to range from 23% to 24%.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Cash provided by operating activities, our principal source of liquidity, was $3.9 billion in 2019, $3.7 billion in 2018, and $3.3 billion in 2017. The increases in both 2019 and 2018 were primarily the result of improved operating results. We had working capital deficits of $219 million and $729 million at December 31, 2019, and 2018, respectively. Cash, cash equivalents, and restricted cash totaled $580 million and $446 million at December 31, 2019, and 2018,
respectively. We expect cash on hand combined with cash provided by operating activities will be sufficient to meet our ongoing obligations.
Contractual obligations at December 31, 2019, include interest on fixed-rate long-term debt, long-term debt (Note 9), unconditional purchase obligations (Note 17), operating leases (Note 10), long-term advances from Conrail and agreements with Consolidated Rail Corporation (CRC) (Note 6), and unrecognized tax benefits (Note 4):
Total
2020
2021
- 2022
2023 - 2024
2025 and Subsequent
Other
($ in millions)
Interest
on fixed-rate long-term debt
$
15,285
$
568
$
1,070
$
988
$
12,659
$
—
Long-term
debt principal
13,005
316
1,189
1,000
10,500
—
Unconditional purchase obligations
1,225
499
521
82
123
—
Operating
leases
630
110
183
131
206
—
Long-term advances from Conrail
280
—
—
—
280
—
Agreements
with CRC
176
40
80
56
—
—
Unrecognized tax benefits*
24
—
—
—
—
24
Total
$
30,625
$
1,533
$
3,043
$
2,257
$
23,768
$
24
* This
amount is shown in the Other column because the year of settlement cannot be reasonably estimated.
Off balance sheet arrangements consist primarily of unrecognized obligations, including unconditional purchase obligations and future interest payments on fixed-rate long-term debt, which are included in the table above. In addition, we entered into a synthetic lease during 2019 which is discussed further in Note 10.
Cash used in investing activities was $1.8 billion in 2019, compared with $1.7 billion in 2018, and $1.5 billion in 2017. In 2019, increased corporate owned life insurance activity and higher property additions were partially offset by increased proceeds from property sales. In 2018, higher property additions drove the increase.
Capital
spending and track and equipment statistics can be found within the “Railway Property” section of Part I of this report on Form 10-K. For 2020, we expect capital spending to approximate 16% to 18% of revenues.
Cash used in financing activities was $2.0 billion in 2019, compared with $2.3 billion in 2018, and $2.0 billion in 2017. Both year-over-year comparisons reflect higher debt repayments and increased dividends. In 2019, the decrease was also impacted by fewer repurchases of common stock. In 2018, the increase was also impacted by increased repurchases of common stock, but tempered by increased proceeds from borrowings.
Share repurchases totaled $2.1 billion in 2019, $2.8 billion in 2018, and $1.0 billion in 2017 for the purchase and retirement of 11.3 million, 17.1 million (including 7.0 million shares repurchased
for $1.2 billion under the Accelerated Share Repurchase (ASR) program), and 8.2 million shares, respectively. As of December 31, 2019, 28.0 million shares remain authorized by our Board of Directors for repurchase. The timing and volume of future
K26
share repurchases will be guided by our assessment of market conditions and other pertinent factors. Any near-term purchases under the program are expected to be made with internally generated cash, cash on hand, or proceeds from borrowings.
In May 2019, we issued $200 million of 3.80% senior notes due 2028, $400 million of 4.10% senior notes due 2049, and $200 million of 5.10% senior notes due 2118. In November 2019, we
issued $400 million of 2.55% senior notes due 2029, and $400 million of 3.40% senior notes due 2049.
In May 2019, we also renewed and amended our accounts receivable securitization program, increasing our maximum borrowing capacity from $400 million to $450 million with a term expiring in May 2020. We had no amounts outstanding at both December 31, 2019 and 2018.
We discuss our credit agreement and our accounts receivable securitization program in Note 9, and we have authority from our Board of Directors to issue an additional $1.6 billion of debt or equity securities through public or private sale, all of which provide for access to additional liquidity should the need arise. Our debt-to-total capitalization ratio was 44.5% at December
31, 2019, compared with 42.0% at December 31, 2018.
Upcoming annual debt maturities are disclosed in Note 9. Overall, our goal is to maintain a capital structure with appropriate leverage to support our business strategy and provide flexibility through business cycles.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. These estimates
and assumptions may require judgment about matters that are inherently uncertain, and future events are likely to occur that may require us to make changes to these estimates and assumptions. Accordingly, we regularly review these estimates and assumptions based on historical experience, changes in the business environment, and other factors we believe to be reasonable under the circumstances. The following critical accounting policies are a subset of our significant accounting policies described in Note 1.
Pensions and Other Postretirement Benefits
Accounting for pensions and other postretirement benefit plans requires us to make several estimates and assumptions (Note 12). These include the expected rate of return from investment of the plans’ assets and the expected retirement age of employees as well as their projected earnings
and mortality. In addition, the amounts recorded are affected by changes in the interest rate environment because the associated liabilities are discounted to their present value. We make these estimates based on our historical experience and other information that we deem pertinent under the circumstances (for example, expectations of future stock market performance). We utilize an independent actuarial consulting firm’s studies to assist us in selecting appropriate actuarial assumptions and valuing related liabilities.
In recording our net pension benefit, we assumed a long-term investment rate of return of 8.25%, which was supported by the long-term total rate of return on plan assets since inception, as well as our expectation of future returns. A one-percentage point change to this rate of return assumption would result in a $23 million change in pension expense. We review assumptions related
to our defined benefit plans annually, and while changes are likely to occur in assumptions concerning retirement age, projected earnings, and mortality, they are not expected to have a material effect on our net pension expense or net pension liability in the future. The net pension liability is recorded at net present value using discount rates that are based on the current interest rate environment in light of the timing of expected benefit payments. We utilize analyses in which the projected annual cash flows from the pension and postretirement benefit plans are matched with yield curves based on an appropriate universe of high-quality corporate bonds. We use the results of the yield curve analyses to select the discount rates that match the payment streams of the benefits in these plans. A one-percentage point change to this discount rate assumption would result in about an $18 million change in pension expense.
K27
Properties
and Depreciation
Most of our assets are long-lived railway properties (Note 7). “Properties” are stated principally at cost and are depreciated using the group method whereby assets with similar characteristics, use, and expected lives are grouped together in asset classes and depreciated using a composite depreciation rate. See Note 1 for a more detailed discussion of the assumptions and estimates in this area.
Expenditures, including those on leased assets, that extend an asset’s useful life or increase its utility are capitalized. Expenditures capitalized include those that are directly related to a capital project and may include materials, labor, and other direct costs, in addition to an allocable portion of indirect costs that relate to a capital project. A significant portion of our annual capital spending relates to the
replacement of self-contructed assets. Costs related to repairs and maintenance activities that, in our judgment, do not extend an asset’s useful life or increase its utility are expensed when such repairs are performed.
Depreciation expense for 2019 totaled $1.1 billion. Our composite depreciation rates for 2019 are disclosed in
Note 7; a one year increase (or decrease) in the estimated average useful lives of depreciable assets would have resulted in an approximate $40 million decrease (or increase) to depreciation expense.
Personal Injury
Casualties and other claims expense, included in “Materials and other” in the Consolidated Statements of Income, includes our accrual for personal injury liabilities.
To
aid in valuing our personal injury liability and determining the amount to accrue with respect to such claims during the year, we utilize studies prepared by an independent consulting actuarial firm. The actuarial firm studies our historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences. We adjust the liability quarterly based upon our assessment and the results of the study. Our estimate is subject to inherent limitation given the difficulty of predicting future events and as such the ultimate loss sustained may vary from the estimated liability recorded.
For a more detailed discussion of the assumptions and estimates in accounting for personal injury see Note 17.
Income Taxes
Our net deferred tax liability totaled
$6.8 billion at December 31, 2019 (Note 4). This liability is estimated based on the expected future tax consequences of items recognized in the financial statements. After application of the federal statutory tax rate to book income, judgment is required with respect to the timing and deductibility of expenses in our income tax returns. For state income and other taxes, judgment is also required with respect to the apportionment among the various jurisdictions. A valuation allowance is recorded if we expect that it is more likely than not that deferred tax assets will not be realized. We have a $54 million valuation allowance on $513 million of deferred tax assets as of December 31, 2019, reflecting the expectation that almost all of these assets will be realized.
OTHER
MATTERS
Labor Agreements
Approximately 80% of our railroad employees are covered by collective bargaining agreements with various labor unions. Pursuant to the Railway Labor Act, these agreements remain in effect until new agreements are reached, or until the bargaining procedures mandated by the Railway Labor Act are completed. We largely bargain nationally in concert with other major railroads, represented by the National Carriers Conference Committee. Moratorium provisions in the labor agreements govern when the railroads and unions may propose changes to the agreements.
K28
The next round of bargaining commenced on November
1, 2019 with both management and the unions serving their formal proposals for changes to the collective bargaining agreements.
Market Risks
At December 31, 2019, we had no outstanding debt subject to interest rate fluctuations. Market risk for fixed-rate debt is estimated as the potential increase in fair value resulting from a one percentage point decrease in interest rates as of December 31, 2019, and amounts to an increase of approximately $2.1 billion to the fair value of our debt at December 31, 2019. We consider it unlikely that interest rate fluctuations applicable to these instruments will result in a material adverse effect on our financial position, results of operations, or
liquidity.
New Accounting Pronouncements
For a detailed discussion of new accounting pronouncements, see Note 1.
Inflation
In preparing financial statements, GAAP requires the use of historical cost that disregards the effects of inflation on the replacement cost of property. As a capital-intensive company, we have most of our capital invested in long-lived assets. The replacement cost of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical cost.
FORWARD-LOOKING STATEMENTS
Certain
statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations are “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or our achievements or those of our industry to be materially different from those expressed or implied by any forward-looking statements. In some cases, forward-looking statements can be identified by terminology such as “may,”“will,”“could,”“would,”“should,”“expect,”“plan,”“anticipate,”“intend,”“believe,”“estimate,”“project,”“consider,”“predict,”“potential,”“feel,”
or other comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates, beliefs, and projections. While we believe these expectations, assumptions, estimates, beliefs, and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which involve factors or circumstances that are beyond our control. These and other important factors, including those discussed in Item 1A “Risk Factors,” may cause actual results, performance, or achievements to differ materially from those expressed or implied by these forward-looking statements. The forward-looking statements herein are made only as of the date they were first issued, and unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events,
or otherwise.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is included in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Market Risks.”
K29
Item 8. Financial Statements and Supplementary Data
Management is responsible for establishing and maintaining adequate internal control over financial reporting. In order to ensure that Norfolk Southern Corporation’s internal control over financial reporting is effective, management regularly assesses such controls and did so most recently as of December 31, 2019. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2019.
KPMG LLP, independent registered public accounting firm, has audited the Corporation’s financial statements and issued an attestation report on the Corporation’s internal control over financial reporting as of December 31, 2019.
Report of Independent Registered Public Accounting Firm
To
the Stockholders and Board of Directors
Norfolk Southern Corporation:
Opinion on Internal Control Over Financial Reporting
We have audited Norfolk Southern Corporation and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company
maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, cash flows, and changes in stockholders’ equity for each of the years in the
three-year period ended December 31, 2019, and the related notes and financial statement schedule of valuation and qualifying accounts as listed in Item 15(A)2 (collectively, the consolidated financial statements), and our report dated February 6, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management. Our responsibility is to express an opinion on the
Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the
design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
K32
Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Report
of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Norfolk Southern Corporation:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Norfolk Southern Corporation and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, cash flows,
and changes in stockholders’ equity for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement schedule of valuation and qualifying accounts as listed in Item 15(A)2 (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 6, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Change in Accounting Principle
As
discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases as of January 1, 2019, due to the adoption of Accounting Standards Update 2016-02, Leases (Topic 842) and related amendments.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the
Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
K34
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of a critical audit matter does not alter in any way our opinion on the consolidated
financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Assessment of capitalization of property expenditures
As discussed in Note 1 to the consolidated financial statements, expenditures that extend an asset’s useful life or increase its utility are capitalized. The Company has recorded $31,614 million in net book value of properties at December 31, 2019 and has recorded $2,019 million in property additions for the year ended December 31, 2019. Expenditures capitalized
include those that are directly related to a capital project and may include materials, labor and other direct costs, in addition to an allocable portion of indirect costs that relate to a capital project. A significant portion of the Company's annual capital spending relates to the replacement of self-constructed assets. Costs related to repair and maintenance activities, that in the Company's judgment, do not extend an asset’s useful life or increase its utility are expensed when such repairs are performed.
We identified the assessment of capitalization of property expenditures as a critical audit matter. A higher degree of auditor judgment was required in determining procedures and evaluating audit results related
to the capitalization or expense treatment of purchased services and compensation due to their usage for both self-constructed assets and repairs and maintenance.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s capitalization process, including controls that establish whether a project is a capital or repair expenditure and the appropriateness of accumulated charges to capitalized projects. We selected a sample of capital projects and assessed the capital nature of the project. We obtained support for a sample of property addition expenditures and tested the classification of the related expenditure as capital, which included inquiry with Company personnel regarding the relevance of the sampled
expenditure to the capital project.
The following Notes are an integral part of the Consolidated Financial Statements.
1. iSummary
of Significant Accounting Policies
i
Description of Business
Norfolk Southern Corporation is a Virginia-based holding company engaged principally in the rail transportation business, operating approximately i19,500
route miles primarily in the East and Midwest. These consolidated financial statements include Norfolk Southern and its majority-owned and controlled subsidiaries (collectively, NS, we, us, and our). Norfolk Southern’s major subsidiary is NSR. All significant intercompany balances and transactions have been eliminated in consolidation.
NSR and its railroad subsidiaries transport raw materials, intermediate products, and finished goods classified in the following commodity groups (percent of total railway operating revenues in 2019): intermodal (i25%);
chemicals (i17%); coal (i15%); agriculture products (i14%);
metals and construction (i13%); automotive (i9%); and, forest and consumer (i7%). Although
most of our customers are domestic, ultimate points of origination or destination for some of the products transported (particularly coal bound for export and some intermodal shipments) may be outside the U.S. Approximately i80% of our railroad employees are covered by collective bargaining agreements with various labor unions.
/
i
Use
of Estimates
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We periodically review our estimates, including those related to the recoverability and useful lives of assets, as well as liabilities for litigation, environmental remediation, casualty claims, income taxes and pension and other postretirement benefits. Changes in facts and circumstances may result in revised estimates.
i
Revenue
Recognition
Transportation revenue is recognized proportionally as a shipment moves from origin to destination, and related expenses are recognized as incurred. Certain of our contract refunds (which are primarily volume-based incentives) are recorded as a reduction to revenues on the basis of management’s best estimate of projected liability, which is based on historical activity, current shipment counts and expectation of future activity. Certain accessorial services may be provided to customers under their transportation contracts such as switching, demurrage and other incidental service revenues. These are distinct performance obligations that are recognized at a point in time when the services are performed
or as contractual obligations are met.
i
Cash Equivalents
“Cash equivalents” are highly liquid investments purchased three months or less from maturity.
i
Allowance
for Doubtful Accounts
Our allowance for doubtful accounts was $i9 million and $i7
million at December 31, 2019 and 2018, respectively. To determine our allowance for doubtful accounts, we evaluate historical loss experience (which has not been significant), the characteristics of current accounts, and general economic conditions and trends.
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i
Materials
and Supplies
“Materials and supplies,” consisting mainly of items for maintenance of property and equipment, are stated at the lower of average cost or net realizable value. The cost of materials and supplies expected to be used in property additions or improvements is included in “Properties.”
i
Investments
Investments in entities over which we have the ability to exercise significant influence but do not control the entity
are accounted for using the equity method, whereby the investment is carried at the cost of the acquisition plus our equity in undistributed earnings or losses since acquisition.
i
Properties
“Properties” are stated principally at cost and are depreciated using the group method whereby assets with similar characteristics, use, and expected lives are grouped together in asset classes and depreciated using a composite
depreciation rate. This methodology treats each asset class as a pool of resources, not as singular items. We use approximately i75 depreciable asset classes. “Depreciation” in the Consolidated Statements of Cash Flows includes both depreciation and depletion on operating and nonoperating properties.
Depreciation expense is based on our assumptions concerning expected service lives of our properties as well as the expected net salvage that will be received upon their retirement. In
developing these assumptions, we utilize periodic depreciation studies that are performed by an independent outside firm of consulting engineers and approved by the STB. Our depreciation studies are conducted about every ithree years for equipment and every isix years for track assets and other roadway property. The
frequency of these studies is consistent with guidelines established by the STB. We adjust our rates based on the results of these studies and implement the changes prospectively. The studies may also indicate that the recorded amount of accumulated depreciation is deficient (or in excess) of the amount indicated by the study. Any such deficiency (or excess) is amortized as a component of depreciation expense over the remaining service lives of the affected class of property, as determined by the study.
Key factors that are considered in developing average service life and salvage estimates include:
•statistical analysis of historical retirement data and surviving asset records;
•review of historical salvage received and current market rates;
•review
of our operations including expected changes in technology, customer demand, maintenance practices and asset management strategies;
•review of accounting policies and assumptions; and
•industry review and analysis.
The composite depreciation rate for rail in high density corridors is derived based on consideration of annual gross tons as compared to the total or ultimate capacity of rail in these corridors. Our experience has shown that traffic density is a leading factor in the determination of the expected service life of rail in high density corridors. In developing the respective depreciation rate, consideration is also given to several rail characteristics including age, weight, condition (new or second-hand) and type (curved or straight).
We
capitalize interest on major projects during the period of their construction. Expenditures, including those on leased assets, that extend an asset’s useful life or increase its utility are capitalized. Expenditures capitalized include those that are directly related to a capital project and may include materials, labor, and other direct costs, in addition to an allocable portion of indirect costs that relate to a capital project. A significant portion of our annual capital spending relates to the replacement of self-constructed assets. Removal activities occur in conjunction with replacement and are estimated based on the average percentage of time employees replacing assets spend on removal functions. Costs related to repairs and maintenance activities that, in our judgment, do not extend an asset’s useful life or increase its utility are expensed when such repairs are performed.
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When
depreciable operating road and equipment assets are sold or retired in the ordinary course of business, the cost of the assets, net of sale proceeds or salvage, is charged to accumulated depreciation, and no gain or loss is recognized in earnings. Actual historical cost values are retired when available, such as with most equipment assets. The use of estimates in recording the retirement of certain roadway assets is necessary based on the impracticality of tracking individual asset costs. When retiring rail, ties and ballast, we use statistical curves that indicate the relative distribution of the age of the assets retired. The historical cost of other roadway assets is estimated using a combination of inflation indices specific to the rail industry and those published by the U.S. Bureau of Labor Statistics. The indices are applied to the replacement value based on the age of the retired assets. These indices are used because they closely correlate with the costs
of roadway assets. Gains and losses on disposal of operating land are included in “Materials and other” expenses. Gains and losses on disposal of nonoperating land and nonrail assets are included in “Other income – net” since such income is not a product of our railroad operations.
A retirement is considered abnormal if it does not occur in the ordinary course of business, if it relates to disposition of a large segment of an asset class and if the retirement varies significantly from the retirement profile identified through our depreciation studies, which inherently consider the impact of normal retirements on expected service lives and depreciation rates. Gains or losses from abnormal retirements would be recognized in income from railway operations.
We review the carrying amount of properties whenever events
or changes in circumstances indicate that such carrying amount may not be recoverable based on future undiscounted cash flows. Assets that are deemed impaired as a result of such review are recorded at the lower of carrying amount or fair value.
i
New Accounting Pronouncements
The FASB issued ASU 2014-09, “Revenue from Contracts
with Customers,” and related amendments, which are jointly referred to as Accounting Standards Codification (ASC) Topic 606. This standard replaced most existing revenue recognition guidance in GAAP and requires entities to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. A performance obligation is defined as a promise in a contract to transfer a distinct good or service to the customer. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. We adopted the provisions of this standard on January 1, 2018, using the modified retrospective
method. There was no cumulative effect of initially applying the standard, nor was there any material difference in revenue for the year ended December 31, 2018, as compared with GAAP that was in effect prior to January 1, 2018. See Note 2 for additional information.
In March 2017, the FASB issued ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” This update requires segregation of net benefit costs between operating and nonoperating expenses and requires retrospective application. We adopted the standard on January 1, 2018. Under the new standard, only the service cost component of defined benefit pension cost and postretirement benefit
cost are reported within “Compensation and benefits” and all other components of net benefit cost are presented in “Other income – net” on the Consolidated Statements of Income, whereas under the previous standard all components were included in “Compensation and benefits.” The retrospective application resulted in an increase to “Compensation and benefits” expense and an offsetting increase to “Other income – net” on the Consolidated Statements of Income of $ii64/
million for the year ended December 31, 2017, with no impact on “Net income.”
In February 2018, the FASB issued ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This update is intended to reclassify the stranded tax effects resulting from tax reform from accumulated other comprehensive income (AOCI) to retained earnings. The amount of the reclassification is the difference between the amount initially charged or credited directly to other comprehensive income at the previously enacted U.S. federal corporate income tax rate that remains in AOCI and the amount that would have been charged or credited directly to other comprehensive income using the newly enacted U.S. federal corporate income tax rate. In the first quarter of 2018, we adopted the
provisions of ASU 2018-02 resulting in an increase to
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“Accumulated other comprehensive loss” of $ii88/
million and a corresponding increase to “Retained income,” with no impact on “Total stockholders’ equity.”
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” and subsequent amendments, which replaced existing lease guidance in GAAP. We adopted the standard on January 1, 2019 using the modified retrospective method and used the effective date as our date of initial application. See Note 10 for additional information.
In June 2016, the FASB issued ASU 2016-13, “Credit Losses - Measurement of Credit Losses on Financial Instruments,” which replaces the current incurred loss impairment method with a method that reflects expected credit losses. We adopted the
standard on January 1, 2020. Because credit losses associated from our trade receivables have historically been insignificant, we do not expect this standard to have a material effect on our financial statements.
In December 2019, the FASB issued ASU 2019-12, “Simplifying the Accounting for Income Taxes,” which adds new guidance to simplify the accounting for income taxes, changes the accounting for certain income tax transactions, and makes other minor changes. The new standard is effective as of January 1, 2021, and early adoption is permitted for any interim period for which financial statements have not been issued. We do not expect this standard to have a material effect on our financial statements. We will not adopt the standard early.
2.
iRailway Operating Revenues
i
The following table disaggregates our revenues by major commodity group:
2019
2018
($
in millions)
Merchandise:
Chemicals
$
i1,874
$
i1,858
Agriculture
products
i1,567
i1,514
Metals
and construction
i1,522
i1,539
Automotive
i994
i991
Forest
and consumer
i846
i842
Merchandise
i6,803
i6,744
Intermodal
i2,824
i2,893
Coal
i1,669
i1,821
Total
$
i11,296
$
i11,458
/
At
the beginning of 2019, we recategorized certain commodities within Merchandise major commodity groups to
better align with how we internally manage these commodities. Prior period amounts have been reclassified to
conform to the current presentation with no net impact to overall Merchandise revenue or total railway operating
revenues. Specifically, certain commodities were shifted between chemicals, agriculture products, metals and construction, and forest and consumer.
We recognize the amount of revenue we expect to be entitled to for the transfer of promised goods or services to
customers. A performance obligation is created when a customer under a transportation contract or public
tariff submits a bill of lading to NS for the transport of goods. These performance obligations are satisfied as the shipments move from origin to destination. As such, transportation revenue is recognized proportionally as a shipment moves, and related expenses are recognized as incurred. These performance obligations are generally short-term in nature with transit days averaging approximately one week or less for each commodity group. The customer has an unconditional obligation to pay for the service once the service has been completed. Estimated revenue associated with in-process shipments at period-end is recorded based on the estimated percentage of service
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completed to total transit days. We had no material remaining performance obligations at December 31,
2019 and 2018.
Revenue related to interline transportation services that involve another railroad is reported on a net basis. Therefore, the portion of the amount that relates to another party is not reflected in revenue.
Under the typical payment terms of our freight contracts, payment for services is due within ififteen days of billing the customer, thus there are no significant financing
components. i“Accounts receivable – net” on the Consolidated Balance Sheets includes both customer and non-customer receivables as follows:
Non-customer
receivables include non-revenue-related amounts due from other railroads, governmental entities, and others. “Other assets” on the Consolidated Balance Sheets includes non-current customer receivables of $i23 million and $i55
million at December 31, 2019 and 2018, respectively. In 2019, we wrote off a $i32 million non-current customer receivable resulting from a legal dispute and this expense is included in “Materials and other” on the Consolidated Statements of Income. We do not have any material contract assets or liabilities at December 31,
2019 and 2018.
Certain accessorial services may be provided to customers under their transportation contracts such as switching, demurrage and other incidental service revenues. These are distinct performance obligations that are recognized at a point in time when the services are performed or as contractual obligations are met. This revenue is included within each of the commodity groups and represents approximately i5%
and i4% of total “Railway operating revenues” on the Consolidated Statements of Income for the years ended December 31, 2019 and 2018, respectively.
3. iOther
Income – Net
i
2019
2018
2017
($
in millions)
Corporate-owned life insurance – net
$
i69
$
(i10)
$
i33
Net
pension and other postretirement benefit cost (Note 12)
i63
i61
i64
Rental
income
i4
i5
i87
Other
(i30)
i11
(i28)
Total
$
i106
$
i67
$
i156
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4. iIncome
Taxes
i
2019
2018
2017
($
in millions)
Current:
Federal
$
i356
$
i499
$
i500
State
i83
i131
i83
Total
current taxes
i439
i630
i583
Deferred:
Federal
i280
i156
(i2,924)
State
i50
i17
i65
Total
deferred taxes
i330
i173
(i2,859)
Income
taxes
$
i769
$
i803
$
(i2,276)
/
Reconciliation
of Statutory Rate to Effective Rate
i
“Income taxes” on the Consolidated Statements of Income differs from the amounts computed by applying the statutory federal corporate tax rate as follows:
2019
2018
2017
Amount
%
Amount
%
Amount
%
($
in millions)
Federal income tax at statutory rate
$
i733
i21.0
$
i728
i21.0
$
i1,095
i35.0
State
income taxes, net of federal tax effect
i110
i3.1
i120
i3.5
i88
i2.8
Equity
in earnings related to tax reform
i—
i—
i—
i—
(i38)
(i1.2)
Tax
reform
i—
i—
i—
i—
(i3,331)
(i106.5)
Excess
tax benefits on stock-based compensation
(i29)
(i0.8)
(i22)
(i0.7)
(i39)
(i1.2)
Other,
net
(i45)
(i1.3)
(i23)
(i0.7)
(i51)
(i1.7)
Income
Taxes
$
i769
i22.0
$
i803
i23.1
$
(i2,276)
(i72.8)
/
Tax
reform, enacted in 2017, lowered the Federal corporate tax rate from 35% to 21% and made numerous other tax law changes. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. As a result, in 2017, “Purchased services and rents” included a $i151 million benefit for earnings generated from reductions to net deferred tax liabilities at certain equity investees and “Income taxes” included a $i3,331
million benefit primarily due to the remeasurement of our net deferred tax liabilities to reflect the lower rate.
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Deferred Tax Assets and Liabilities
Certain items are reported in different periods for financial reporting and income tax purposes. Deferred tax assets and liabilities are recorded in recognition of these differences. iThe
tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
Compensation and benefits, including postretirement benefits
$
i222
$
i284
Accruals,
including casualty and other claims
i89
i69
Other
i202
i72
Total
gross deferred tax assets
i513
i425
Less
valuation allowance
(i54)
(i50)
Net
deferred tax assets
i459
i375
Deferred
tax liabilities:
Property
(i6,714)
(i6,422)
Other
(i560)
(i413)
Total
deferred tax liabilities
(i7,274)
(i6,835)
Deferred
income taxes
$
(i6,815)
$
(i6,460)
Except
for amounts for which a valuation allowance has been provided, we believe that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The valuation allowance at the end of each year primarily relates to subsidiary state income tax net operating losses and state investment tax credits that may not be utilized prior to their expiration. The total valuation allowance increased by $i4 million in 2019, $i6
million in 2018, and $i5 million in 2017.
Uncertain Tax Positions
i
A
reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Additions
based on tax positions related to the current year
i4
i5
Lapse
of statutes of limitations
(i1)
(i1)
Balance
at end of year
$
i24
$
i21
/
Included
in the balance of unrecognized tax benefits at December 31, 2019 are potential benefits of $i19 million that would affect the effective tax rate if recognized. Unrecognized tax benefits are adjusted in the period in which new information about a tax position becomes available or the final outcome differs from the amount recorded.
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The
statute of limitations on Internal Revenue Service examinations has expired for all years prior to 2015. We have amended our 2012 income tax return to request a refund of $i46 million, which is not included in the above balance of unrecognized tax benefits. We would recognize a tax benefit of around $i18 million
if the refund is allowed. State income tax returns generally are subject to examination for a period of three to four years after filing of the return. In addition, we are generally obligated to report changes in taxable income arising from federal income tax examinations to the states within a period of up to two years from the date the federal examination is final. We have various state income tax returns either under examination, administrative appeal, or litigation.
5. iFair
Value Measurements
FASB ASC 820-10, “Fair Value Measurements,”established a framework for measuring fair value and a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
Level 1
Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that we have the ability to access.
Level
2
Inputs to the valuation methodology include:
• quoted prices for similar assets or liabilities in active markets;
• quoted prices for identical or similar assets or liabilities in inactive markets;
• inputs other than quoted prices that are observable for the asset or liability;
• inputs that are derived principally from or corroborated by observable market data by correlation or other means.
If
the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.
Level 3
Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The asset or liability’s fair value measurement level within the hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Fair Values of Financial Instruments
The fair values of “Cash
and cash equivalents,”“Accounts receivable – net,” and “Accounts payable,” approximate carrying values because of the short maturity of these financial instruments. The carrying value of COLI is recorded at cash surrender value and, accordingly, approximates fair value. There are no other assets or liabilities measured at fair value on a recurring basis at December 31, 2019 or 2018. iThe carrying amounts and estimated fair values, based on
Level 1 inputs, of long-term debt consisted of the following at December 31:
Corporate-owned
life insurance at net cash surrender value
i767
i556
Other
investments
i15
i21
Total
long-term investments
$
i3,428
$
i3,109
/
Investment
in Conrail
Through a limited liability company, we and CSX jointly own Conrail, whose primary subsidiary is CRC. We have a i58% economic and i50%
voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests. We are amortizing the excess of the purchase price over Conrail’s net equity using the principles of purchase accounting, based primarily on the estimated useful lives of Conrail’s depreciable property and equipment, including the related deferred tax effect of the differences in book and tax accounting bases for such assets, as all of the purchase price at acquisition was allocable to Conrail’s tangible assets and liabilities.
At December 31, 2019, based on the funded status of Conrail’s pension plans, we decreased our proportional investment in Conrail by $i3
million. This resulted in a loss of $i3 million recorded to “Other comprehensive loss”.
At December 31, 2018, based on the funded status of Conrail’s pension plans, we decreased our proportional investment in Conrail by $i11
million. This resulted in a loss of $i10 million recorded to “Other comprehensive loss” and a combined federal and state deferred tax liability of $i1
million.
At December 31, 2019, the difference between our investment in Conrail and our share of Conrail’s underlying net equity was $i497 million. Our equity in the earnings of Conrail, net of amortization, included in “Purchased services and rents,” which offsets the costs of operating the Shared Assets Areas, was $i53
million for 2019, $i55 million for 2018, and $i75 million for 2017 (including $i33
million related to the enactment of tax reform – see Note 4). Equity in earnings are included in the “Other – net” line item within operating activities in the Consolidated Statements of Cash Flows.
CRC owns and operates certain properties (the Shared Assets Areas) for the joint and exclusive benefit of NSR and CSX Transportation, Inc. (CSXT). The costs of operating the Shared Assets Areas are borne by NSR and CSXT based on usage. In addition, NSR and CSXT pay CRC a fee for access to the Shared Assets Areas. “Purchased services and rents” and “Fuel” include expenses payable to CRC for operation of the Shared Assets Areas totaling $i149
million in 2019, $i150 million in 2018, and $i141
million in 2017. Future payments for access fees due to CRC under the Shared Assets Areas agreements are as follows: $i40 million in each of 2020 through 2023 and $i16
million thereafter. We provide certain general and administrative support functions to Conrail, the fees for which are billed in accordance with several service-provider arrangements and approximate $i6 million annually.
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“Accounts payable” includes
$i264 million at December 31, 2019, and $i202 million at December 31, 2018, due to Conrail for
the operation of the Shared Assets Areas. “Other liabilities” includes $ii280/
million at both December 31, 2019 and 2018 for long-term advances from Conrail, maturing in 2044, that bear interest at an average rate of ii2.9/%.
Investment
in TTX
NS and eight other North American railroads jointly own TTX Company (TTX). NS has a i19.65% ownership interest in TTX, a railcar pooling company that provides its owner-railroads with standardized fleets of intermodal,
automotive, and general use railcars at stated rates.
Amounts paid to TTX for use of equipment are included in “Purchased services and rents.” This amounted to $i244
million, $i262 million, and $i237
million of expense, respectively, for the years ended December 31, 2019, 2018 and 2017. Our equity in the earnings of TTX, which offset the costs and are also included in “Purchased services and rents,” totaled $i58 million for 2019, $i61
million for 2018, and $i158 million for 2017 (including $i115
million related to the enactment of tax reform – see Note 4).
(1)Composite
annual depreciation rate for the underlying assets, excluding the effects of the amortization of any deficiency (or excess) that resulted from our depreciation studies.
“Other current assets” on the Consolidated Balance Sheets at December 31, 2019 includes natural resource assets of $i88 million, reflecting their status as held for sale. In 2019, we recorded a $i49
million impairment loss related to our natural resource assets that we are actively marketing to sell. The impairment loss is reflected in “Gains and losses on properties” in the Consolidated Statements of Cash Flows for the year ended December 31, 2019. At December 31, 2018, these assets were reflected in other property within “Properties” on the Consolidated Balance Sheets, reflecting costs of obtaining rights to natural resources of $i336
million, with associated accumulated depletion of $i200 million.
Capitalized Interest
Total interest cost incurred on debt was $i620
million, $i574 million, and $i570 million during 2019, 2018 and 2017, respectively, of which $i16
million, $i17 million, and $i20 million were capitalized during 2019, 2018, and 2017, respectively.
Long-term
debt maturities subsequent to 2020 are as follows:
2021
$
i586
2022
i603
2023
i600
2024
i400
2025
and subsequent years
i9,691
Total
$
i11,880
In
May 2019, we issued $i200 million of i3.80% senior notes due 2028, $i400
million of i4.10% senior notes due 2049, and $i200 million of i5.10%
senior notes due 2118. In November 2019, we issued $i400 million of i2.55% senior notes due 2029 and $i400
million of i3.40% senior notes due 2049.
In May 2019, we also renewed and amended our accounts receivable securitization program, increasing the program’s maximum borrowing capacity from $i400
million to $i450 million with a term expiring in May 2020. Under this facility, NSR sells substantially all of its eligible third-party receivables to a subsidiary, which in turn may transfer beneficial interests in the receivables to various commercial paper vehicles. Under this facility, we received $i600
million in 2019 and $i50 million in 2018, and paid $i600 million and $i150
million during 2019 and 2018, respectively. We had iino/
amounts outstanding at both December 31, 2019 and 2018, and our available borrowing capacity was $i429 million and $i400
million, respectively.
The January 1, 2019 and December 31, 2018“Cash, cash equivalents, and restricted cash” line item in the Consolidated Statements of Cash Flows includes restricted cash of $i88 million which reflects deposits held by a third-party bond agent as collateral for certain debt obligations, which matured on October 1, 2019. The restricted cash balance is included as
part of “Other current assets” on the Consolidated Balance Sheets at December 31, 2018.
Credit Agreement and Debt Covenants
We have in place and available a $i750 million, five-year credit agreement which expires in May 2021 and provides for borrowings at prevailing rates and includes covenants. We had iino/
amounts outstanding under this facility at both December 31, 2019 and 2018, and we are in compliance with all of its covenants.
10. iLeases
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” and subsequent amendments,
which replaced existing lease guidance in GAAP and requires lessees to recognize ROU assets and lease liabilities on the balance sheet for leases greater than twelve months and disclose key information about leasing arrangements. We adopted the standard on January 1, 2019 using the modified retrospective method and used the effective date as our date of initial application. Financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. Upon adoption of the standard, we recognized ROU assets and corresponding lease liabilities of $ii586/
million on the Consolidated Balance Sheets as of January 1, 2019. There were no adjustments to “Retained income” on adoption.
The new standard provides a number of optional practical expedients for transition. We elected the package of practical expedients under the transition guidance which permitted us not to reassess under the new standard our prior conclusions for lease identification and lease classification on expired or existing contracts and whether initial direct costs previously capitalized would qualify for capitalization under FASB ASC 842. We also elected the practical expedient related to land easements, which allowed us to not reassess our current accounting treatment for existing agreements on land easements, which are not accounted for as
leases. We did not elect the hindsight practical expedient to determine the reasonably certain lease term for existing leases.
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The new standard also provides practical expedients and recognition exemptions for an entity’s ongoing accounting policy elections. We elected the short-term lease recognition exemption for all leases that qualify. This means, for those leases that qualify, we do not recognize ROU assets or lease liabilities. We also elected the practical expedient not to separate lease and non-lease components for all of our leases.
We are committed under long-term lease agreements for equipment, lines of road, and other property. Some of these agreements contain variable payment
provisions that depend on an index or rate, initially measured using the index or rate at the lease commencement date, and are therefore not included in our future minimum lease payments. These variable lease agreements include usage-based payments for equipment under service contracts, lines of road, and other property. Our long-term lease agreements do not contain any material restrictive covenants.
Our equipment leases have remaining terms of less than i1
year to i9 years and our lines of road and land leases have remaining terms of less than i1 year to i138
years. Some of these leases include options to extend the leases for up to i99 years and some include options to terminate the leases within i30 days. Because we are not reasonably certain to exercise these renewal options, the options are not considered in determining the lease
term, and associated payments are excluded from future minimum lease payments.
Leases with an initial term of twelve months or less are not recorded on the balance sheet. We recognize lease expense for these leases on a straight-line basis over the lease term.
i
Operating lease amounts included on the Consolidated Balance Sheet were as follows:
At December 31, 2019, we do not have any material finance lease assets or liabilities, nor do we have any material subleases.
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In
March 2019, we entered into a non-cancellable lease for an office building with an estimated construction cost of $i550 million. The lease will commence upon completion of the construction (for which we are a construction agent) of the office building which is expected to be in 2021. The initial term of the lease is ifive
years with options to renew, purchase, or sell the office building at the end of the lease term. Upon lease commencement, the ROU asset and lease liability will be determined and recorded. The lease also contains a residual value guarantee of up to ininety percent of the total construction cost.
Other information related to operating leases was as follows:
Weighted-average remaining lease term (years) on operating leases
i8.25
Weighted-average discount rates on operating leases
i3.52
%
As
the rates implicit in most of our leases are not readily determinable, we use a collateralized incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future payments. We use the portfolio approach and group leases into short, medium, and long-term categories, applying the corresponding incremental borrowing rates to these categories of leases.
During 2019, ROU assets obtained in exchange for new operating lease liabilities were $i49
million. During 2019, cash paid for amounts included in the measurement of lease liabilities was $i114 million and is included in operating cash flows. During 2019, cash proceeds from a sale and leaseback transaction were $i82
million and the gain on the transaction was $i15 million.
i
Future minimum lease payments
under non-cancellable operating leases were as follows:
Net
other postretirement benefit obligations (Note 12)
i287
i308
Long-term
advances from Conrail (Note 6)
i280
i280
Casualty
and other claims (Note 17)
i171
i158
Deferred
compensation
i104
i106
Other
i159
i136
Total
$
i1,744
$
i1,266
/
K56
12. iPensions
and Other Postretirement Benefits
We have both funded and unfunded defined benefit pension plans covering principally salaried employees. We also provide specified health care and life insurance benefits to eligible retired employees; these plans can be amended or terminated at our option. Under our self-insured retiree health care plan, for those participants who are not Medicare-eligible, certain health care expenses are covered for retired employees and their dependents, reduced by any deductibles, coinsurance, and, in some cases, coverage provided under other group insurance policies. Those participants who are Medicare-eligible are not covered under the self-insured retiree health care plan, but instead are provided with an employer-funded health reimbursement account which can be used for reimbursement of health insurance premiums or eligible out-of-pocket medical expenses.
i
Pension
and Other Postretirement Benefit Obligations and Plan Assets
Pension Benefits
Other Postretirement Benefits
2019
2018
2019
2018
($
in millions)
Change in benefit obligations:
Benefit obligation at beginning of year
$
i2,371
$
i2,541
$
i466
$
i510
Service
cost
i35
i39
i6
i7
Interest
cost
i93
i83
i17
i15
Actuarial
losses (gains)
i235
(i149)
i28
(i24)
Plan
amendment
i—
i—
(i18)
i—
Benefits
paid
(i146)
(i143)
(i42)
(i42)
Benefit
obligation at end of year
i2,588
i2,371
i457
i466
Change
in plan assets:
Fair value of plan assets at beginning of year
i2,105
i2,373
i158
i201
Actual
return on plan assets
i485
(i143)
i34
(i19)
Employer
contribution
i18
i18
i20
i18
Benefits
paid
(i146)
(i143)
(i42)
(i42)
Fair
value of plan assets at end of year
i2,462
i2,105
i170
i158
Funded
status at end of year
$
(i126)
$
(i266)
$
(i287)
$
(i308)
Amounts
recognized in the Consolidated
Balance Sheets:
Other assets
$
i194
$
i30
$
i—
$
i—
Other
current liabilities
(i18)
(i18)
i—
i—
Other
liabilities
(i302)
(i278)
(i287)
(i308)
Net
amount recognized
$
(i126)
$
(i266)
$
(i287)
$
(i308)
Amounts
included in accumulated other comprehensive
loss (before tax):
Net loss
$
i781
$
i895
$
i29
$
i21
Prior
service cost (benefit)
i1
i2
(i253)
(i259)
/
K57
Our
accumulated benefit obligation for our defined benefit pension plans is $i2.3 billion and $i2.2
billion at December 31, 2019 and 2018, respectively. Our unfunded pension plans, included above, which in all cases have no assets, had projected benefit obligations of $i320 million and $i296
million at December 31, 2019 and 2018, respectively, and had accumulated benefit obligations of $i292 million and $i263
million at December 31, 2019 and 2018, respectively.
i
Pension and Other Postretirement Benefit Cost Components
2019
2018
2017
($
in millions)
Pension benefits:
Service cost
$
i35
$
i39
$
i38
Interest
cost
i93
i83
i80
Expected
return on plan assets
(i179)
(i177)
(i172)
Amortization
of net losses
i43
i57
i51
Amortization
of prior service cost
i1
i—
i1
Net
cost (benefit)
$
(i7)
$
i2
$
(i2)
Other
postretirement benefits:
Service cost
$
i6
$
i7
$
i7
Interest
cost
i17
i15
i15
Expected
return on plan assets
(i14)
(i15)
(i15)
Amortization
of prior service benefit
(i24)
(i24)
(i24)
Net
benefit
$
(i15)
$
(i17)
$
(i17)
/
i
Other
Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income
2019
Pension Benefits
Other Postretirement Benefits
($ in millions)
Net
loss (gain) arising during the year
$
(i71)
$
i8
Prior
service effect of plan amendment
i—
(i18)
Amortization
of net losses
(i43)
i—
Amortization
of prior service (cost) benefit
(i1)
i24
Total
recognized in other comprehensive income
$
(i115)
$
i14
Total
recognized in net periodic cost
and other comprehensive income
$
(i122)
$
(i1)
/
Net
gains arising during the year for pension benefits were due primarily to higher actual returns on plan assets, partially offset by a decrease in discount rates. Net losses arising during the year for other postretirement benefits were due primarily to a decrease in discount rates, partially offset by higher actual returns on plan assets.
K58
The estimated net losses for the pension plans that will be amortized from accumulated other comprehensive loss into net periodic cost over the next year are $i52
million. The estimated prior service benefit for the other postretirement benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit over the next year is $i25 million.
Pension and Other Postretirement BenefitsAssumptions
Costs
for pension and other postretirement benefits are determined based on actuarial valuations that reflect appropriate assumptions as of the measurement date, ordinarily the beginning of each year. The funded status of the plans is determined using appropriate assumptions as of each year end. iA summary of the major assumptions follows:
2019
2018
2017
Pension
funded status:
Discount rate
i3.38
%
i4.33
%
i3.74
%
Future
salary increases
i4.21
%
i4.21
%
i4.21
%
Other
postretirement benefits funded status:
Discount rate
i3.13
%
i4.18
%
i3.57
%
Pension
cost:
Discount rate - service cost
i4.55
%
i4.01
%
i4.31
%
Discount
rate - interest cost
i3.99
%
i3.33
%
i3.43
%
Return
on assets in plans
i8.25
%
i8.25
%
i8.25
%
Future
salary increases
i4.21
%
i4.21
%
i4.21
%
Other
postretirement benefits cost:
Discount rate- service cost
i4.39
%
i3.83
%
i4.17
%
Discount
rate - interest cost
i3.83
%
i3.13
%
i3.14
%
Return
on assets in plans
i8.00
%
i8.00
%
i8.00
%
Health
care trend rate
i6.50
%
i6.30
%
i6.56
%
To
determine the discount rates used to measure our benefit obligations, we utilize analyses in which the projected annual cash flows from the pension and other postretirement benefit plans were matched with yield curves based on an appropriate universe of high-quality corporate bonds. We use the results of the yield curve analyses to select the discount rates that match the payment streams of the benefits in these plans.
We use a spot rate approach to estimate the service cost and interest cost components of net periodic benefit cost for our pension and other postretirement benefit plans.
Health Care Cost Trend Assumptions
For measurement purposes at December 31, 2019, increases in the per capita cost of pre-Medicare covered
health care benefits were assumed to be i6.25% for 2020. It is assumed the rate will decrease gradually to an ultimate rate of i5.0%
for 2025 and remain at that level thereafter.
K59
Assumed health care cost trend rates affect the amounts reported in the consolidated financial statements. iTo illustrate, a one-percentage point change in the assumed health
care cost trend would have the following effects:
One-percentage point
Increase
Decrease
($ in millions)
Increase
(decrease) in:
Total service and interest cost components
$
i1
$
(i1)
Postretirement
benefit obligation
i8
(i7)
Asset
Management
iEleven investment firms manage our defined benefit pension plans’ assets under investment guidelines approved by our Benefits Investment Committee that is composed of members of our management. Investments are restricted to domestic and international equity securities, domestic and international fixed income securities, and unleveraged exchange-traded options and financial futures. Limitations restrict investment concentration and use of certain derivative
investments. The target asset allocation for equity is i75% of the pension plans’ assets. Fixed income investments must consist predominantly of securities rated investment grade or higher. Equity investments must be in liquid securities listed on national exchanges. No investment is permitted in our securities (except through commingled pension trust funds).
i
Our
pension plans’ weighted average asset allocations, by asset category, were as follows:
The
other postretirement benefit plan assets consist primarily of trust-owned variable life insurance policies with an asset allocation at December 31, 2019 of i67% in equity securities and i33%
in debt securities compared with i64% in equity securities and i36%
in debt securities at December 31, 2018. The target asset allocation for equity is between i50% and i75%
of the plan’s assets.
The plans’ assumed future returns are based principally on the asset allocations and historical returns for the plans’ asset classes determined from both actual plan returns and, over longer time periods, expected market returns for those asset classes. For 2020, we assume an i8.25% return on pension plan assets.
K60
Fair
Value of Plan Assets
The following is a description of the valuation methodologies used for pension plan assets measured at fair value.
Common stock: Shares held by the plan at year end are valued at the official closing price as defined by the exchange or at the most recent trade price of the security at the close of the active market.
Common collective trusts: The readily determinable fair value is based on the published fair value per unit of the trusts. The common collective trusts hold equity securities, fixed income securities and cash and cash equivalents.
Fixed income securities: Valued based on quotes received from independent
pricing services or at an estimated price at which a dealer would pay for the security at year end using observable market-based inputs.
Commingled funds: The readily determinable fair value is based on the published fair value per unit of the funds. The commingled funds hold equity securities.
Cash and cash equivalents: Short-term Treasury bills or notes are valued at an estimated price at which a dealer would pay for the security at year end using observable market-based inputs; money market funds are valued at the closing price reported on the active market on which the funds are traded.
i
The
following table sets forth the pension plans’ assets by valuation technique level, within the fair value hierarchy. There were no level 3 valued assets at December 31, 2019 or 2018.
The
following is a description of the valuation methodologies used for other postretirement benefit plan assets measured at fair value.
Trust-owned life insurance: Valued at our share of the net assets of trust-owned life insurance issued by a major insurance company. The underlying investments of that trust consist of a U.S. stock account and a U.S. bond account but may retain cash at times as well. The U.S. stock account and U.S. bond account are valued based on readily determinable fair values.
The other postretirement benefit plan assets consisted of trust-owned life insurance with fair values of $i170
million and $i158 million at December 31, 2019 and 2018, respectively, and are valued under level 2 of the fair value hierarchy. There were no level 1 or level 3 valued assets.
Contributions and Estimated Future Benefit Payments
In 2020, we expect to contribute approximately $i18
million to our unfunded pension plans for payments to pensioners and approximately $i37 million to our other postretirement benefit plans for retiree health and death benefits. We do not expect to contribute to our funded pension plan in 2020.
i
Benefit
payments, which reflect expected future service, as appropriate, are expected to be paid as follows:
Pension Benefits
Other
Postretirement
Benefits
($ in millions)
2020
$
i144
$
i37
2021
i144
i36
2022
i144
i34
2023
i144
i33
2024
i144
i32
Years
2025 – 2029
i719
i148
/
K62
Other
Postretirement Coverage
Under collective bargaining agreements, Norfolk Southern and certain subsidiaries participate in a multi-employer benefit plan, which provides certain postretirement health care and life insurance benefits to eligible union employees. Premiums under this plan are expensed as incurred and totaled $i31 million in 2019, $i35
million in 2018, and $i44 million in 2017.
Section 401(k) Plans
Norfolk Southern and certain subsidiaries provide Section 401(k) savings plans for employees. Under the plans, we match a portion of employee contributions, subject to applicable limitations. Our matching contributions, recorded as an expense,
under these plans were $i22 million in 2019 and $ii23/
million in both 2018 and 2017.
13. iStock-Based Compensation
Under the stockholder-approved Long-Term Incentive Plan (LTIP), the Compensation Committee (Committee), which is made up of nonemployee members of the Board of Directors, or the Chief Executive Officer (when delegated authority by such Committee), may
grant stock options, stock appreciation rights (SARs), restricted stock units (RSUs), restricted shares, performance share units (PSUs), and performance shares, up to a maximum of i104,125,000 shares of our Common Stock, of which i9,294,726
remain available for future grants as of December 31, 2019.
The number of shares remaining for issuance under the LTIP is reduced (i) by i1 for each award granted as a stock option or stock-settled SAR, or (ii) by i1.61
for an award made in the form other than a stock option or stock-settled SAR. Under the Board-approved Thoroughbred Stock Option Plan (TSOP), the Committee may grant stock options up to a maximum of i6,000,000 shares of Common Stock. We use newly issued shares to satisfy any exercises and awards under the LTIP and the TSOP.
The LTIP also permits the payment, on a current or a deferred
basis and in cash or in stock, of dividend equivalents on shares of Common Stock covered by stock options, RSUs, or PSUs in an amount commensurate with regular quarterly dividends paid on Common Stock. With respect to stock options, if employment of the participant is terminated for any reason, including retirement, disability, or death, we have no further obligation to make any dividend equivalent payments. Regarding RSUs, we have no further obligation to make any dividend equivalent payments unless employment of the participant is terminated as a result of qualifying retirement or disability. Should an employee terminate employment, they are not required to forfeit dividend equivalent payments already received. Outstanding PSUs do not receive dividend equivalent payments.
i
The
Committee granted stock options, RSUs and PSUs pursuant to the LTIP and granted stock options pursuant to the TSOP for the last three years as follows:
2019
2018
2017
Granted
Weighted
Average Grant-Date Fair Value
Granted
Weighted Average Grant-Date Fair Value
Granted
Weighted Average Grant-Date Fair Value
Stock options:
LTIP
i47,360
$
i45.74
i40,960
$
i41.70
i341,120
$
i37.73
TSOP
i—
i—
i—
i—
i144,440
i31.33
Total
i47,360
i40,960
i485,560
RSUs
i219,710
i164.47
i217,290
i148.37
i83,330
i120.16
PSUs
i102,250
i160.97
i92,314
i147.47
i300,334
i88.56
/
K63
Beginning
in 2018, recipients of certain RSUs and PSUs pursuant to the LTIP who retire prior to October 1st will forfeit awards received in the current year. Receipt of certain LTIP awards is contingent on the recipient having executed a non-compete agreement with the company.
We account for our grants of stock options, RSUs, PSUs, and dividend equivalent payments in accordance with FASB ASC 718, “Compensation - Stock Compensation.” Accordingly, all awards result in charges to net income while dividend equivalent payments, which are all related to equity classified awards, are charged to retained income. Compensation cost for the awards is recognized on a straight-line basis over the requisite service period for the entire award. iRelated
compensation costs and tax benefits during the year were:
2019
2018
2017
($ in millions)
Stock-based
compensation expense
$
i53
$
i47
$
i45
Total
tax benefit
i37
i33
i54
Stock
Options
Option exercise prices will be at least the higher of (i) the average of the high and low prices at which Common Stock is traded on the grant date, or (ii) the closing price of Common Stock on the grant date. All options are subject to a vesting period of at least ione year, and the term of the option will not exceed iten
years. Holders of the options granted under the LTIP who remain actively employed receive cash dividend equivalent payments for ifour years in an amount equal to the regular quarterly dividends paid on Common Stock. Dividend equivalent payments are not made on the TSOP options.
For all years, options granted under the LTIP and the TSOP may not be exercised prior to the fourth and third anniversaries of the date of grant, respectively, or if the optionee retires or dies before that anniversary date, may not be exercised before the later of one year
after the grant date or the date of the optionee’s retirement or death.
The fair value of each option awarded in 2019 and 2018 was measured on the date of grant using the Black-Scholes valuation model. The fair value of each option awarded in 2017 was measured on the date of grant using a binomial lattice-based option valuation model. Expected volatility is based on implied volatility from traded options on, and historical volatility of, Common Stock. Historical data is used to estimate option exercises and employee terminations within the valuation model. For the 2019 and 2018 grant years, historical exercise data is used to estimate the average expected option term. For the 2017 grant year, the average expected option term is derived from the output of the valuation model and represents the period of time that all options granted are expected to be outstanding, including the branches of the
model that result in options expiring unexercised. The average risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. A dividend yield of izero was used for the LTIP options during the vesting period. For 2019, 2018, and 2017, a dividend yield of i2.06%,
i1.94%, and i2.04%,
respectively, was used for all vested LTIP options and all TSOP options.
i
The assumptions for the LTIP and TSOP grants for the last three years are shown in the following table:
2019
2018
2017
Average
expected volatility
i23
%
i24
%
i26
%
Average
risk-free interest rate
i2.56
%
i2.55
%
i2.51
%
Average
expected option term LTIP
i7.2 years
i7.2
years
i8.6 years
Average expected option term TSOP
—
—
i8.3
years
/
K64
i
A summary of changes in stock options is presented below:
The
aggregate intrinsic value of options outstanding at December 31, 2019 was $i275 million with a weighted average remaining contractual term of i5
years. Of these options outstanding, i1,856,019 were exercisable and had an aggregate intrinsic value of $i196
million with a weighted average exercise price of $i88.48 and a weighted average remaining contractual term of i2.9
years.
i
The following table provides information related to options exercised for the last three years:
2019
2018
2017
($
in millions)
Options exercised
i770,597
i840,175
i1,789,939
Total
intrinsic value
$
i86
$
i72
$
i114
Cash
received upon exercise
i53
i58
i104
Related
tax benefits realized
i18
i16
i35
/
At
December 31, 2019, total unrecognized compensation related to options granted under the LTIP and the TSOP was $i2 million, and is expected to be recognized over a weighted-average period of approximately i1.6
years.
Restricted Stock Units
Beginning in 2018, RSUs granted primarily have a four-year ratable restriction period and will be settled through the issuance of shares of Common Stock. RSUs granted prior to 2018 have a five-year restriction period and will also be settled through the issuance of shares of Common Stock. Certain RSU grants include cash dividend equivalent payments during the restriction period in an amount equal to regular quarterly dividends paid on Common Stock.
At
December 31, 2019, total unrecognized compensation related to RSUs was $i25 million, and is expected to be recognized over a weighted-average period of approximately i2.6
years.
Performance Share Units
PSUs provide for awards based on the achievement of certain predetermined corporate performance goals at the end of a three-year cycle and are settled through the issuance of shares of Common Stock. All PSUs will earn out based on the achievement of performance conditions and some will also earn out based on a market condition. The market condition fair value was measured on the date of grant using a Monte Carlo simulation model.
At
December 31, 2019, total unrecognized compensation related to PSUs granted under the LTIP was $i6 million, and is expected to be recognized over a weighted-average period of approximately i1.7
years.
K66
Shares Available and Issued
i
Shares of Common Stock available for future grants and issued in connection with all features of the LTIP and the TSOP at December 31, were as follows:
2019
2018
2017
Available
for future grants:
LTIP
i9,294,726
i8,644,108
i8,774,768
TSOP
i434,401
i422,973
i410,895
Issued:
LTIP
i852,869
i820,746
i1,679,547
TSOP
i258,315
i213,796
i291,515
/
14.
iStockholders’ Equity
Common Stock
Common Stock is reported net of shares held by our consolidated subsidiaries (Treasury Shares). Treasury Shares at December 31, 2019 and 2018 amounted to ii20,320,777/,
with a cost of $ii19/ million at both dates.
Accumulated
Other Comprehensive Loss
i
The components of “Other comprehensive income (loss)” reported in the Consolidated Statements of Comprehensive Income and changes in the cumulative balances of “Accumulated other comprehensive loss” reported in the Consolidated Balance Sheets consisted of the following:
The
adoption of FASB ASU 2018-02 (see Note 1) resulted in an increase to “Accumulated other comprehensive loss” of $ii88/
million and a corresponding increase to “Retained income,” with no impact on “Total stockholders’ equity.”
Other Comprehensive Income (Loss)
i
“Other comprehensive income (loss)” reported in the Consolidated Statements of Comprehensive Income consisted of the following:
We repurchased and retired i11.3 million, i17.1
million (i7.0 million shares under the ASR and i10.1 million shares under
our ongoing open-market program), and i8.2 million shares of Common Stock under our stock repurchase programs in 2019, 2018, and 2017, respectively, at a cost of $i2.1
billion, $i2.8 billion, and $i1.0 billion, respectively.
On
September 26, 2017, our Board of Directors authorized the repurchase of up to an additional i50 million shares of Common Stock through December 31, 2022. As of December 31, 2019, i28.0
million shares remain authorized for repurchase. Since the beginning of 2006, we have repurchased and retired i196.9 million shares at a total cost of $i16.2
billion.
16. iEarnings Per Share
i
The
following table sets forth the calculation of basic and diluted earnings per share:
Basic
Diluted
2019
2018
2017
2019
2018
2017
($
in millions except per share amounts, shares in millions)
Net income
$
i2,722
$
i2,666
$
i5,404
$
i2,722
$
i2,666
$
i5,404
Dividend
equivalent payments
(i5)
(i6)
(i4)
i—
(i1)
(i2)
Income
available to common stockholders
$
i2,717
$
i2,660
$
i5,400
$
i2,722
$
i2,665
$
i5,402
Weighted-average
shares outstanding
i263.3
i277.7
i287.9
i263.3
i277.7
i287.9
Dilutive
effect of outstanding options
and share-settled awards
i2.3
i2.5
i2.4
Adjusted
weighted-average shares outstanding
i265.6
i280.2
i290.3
Earnings
per share
$
i10.32
$
i9.58
$
i18.76
$
i10.25
$
i9.51
$
i18.61
/
In
each year, dividend equivalent payments were made to holders of stock options and RSUs. For purposes of computing basic earnings per share, dividend equivalent payments made to holders of stock options and RSUs were deducted from net income to determine income available to common stockholders. For purposes of computing diluted earnings per share, we evaluate on a grant-by-grant basis those stock options and RSUs receiving dividend equivalent payments under the two-class and treasury stock methods to determine which method is more dilutive for each grant. For those grants for which the two-class method was more dilutive, net income was reduced by dividend equivalent payments to determine income available to common stockholders. The dilution calculations exclude options having exercise prices exceeding the average market price of Common Stock of iizero/
for the years ended December 31, 2019 and 2018, and i0.2 million for the year ended December 31, 2017.
17. iCommitments
and Contingencies
Lawsuits
We and/or certain subsidiaries are defendants in numerous lawsuits and other claims relating principally to railroad operations. When we conclude that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, it is accrued through a charge to earnings. While the ultimate amount of liability incurred in any of these lawsuits and claims is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payment of such liability and claims. However, the final outcome of any of
K69
these
lawsuits and claims cannot be predicted with certainty, and unfavorable or unexpected outcomes could result in additional accruals that could be significant to results of operations in a particular year or quarter. Any adjustments to the recorded liability will be reflected in earnings in the periods in which such adjustments become known.
In 2007, various antitrust class actions filed against us and other Class I railroads in various Federal district courts regarding fuel surcharges were consolidated in the District of Columbia by the Judicial Panel on Multidistrict Litigation. In 2012, the court certified the case as a class action. The defendant railroads appealed this certification, and the Court of Appeals for the District of Columbia vacated the District Court’s decision and remanded the case for further consideration. On October 10, 2017, the District
Court denied class certification. The decision was upheld by the Court of Appeals on August 16, 2019. Since that decision, various individual cases have been filed in multiple jurisdictions. We believe the allegations in the complaints are without merit and intend to vigorously defend the cases. We do not believe the outcome of these proceedings will have a material effect on our financial position, results of operations, or liquidity.
Casualty Claims
Casualty claims include employee personal injury and occupational claims as well as third-party claims, all exclusive of legal costs. To aid in valuing our personal injury liability and determining the amount to accrue with respect to such claims during the year, we utilize studies prepared by an independent consulting actuarial firm. Job-related
personal injury and occupational claims are subject to FELA, which is applicable only to railroads. FELA’s fault-based tort system produces results that are unpredictable and inconsistent as compared with a no-fault workers’ compensation system. The variability inherent in this system could result in actual costs being different from the liability recorded. While the ultimate amount of claims incurred is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payments of claims and is supported by the most recent actuarial study. In all cases, we record a liability when the expected loss for the claim is both probable and reasonably estimable.
Employee personal injury claims – The largest component of casualties and other claims expense is employee personal injury costs. The independent actuarial firm engaged by us provides
quarterly studies to aid in valuing our employee personal injury liability and estimating personal injury expense. The actuarial firm studies our historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences. The actuarial firm uses the results of these analyses to estimate the ultimate amount of liability. We adjust the liability quarterly based upon our assessment and the results of the study. Our estimate of the liability is subject to inherent limitation given the difficulty of predicting future events such as jury decisions, court interpretations, or legislative changes. As a result, actual claim settlements may vary from the estimated liability recorded.
Occupational claims – Occupational claims include injuries and illnesses alleged to be caused by exposures which occur over time as opposed to injuries or illnesses
caused by a specific accident or event. Types of occupational claims commonly seen allege exposure to asbestos and other claimed toxic substances resulting in respiratory diseases or cancer. Many such claims are being asserted by former or retired employees, some of whom have not been employed in the rail industry for decades. The independent actuarial firm provides an estimate of the occupational claims liability based upon our history of claim filings, severity, payments, and other pertinent facts. The liability is dependent upon judgments we make as to the specific case reserves as well as judgments of the actuarial firm in the quarterly studies. The actuarial firm’s estimate of ultimate loss includes a provision for those claims that have been incurred but not reported. This provision is derived by analyzing industry data and projecting our experience. We adjust the liability quarterly based upon our assessment and the results of the study. However, it is
possible that the recorded liability may not be adequate to cover the future payment of claims. Adjustments to the recorded liability are reflected in operating expenses in the periods in which such adjustments become known.
Third-party claims – We record a liability for third-party claims including those for highway crossing accidents, trespasser and other injuries, property damage, and lading damage. The actuarial firm assists us with the calculation
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of potential liability for third-party claims, except lading damage, based upon our experience including the number and timing of incidents, amount of payments, settlement rates, number of open claims, and legal defenses. We adjust the liability
quarterly based upon our assessment and the results of the study. Given the inherent uncertainty in regard to the ultimate outcome of third-party claims, it is possible that the actual loss may differ from the estimated liability recorded.
Environmental Matters
We are subject to various jurisdictions’ environmental laws and regulations. We record a liability where such liability or loss is probable and reasonably estimable. Environmental specialists regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates.
Our Consolidated Balance Sheets include liabilities for environmental exposures of $i56
million at December 31, 2019, and $i55 million at December 31, 2018, of which $ii15/
million is classified as a current liability at the end of both 2019 and 2018. At December 31, 2019, the liability represents our estimates of the probable cleanup, investigation, and remediation costs based on available information at i110 known locations and projects compared with i114
locations and projects at December 31, 2018. At December 31, 2019, isixteen sites accounted for $i40
million of the liability, and no individual site was considered to be material. We anticipate that much of this liability will be paid out over ifive years; however, some costs will be paid out over a longer period.
At ieleven
locations, one or more of our subsidiaries in conjunction with a number of other parties have been identified as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 or comparable state statutes that impose joint and several liability for cleanup costs. We calculate our estimated liability for these sites based on facts and legal defenses applicable to each site and not solely on the basis of the potential for joint liability.
With respect to known environmental sites (whether identified by us or by the Environmental Protection Agency or comparable state authorities), estimates of our ultimate potential financial exposure for a given site or in the aggregate for all such sites can change over time because of the widely varying costs of currently
available cleanup techniques, unpredictable contaminant recovery and reduction rates associated with available cleanup technologies, the likely development of new cleanup technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant’s share of any estimated loss (and that participant’s ability to bear it), and evolving statutory and regulatory standards governing liability.
The risk of incurring environmental liability for acts and omissions, past, present, and future, is inherent in the railroad business. Some of the commodities we transport, particularly those classified as hazardous materials, pose special risks that we work diligently to reduce. In addition, several of our subsidiaries own, or have owned, land used as operating property,
or which is leased and operated by others, or held for sale. Because environmental problems that are latent or undisclosed may exist on these properties, there can be no assurance that we will not incur environmental liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and potentially other unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial position, results of operations, or liquidity in a particular year or quarter.
Based on our assessment of the facts and circumstances now known, we believe we have recorded the probable and reasonably estimable costs for dealing with those environmental matters of which we are aware. Further, we believe that it is unlikely that
any known matters, either individually or in the aggregate, will have a material adverse effect on our financial position, results of operations, or liquidity.
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Insurance
We obtain on behalf of ourself and our subsidiaries insurance for potential losses for third-party liability and first-party property damages. With limited exceptions, we are currently insured above $i75
million and below $i1.1 billion ($i1.5
billion for specific perils) per occurrence and/or policy year for bodily injury and property damage to third parties and above $i25 million and below $i200
million per occurrence and/or policy year for property owned by us or in our care, custody, or control.
Purchase Commitments
At December 31, 2019, we had outstanding purchase commitments totaling approximately $i1.2 billion for locomotives, track material, long-term service contracts,
track and yard expansion projects in connection with our capital programs as well as freight cars and containers through 2024.
Change-In-Control Arrangements
We have compensation agreements with certain officers and key employees that become operative only upon a change in control of Norfolk Southern, as defined in those agreements. The agreements provide generally for payments based on compensation at the time of a covered individual’s involuntary or other specified termination and for certain other benefits.
Indemnifications
In a number of instances, we have agreed to indemnify lenders for additional costs they may bear as a result of certain changes in laws or regulations applicable to their loans. Such
changes may include impositions or modifications with respect to taxes, duties, reserves, liquidity, capital adequacy, special deposits, and similar requirements relating to extensions of credit by, deposits with, or the assets or liabilities of such lenders. The nature and timing of changes in laws or regulations applicable to our financings are inherently unpredictable, and therefore our exposure in connection with the foregoing indemnifications cannot be quantified. No liability has been recorded related to these indemnifications.
Item
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer, with the assistance of management, evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)) at December 31, 2019. Based on such evaluation, our officers have concluded that, at December 31,
2019, our disclosure controls and procedures were effective to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized, and reported, within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting includes those policies and procedures that pertain to our ability to record, process, summarize, and report reliable financial data. We
recognize that there are inherent limitations in the effectiveness of any internal control over financial reporting, including the possibility of human error and the circumvention or overriding of internal control. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.
Our Board of Directors, acting through its Audit Committee, is responsible for the oversight of our accounting policies, financial reporting, and internal control. The Audit Committee of our Board of Directors is comprised of outside directors who are independent of management. The independent registered public accounting firm and our internal auditors have full and unlimited access to the Audit Committee,
with or without management, to discuss the adequacy of internal control over financial reporting, and any other matters which they believe should be brought to the attention of the Audit Committee.
We have issued a report of our assessment of internal control over financial reporting, and our independent registered public accounting firm has issued an attestation report on our internal control over financial reporting at December 31, 2019. These reports appear in Item 8 of this report on Form 10-K.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of 2019, we have not identified any changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially
effect, our internal control over financial reporting.
Item 10. Directors, Executive Officers and Corporate Governance
In
accordance with General Instruction G(3), information called for by Part III, Item 10, is incorporated herein by reference from the information appearing under the caption “Election of Directors,” under the caption “Delinquent Section 16(a) Reports,” under the caption “Committees of the Board,” under the caption “Shareholder Recommendations and Nominations,” and under the caption “The Thoroughbred Code of Ethics” in our definitive Proxy Statement for our 2020 Annual Meeting of Stockholders, which definitive Proxy Statement will be filed electronically with the SEC pursuant to Regulation 14A. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I hereof beginning under “Information about our Executive Officers.”
Item
11. Executive Compensation
In accordance with General Instruction G(3), information called for by Part III, Item 11, is incorporated herein by reference from the information:
•under the caption “Compensation of Directors;”
•appearing under the caption “Compensation Discussion and Analysis,” the information appearing in the “Summary Compensation Table” and the “2019 Grants of Plan-Based Awards” table, including the narrative to such tables, the “Outstanding Equity Awards at Fiscal Year-End 2019” and “Option Exercises and Stock Vested in 2019” tables, and the tabular and narrative information appearing under the subcaptions “Retirement Benefits,”“Deferred Compensation,”
and “Potential Payments Upon a Change in Control or Other Termination of Employment;” and
•appearing under the captions “Compensation Committee Interlocks and Insider Participation,”“Compensation Policy Risk Assessment,” and “Compensation Committee Report,”
in each case included in our definitive Proxy Statement for our 2020 Annual Meeting of Stockholders, which definitive Proxy Statement will be filed electronically with the SEC pursuant to Regulation 14A.
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Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters
In accordance with General Instruction G(3), information on security ownership of certain beneficial owners and management called for by Part III, Item 12, is incorporated herein by reference from the information appearing under the caption “Beneficial Ownership of Stock” in our definitive Proxy Statement for our 2020 Annual Meeting of Stockholders, which definitive Proxy Statement will be filed electronically with the SEC pursuant to Regulation 14A.
Number
of securities to be issued upon exercise of outstanding options, warrants and rights
Weighted- average exercise price of outstanding options, warrants and rights
Number of securities
remaining available
for future issuance
under equity
compensation plans(1)
(a)
(b)
(c)
Equity
compensation plans
approved by securities holders(2)
3,577,895
(3)
$
91.86
(5)
9,294,726
Equity
compensation plans
not approved by securities holders
463,759
(4)
89.81
434,401
(6)
Total
4,041,654
9,729,127
(1)Excludes
securities reflected in column (a).
(2)LTIP.
(3)Includes options, RSUs and PSUs granted under LTIP that will be settled in shares of stock.
(4)TSOP.
(5)Calculated without regard to 1,364,205 outstanding RSUs and PSUs at December 31, 2019.
(6)Reflects shares remaining available for grant under TSOP.
Norfolk Southern Corporation Long-Term Incentive Plan
Established on June 28, 1983, and approved by our stockholders at their Annual Meeting held on May 10, 1984, LTIP
was adopted to promote the success of our company by providing an opportunity for non-employee Directors, officers, and other key employees to acquire a proprietary interest in the Corporation. The Board of Directors amended LTIP on January 23, 2015, which amendment was approved by shareholders on May 14, 2015, to include the reservation for issuance of an additional 8,000,000 shares of authorized but unissued Common Stock.
The amended LTIP adopted a fungible share reserve ratio so that, for awards granted after May 13, 2010, the number of shares remaining for issuance under the amended LTIP will be reduced (i) by 1 for each award granted as an option or stock-settled
SAR, or (ii) by 1.61 for an award made in the form other than an option or stock-settled SAR. Any shares of Common Stock subject to options, PSUs, restricted shares, or RSUs which are not issued as Common Stock will again be available for award under LTIP after the expiration or forfeiture of an award.
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Non-employee Directors, officers, and other key employees residing in the United States of America or Canada are eligible for selection to receive LTIP awards. Under LTIP, the Committee, or the Corporation’s chief executive officer to the extent the Committee delegates award-making authority pursuant to LTIP, may grant incentive stock options, nonqualified stock options, SARs, RSUs, restricted shares, PSUs, and performance shares. In
addition, dividend equivalent payments may be awarded for options, RSUs, and PSUs. Awards under LTIP may be made subject to forfeiture under certain circumstances and the Committee may establish such other terms and conditions for the awards as provided in LTIP.
For options granted after May 13, 2010, the option price will be at least the higher of (i) the average of the high and low prices at which Common Stock is traded on the date of grant, or (ii) the closing price of Common Stock on the date of the grant. All options are subject to a vesting period of at least one year, and the term of the option will not exceed ten years. LTIP specifically prohibits option repricing without stockholder approval, except that adjustments may be made in the event of changes in our capital structure or Common Stock.
PSUs
entitle a recipient to receive performance-based compensation at the end of a three-year cycle based on our performance during that period. For the 2019 PSU awards, corporate performance will be based directly on return on average capital invested, with total return to stockholders serving as a modifier, and will be settled in shares of Common Stock. In 2016, the Committee also granted an “accelerated turnaround incentive” award in the form of a PSU with a three-year performance that was based on equally weighted standards established by the Committee for operating ratio and earnings per share. We did not meet the performance criteria for operating ratio and therefore no payout for the accelerated turnaround incentive award was achieved.
RSUs are payable in cash or in shares of Common Stock at the end of a restriction period. During the restriction period, the holder of the RSUs has no beneficial
ownership interest in the Common Stock represented by the RSUs and has no right to vote the shares represented by the units or to receive dividends (except for dividend equivalent payment rights that may be awarded with respect to the RSUs). The Committee at its discretion may waive the restriction period, but settlement of any RSUs will occur on the same settlement date as would have applied absent a waiver of restrictions, if no performance goals were imposed. RSUs will be settled in shares of Common Stock.
Norfolk Southern Corporation Thoroughbred Stock Option Plan
Our Board of Directors adopted TSOP on January 26, 1999, to promote the success of our company by providing an opportunity for nonagreement
employees to acquire a proprietary interest in our company and thereby to provide an additional incentive to nonagreement employees to devote their maximum efforts and skills to the advancement, betterment, and prosperity of our company and our stockholders. Under TSOP there were 6,000,000 shares of authorized but unissued Common Stock reserved for issuance. TSOP has not been and is not required to have been approved by our stockholders.
Active full-time nonagreement employees residing in the United States of America or Canada are eligible for selection to receive TSOP awards. Under TSOP, the Committee, or the Corporation’s chief executive officer to the extent the Committee delegates award-making authority pursuant to TSOP, may
grant nonqualified stock options subject to such terms and conditions as provided in TSOP.
The option price may not be less than the average of the high and low prices at which Common Stock is traded on the date of the grant. All options are subject to a vesting period of at least one year, and the term of the option will not exceed ten years. TSOP specifically prohibits repricing without stockholder approval, except for capital adjustments.
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Norfolk Southern Corporation Directors’ Restricted Stock Plan (Plan)
The Plan was adopted on January 1, 1994, and was
designed to increase ownership of Common Stock by our non-employee Directors so as to further align their ownership interest in our company with that of our stockholders. The Plan has not been and is not required to have been approved by our stockholders.
Effective January 23, 2015, the Board amended the Plan to provide that no additional awards will be made under the Plan. Prior to that amendment, only non-employee Directors who are not and never have been employees of our company were eligible to participate in the Plan. Upon becoming a Director, each eligible Director received a one-time grant of 3,000 restricted shares of Common Stock. No additional shares may be granted under
the Plan. No individual member of the Board exercised discretion concerning the eligibility of any Director or the number of shares granted.
The restriction period applicable to restricted shares granted under the Plan begins on the date of the grant and ends on the earlier of the recipient’s death or the day after the recipient ceases to be a Director by reason of disability or retirement. During the restriction period, shares may not be sold, pledged, or otherwise encumbered. Directors forfeit the restricted shares if they cease to serve as a Director of our company for reasons other than their disability, retirement, or death.
Item 13. Certain Relationships and Related Transactions,
and Director Independence
In accordance with General Instruction G(3), information called for by Part III, Item 13, is incorporated herein by reference from the information appearing under the caption “Related Persons Transactions” and under the caption “Director Independence” in our definitive Proxy Statement for our 2020 Annual Meeting of Stockholders, which definitive Proxy Statement will be filed electronically with the SEC pursuant to Regulation 14A.
Item 14. Principal Accounting Fees and Services
In accordance with General Instruction G(3), information called for by Part III, Item 14, is incorporated
herein by reference from the information appearing under the caption “Ratification of Appointment of Independent Registered Public Accounting Firm” in our definitive Proxy Statement for our 2020 Annual Meeting of Stockholders, which definitive Proxy Statement will be filed electronically with the SEC pursuant to Regulation 14A.
Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes.
Instruments Defining the Rights of
Security Holders, Including Indentures:
(a)
Indenture, dated as of January 15, 1991, from Norfolk Southern Corporation to First Trust of New York, National Association, as Trustee, is incorporated by reference to Exhibit 4.1 to Norfolk Southern Corporation’s Registration Statement on Form S-3 (No. 33-38595).
In accordance with Item 601(b)(4)(iii) of Regulation S-K, copies of other instruments of Norfolk Southern Corporation and its subsidiaries with respect to the rights of holders of long-term debt are not filed herewith, or incorporated by reference, but will be furnished to the Commission upon request.
Performance
Criteria for bonuses payable in 2021 for the 2020 incentive year. On January 27, 2020, the Compensation Committee of the Norfolk Southern Corporation Board of Directors adopted the following performance criteria for determining bonuses payable in 2021 for the 2020 incentive year under the Norfolk Southern Corporation Executive Management Incentive Plan: 40% based on operating income, and 60% based on operating ratio.
The following financial information from Norfolk Southern Corporation’s Annual Report on Form 10-K for the year ended December
31, 2019, formatted in Inline Extensible Business Reporting Language (iXBRL) includes: (i) the Consolidated Statements of Income for each of the years ended December 31, 2019, 2018, and 2017; (ii) the Consolidated Statements of Comprehensive Income for each of the years ended December 31, 2019, 2018, and 2017; (iii) the Consolidated Balance Sheets at December 31, 2019 and 2018; (iv) the Consolidated Statements of Cash Flows for each of the years ended December 31, 2019, 2018,
and 2017; (v) the Consolidated Statements of Changes in Stockholders’ Equity for each of the years ended December 31, 2019, 2018, and 2017; and (vi) the Notes to Consolidated Financial Statements.
* Management contract or compensatory arrangement.
Financial statement schedules and separate financial statements specified by this Item are included in Item 15(A)2 or are
otherwise not required or are not applicable.
Exhibits 23, 31, and 32 are included in copies assembled for public dissemination. All exhibits are included in the 2019 Form 10-K posted on our website at www.norfolksouthern.com under “Invest in NS” and “SEC Filings” or you may request copies by writing to:
Office
of Corporate Secretary Norfolk Southern Corporation Three Commercial Place Norfolk, Virginia23510-9219
Each person whose signature appears on the next page under SIGNATURES hereby authorizes Vanessa Allen Sutherland and Mark R. George, or any one of them, to execute in the name of each such person, and to file, any amendments to this report, and hereby appoints Vanessa Allen Sutherland and Mark R. George, or any one of them, as attorneys-in-fact to sign on his or her behalf, individually and in each capacity stated below, and to file, any and all amendments to this report.
SIGNATURES
Pursuant to the requirements
of Section 13 or 15(d) of the Securities Exchange Act of 1934, Norfolk Southern Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 6th day of February, 2020.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 6th day of February, 2020, by the following persons on behalf of Norfolk Southern Corporation and in the capacities indicated.