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EX-32 - EXHIBIT 32 - NORFOLK SOUTHERN CORPnsc063018exhibit32.htm
EX-31.B - EXHIBIT 31.B - NORFOLK SOUTHERN CORPnsc063018exhibit31b.htm
EX-31.A - EXHIBIT 31.A - NORFOLK SOUTHERN CORPnsc063018exhibit31a.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
 
(X)   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended JUNE 30, 2018
 
(  )    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ___________ to___________
 
Commission file number 1-8339

nslogoq217a04.jpg
 
NORFOLK SOUTHERN CORPORATION
(Exact name of registrant as specified in its charter) 
Virginia
(State or other jurisdiction of incorporation)
52-1188014
(IRS Employer Identification No.)
Three Commercial Place
Norfolk, Virginia
(Address of principal executive offices)
23510-2191
(Zip Code)
(757) 629-2680
(Registrant’s telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last report)
 
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.
Yes [X] No [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
Yes [X] 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. 
Large accelerated filer [X] Accelerated filer [  ]  Non-accelerated filer [  ]  Smaller reporting company [   ]  Emerging growth company [  ]

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 Exchange Act).
Yes [  ] No [X]
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at June 30, 2018
Common Stock ($1.00 par value per share)
 
280,029,764 (excluding 20,320,777 shares held by the registrant’s consolidated subsidiaries)



TABLE OF CONTENTS

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I. FINANCIAL INFORMATION
  
Item 1. Financial Statements.
 
Norfolk Southern Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
2018
 
2017
 
($ in millions, except per share amounts)
 
 
 
 
 
 
 
 
Railway operating revenues
$
2,898

 
$
2,637

 
$
5,615

 
$
5,212

 
 
 
 
 
 
 
 
Railway operating expenses:
 

 
 

 
 

 
 

Compensation and benefits
706

 
719

 
1,443

 
1,478

Purchased services and rents
430

 
392

 
831

 
769

Fuel
272

 
190

 
538

 
403

Depreciation
273

 
264

 
545

 
523

Materials and other
191

 
200

 
397

 
410

 
 
 
 
 
 
 
 
Total railway operating expenses
1,872

 
1,765

 
3,754

 
3,583

 
 
 
 
 
 
 
 
Income from railway operations
1,026

 
872

 
1,861

 
1,629

 
 
 
 
 
 
 
 
Other income – net
29

 
48

 
37

 
88

Interest expense on debt
131

 
140

 
267

 
282

 
 
 
 
 
 
 
 
Income before income taxes
924

 
780

 
1,631

 
1,435

 
 
 
 
 
 
 
 
Income taxes
214

 
283

 
369

 
505

 
 
 
 
 
 
 
 
Net income
$
710

 
$
497

 
$
1,262

 
$
930

 
 
 
 
 
 
 
 
Per share amounts:
 

 
 

 
 

 
 

Net income
 

 
 

 
 

 
 

Basic
$
2.52

 
$
1.72

 
$
4.46

 
$
3.20

Diluted
2.50

 
1.71

 
4.43

 
3.18

 
 
 
 
 
 
 
 
Dividends
0.72

 
0.61

 
1.44

 
1.22

 

 See accompanying notes to consolidated financial statements.
3


Norfolk Southern Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
2018
 
2017
 
($ in millions)
 
 
 
 
 
 
 
 
Net income
$
710

 
$
497

 
$
1,262

 
$
930

Other comprehensive income, before tax:
 

 
 

 
 

 
 

Pension and other postretirement benefit
8

 
7

 
1

 
14

Other comprehensive income (loss) of equity investees
1

 
1

 
2

 
(1
)
Other comprehensive income, before tax
9

 
8

 
3

 
13

 
 
 
 
 
 
 
 
Income tax expense related to items of
 
 
 
 
 
 
 
other comprehensive income
(2
)
 
(3
)
 

 
(6
)
 
 
 
 
 
 
 
 
Other comprehensive income, net of tax
7

 
5

 
3

 
7

 
 
 
 
 
 
 
 
Total comprehensive income
$
717

 
$
502

 
$
1,265

 
$
937

 

 See accompanying notes to consolidated financial statements.
4


Norfolk Southern Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)

 
June 30,
2018
 
December 31,
2017
 
($ in millions)
 
 
 
 
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
430

 
$
690

Accounts receivable – net
1,035

 
955

Materials and supplies
260

 
222

Other current assets
179

 
282

Total current assets
1,904

 
2,149

 
 
 
 
Investments
3,058

 
2,981

Properties less accumulated depreciation of $12,175 and
 
 
 

$11,909, respectively
30,540

 
30,330

Other assets
286

 
251

 
 
 
 
Total assets
$
35,788

 
$
35,711

 
 
 
 
Liabilities and stockholders’ equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
1,323

 
$
1,401

Short-term debt

 
100

Income and other taxes
269

 
211

Other current liabilities
260

 
233

Current maturities of long-term debt
500

 
600

Total current liabilities
2,352

 
2,545

 
 
 
 
Long-term debt
9,146

 
9,136

Other liabilities
1,317

 
1,347

Deferred income taxes
6,414

 
6,324

Total liabilities
19,229

 
19,352

 
 
 
 
Stockholders’ equity:
 

 
 

Common stock $1.00 per share par value, 1,350,000,000 shares
 

 
 

  authorized; outstanding 280,029,764 and 284,157,187 shares,
 

 
 

  respectively, net of treasury shares
281

 
285

Additional paid-in capital
2,263

 
2,254

Accumulated other comprehensive loss
(441
)
 
(356
)
Retained income
14,456

 
14,176

 
 
 
 
Total stockholders’ equity
16,559

 
16,359

 
 
 
 
Total liabilities and stockholders’ equity
$
35,788

 
$
35,711

 

 See accompanying notes to consolidated financial statements.
5


Norfolk Southern Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
First Six Months
 
 
2018
 
2017
 
 
($ in millions)
 
 
 
 
 
Cash flows from operating activities:
 

 
 

 
Net income
$
1,262

 
$
930

 
Reconciliation of net income to net cash provided by operating activities:
 

 
 

 
Depreciation
546

 
525

 
Deferred income taxes
89

 
114

 
Gains and losses on properties
(14
)
 
(20
)
 
Changes in assets and liabilities affecting operations:
 

 
 

 
Accounts receivable
(92
)
 
(12
)
 
Materials and supplies
(38
)
 
(32
)
 
Other current assets
19

 
48

 
Current liabilities other than debt
134

 
93

 
Other – net
(80
)
 
(70
)
 
 
 
 
 
 
Net cash provided by operating activities
1,826

 
1,576

 
 
 
 
 
Cash flows from investing activities:
 

 
 

 
Property additions
(836
)
 
(883
)
 
Property sales and other transactions
48

 
60

 
Investment purchases
(4
)
 
(4
)
 
Investment sales and other transactions
6

 
3

 
 
 
 
 
 
Net cash used in investing activities
(786
)
 
(824
)
 
 
 
 
 
Cash flows from financing activities:
 

 
 

 
Dividends
(408
)
 
(354
)
 
Common stock transactions
15

 
42

 
Purchase and retirement of common stock
(700
)
 
(402
)
 
Proceeds from borrowings – net of issuance costs
543

 
298

 
Debt repayments
(750
)
 
(650
)
 
 
 
 
 
 
Net cash used in financing activities
(1,300
)
 
(1,066
)
 
 
 
 
 
 
Net decrease in cash and cash equivalents
(260
)
 
(314
)
 
 
 
 
 
Cash and cash equivalents:
 

 
 

 
At beginning of year
690

 
956

 
 
 
 
 
 
At end of period
$
430

 
$
642

 
 
 
 
 
Supplemental disclosures of cash flow information:
 

 
 

 
Cash paid during the period for:
 

 
 

 
Interest (net of amounts capitalized)
$
246

 
$
270

 
Income taxes (net of refunds)
126

 
341



 See accompanying notes to consolidated financial statements.
6


Norfolk Southern Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
 
In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly Norfolk Southern Corporation (Norfolk Southern) and subsidiaries’ (collectively, NS, we, us, and our) financial position at June 30, 2018, and December 31, 2017, our results of operations and comprehensive income for the second quarters and first six months of 2018 and 2017, and our cash flows for the first six months of 2018 and 2017 in conformity with U.S. generally accepted accounting principles (GAAP).
 
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in our latest Annual Report on Form 10-K.

1. Railway Operating Revenues

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers,” and related amendments which are jointly referred to as Accounting Standards Codification (ASC) Topic 606. This update 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. ASC Topic 606 defines a performance obligation 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 ASC Topic 606, nor is there any material difference in revenue in the second quarter and first six months of 2018 as compared with the GAAP that was in effect prior to January 1, 2018.

The following table disaggregates our revenues by major commodity group:
 
 
Second Quarter
 
First Six Months
 
 
2018
 
2018
Merchandise:
 
($ in millions)
Chemicals
 
$
452

 
$
895

Agr./consumer/gov’t
 
423

 
816

Metals/construction
 
389

 
727

Automotive
 
253

 
496

Paper/clay/forest
 
201

 
389

Merchandise
 
1,718

 
3,323

Intermodal
 
714

 
1,392

Coal
 
466

 
900

Total
 
$
2,898

 
$
5,615


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 major 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 completed to total transit days. We had no material remaining performance obligations as of June 30, 2018.


7


Under the typical payment terms of our freight contracts, payment for services is due within fifteen days of billing the customer, thus there are no significant financing components. “Accounts receivable – net” on the Consolidated Balance Sheets includes both customer and non-customer receivables as follows:
 
 
June 30, 2018
 
December 31, 2017
 
 
 
($ in millions)
 
Customer                                       
 
$
773

 
$
703

 
Non-customer
 
262

 
252

 
  Accounts receivable – net
 
$
1,035

 
$
955

 

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 $51 million and $39 million at June 30, 2018 and December 31, 2017, respectively.  We do not have any material contract assets or liabilities.

Certain of our contracts contain refunds (which are primarily volume-based incentives) that are recorded as a reduction to revenue. Refunds are recorded 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. This revenue is included within each of the commodity groups and represents approximately 4% of total “Railway operating revenues.”

2.  Stock-Based Compensation
 
 
Second Quarter
 
First Six Months
 
 
2018
 
2017
 
2018
 
2017
 
 
($ in millions)
Stock-based compensation expense
 
$
13

 
$
5

 
$
29

 
$
32

Total tax benefit
 
6

 
4

 
20

 
34


During 2018, a committee of nonemployee members of our Board of Directors (and the Chief Executive Officer under delegated authority by such committee) granted stock options, restricted stock units (RSUs) and performance share units (PSUs) pursuant to the Long-Term Incentive Plan (LTIP), as follows:
 
 
Second Quarter
 
First Six Months
 
 
Granted
 
Weighted-Average Grant-Date Fair Value
 
Granted
 
Weighted-Average Grant-Date Fair Value
 
 
 
 
 
 
 
 
 
Stock options
 

 
$

 
40,960

 
$
41.70

RSUs
 
840

 
147.58

 
216,720

 
148.31

PSUs
 

 

 
91,914

 
91.55


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. 
 




8





Stock Options
 
 
Second Quarter
 
First Six Months
 
 
2018
 
2017
 
2018
 
2017
 
 
($ in millions)
Stock options exercised
 
215,132

 
125,593

 
470,114

 
1,011,315

Cash received upon exercise
 
$
16

 
$
8

 
$
33

 
$
57

Related tax benefit realized
 
$
3

 
$
3

 
$
7

 
$
19


Restricted Stock Units

RSUs primarily have a four-year ratable restriction period and will be settled through the issuance of shares of Norfolk Southern common stock (Common Stock).  Compensation cost for the award is recognized on a straight-line basis over the requisite service period for the entire award.  Certain RSU grants include cash dividend equivalent payments during the restriction period in an amount equal to the regular quarterly dividends paid on Common Stock.  No RSUs vested or were paid out during the second quarters of 2018 or 2017.

 
 
First Six Months
 
 
2018
 
2017
 
 
($ in millions)
RSUs vested
 
160,200

 
137,200
Common Stock issued net of tax withholding
 
99,968

 
81,318
Related tax benefit realized
 
$
3

 
$
3


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. No PSUs were earned or paid out during the second quarters of 2018 or 2017.

 
 
First Six Months
 
 
2018
 
2017
 
 
($ in millions)
PSUs earned
 
154,189

 
171,080
Common Stock issued net of tax withholding
 
94,399

 
99,805
Related tax benefit realized
 
$
3

 
$
1

 

9


3.  Earnings Per Share

The following table sets forth the calculation of basic and diluted earnings per share:

 
Basic
 
Diluted
 
Second Quarter
 
2018
 
2017
 
2018
 
2017
 
($ in millions, except per share amounts,
shares in millions)
 
 
 
 
 
 
 
 
Net income
$
710

 
$
497

 
$
710

 
$
497

Dividend equivalent payments
(1
)
 
(1
)
 

 

 
 
 
 
 
 
 
 
Income available to common stockholders
$
709

 
$
496

 
$
710

 
$
497

 
 
 
 
 
 
 
 
Weighted-average shares outstanding
281.3

 
289.0

 
281.3

 
289.0

Dilutive effect of outstanding options
 

 
 

 
 

 
 

and share-settled awards
 

 
 

 
2.4

 
2.2

 
 
 
 
 
 
 
 
Adjusted weighted-average shares outstanding
 

 
 

 
283.7

 
291.2

 
 
 
 
 
 
 
 
Earnings per share
$
2.52

 
$
1.72

 
$
2.50

 
$
1.71

 
 
 
 
 
 
 
 
 
Basic
 
Diluted
 
First Six Months
 
2018
 
2017
 
2018
 
2017
 
($ in millions, except per share amounts,
shares in millions)
 
 
 
 
 
 
 
 
Net income
$
1,262

 
$
930

 
$
1,262

 
$
930

Dividend equivalent payments
(2
)
 
(2
)
 
(1
)
 
(1
)
 
 
 
 
 
 
 
 
Income available to common stockholders
$
1,260

 
$
928

 
$
1,261

 
$
929

 
 
 
 
 
 
 
 
Weighted-average shares outstanding
282.4

 
289.6

 
282.4

 
289.6

Dilutive effect of outstanding options
 
 
 
 
 
 
 
and share-settled awards
 
 
 
 
2.4

 
2.4

 
 
 
 
 
 
 
 
Adjusted weighted-average shares outstanding
 
 
 
 
284.8

 
292.0

 
 
 
 
 
 
 
 
Earnings per share
$
4.46

 
$
3.20

 
$
4.43

 
$
3.18



During the second quarters and first six months of 2018 and 2017, 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

10


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 zero and 0.5 million for the first six months ended June 30, 2018 and 2017, respectively.

4. Accumulated Other Comprehensive Loss
The changes in the cumulative balances of “Accumulated other comprehensive loss” reported in the Consolidated Balance Sheets consisted of the following:
 
Balance at
Beginning
of Year
 
Net Income
(Loss)
 
Reclassification of Stranded
Tax Effects
 
Reclassification
Adjustments
 
Balance at
End of Period
 
($ in millions)    
Six Months Ended June 30, 2018
 
 
 
 
 
 
 
 
 
Pensions and other
 
 
 
 
 
 
 
 
 
postretirement liabilities
$
(300
)
 
$
(11
)
 
$
(86
)
 
$
12

 
$
(385
)
Other comprehensive income
 

 
 

 
 
 
 

 
 

(loss) of equity investees
(56
)
 
2

 
(2
)
 

 
(56
)
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive loss
$
(356
)
 
$
(9
)
 
$
(88
)
 
$
12

 
$
(441
)
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2017
 

 
 

 
 
 
 

 
 

Pensions and other
 
 
 
 
 
 
 
 
 
postretirement liabilities
$
(414
)
 
$

 
$

 
$
8

 
$
(406
)
Other comprehensive loss
 
 
 
 
 
 
 
 
 
of equity investees
(73
)
 
(1
)
 

 

 
(74
)
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive loss
$
(487
)
 
$
(1
)
 
$

 
$
8

 
$
(480
)

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 the Tax Cuts and Jobs Act (“tax reform”) that was enacted on December 22, 2017 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 “Accumulated other comprehensive loss” of $88 million and a corresponding increase to “Retained income,” with no impact on “Total stockholders’ equity.”


11


5.  Stock Repurchase Program
 
We repurchased and retired 4.8 million and 3.4 million shares of Common Stock under our stock repurchase program in the first six months of 2018 and 2017, respectively, at a cost of $700 million and $402 million, respectively. Since the beginning of 2006, we have repurchased and retired 173.3 million shares at a total cost of $12.0 billion.

6.  Investments

Investment in Conrail
 
Through a limited liability company, we and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primary subsidiary is Consolidated Rail Corporation (CRC). We have a 58% economic and 50% voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests. Our investment in Conrail was $1.3 billion at both June 30, 2018, and December 31, 2017.

CRC owns and operates certain properties (the Shared Assets Areas) for the joint and exclusive benefit of Norfolk Southern Railway Company (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 amounts payable to CRC for the operation of the Shared Assets Areas totaling $36 million and $37 million for the second quarters of 2018 and 2017, respectively, and $74 million and $72 million for the first six months of 2018 and 2017, respectively.  Our equity in the earnings of Conrail, net of amortization, included in “Purchased services and rents” was $18 million and $10 million for the second quarters of 2018 and 2017, respectively, and $34 million and $20 million for the first six months of 2018 and 2017, respectively. 

“Other liabilities” includes $280 million at both June 30, 2018, and December 31, 2017, for long-term advances from Conrail, maturing 2044, that bear interest at an average rate of 2.9%.

Investment in TTX

NS and eight other North American railroads jointly own TTX Company (TTX).  NS has a 19.65% 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” and amounted to $67 million and $58 million of expense for the second quarters of 2018 and 2017, respectively, and $133 million and $115 million for the first six months of 2018 and 2017, respectively. Our equity in the earnings of TTX, also included in “Purchased services and rents,” totaled $17 million and $10 million for the second quarters of 2018 and 2017, respectively, and $33 million and $18 million for the first six months of 2018 and 2017, respectively.

7.  Debt
 
In June 2018, we renewed and amended our accounts receivable securitization program from $350 million to $400 million on a 364-day term to run through May 2019.  We had no amounts outstanding under this program at June 30, 2018 and $100 million outstanding at December 31, 2017, reflected as “Short-term debt” on the Consolidated Balance Sheets. 

During the first quarter of 2018, we issued $500 million of 4.15% senior notes due 2048.


12


8.  Pensions 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, a defined percentage of health care expenses is 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.

Pension and postretirement benefit cost components for the second quarters and first six months are as follows:
 
 
 
 
 
Other Postretirement
 
Pension Benefits
 
Benefits
 
Second Quarter
 
2018
 
2017
 
2018
 
2017
 
($ in millions)
 
 
 
 
 
 
 
 
Service cost
$
10

 
$
10

 
$
2

 
$
2

Interest cost
22

 
20

 
4

 
4

Expected return on plan assets
(45
)
 
(43
)
 
(4
)
 
(4
)
Amortization of net losses
14

 
13

 

 

Amortization of prior service benefit

 

 
(6
)
 
(6
)
 
 
 
 
 
 
 
 
Net expense (benefit)
$
1

 
$

 
$
(4
)
 
$
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Postretirement
 
Pension Benefits
 
Benefits
 
First Six Months
 
2018
 
2017
 
2018
 
2017
 
($ in millions)
 
 
 
 
 
 
 
 
Service cost
$
20

 
$
19

 
$
4

 
$
4

Interest cost
42

 
40

 
8

 
8

Expected return on plan assets
(89
)
 
(86
)
 
(8
)
 
(8
)
Amortization of net losses
28

 
26

 

 

Amortization of prior service benefit

 

 
(12
)
 
(12
)
 
 
 
 
 
 
 
 
Net expense (benefit)
$
1

 
$
(1
)
 
$
(8
)
 
$
(8
)

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 non-operating expenses and also 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.”


13


The retrospective application resulted in an offsetting increase in “Compensation and benefits” expense and an increase in “Other income – net” on the Consolidated Statements of Income of $16 million and $32 million for the second quarter and first six months of 2017, respectively, with no impact on “Net income.”

9.  Fair Values of Financial Instruments
 
The fair values of “Cash and cash equivalents,” “Accounts receivable,” “Accounts payable,” and “Short-term debt” approximate carrying values because of the short maturity of these financial instruments. The carrying value of corporate-owned life insurance is recorded at cash surrender value and, accordingly, approximates fair value. Other than these assets and liabilities that approximate fair value, there are no other assets or liabilities measured at fair value on a recurring basis at June 30, 2018, or December 31, 2017. The carrying amounts and estimated fair values for the remaining financial instruments, excluding investments accounted for under the equity method, consisted of the following:
 
June 30, 2018
 
December 31, 2017
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
($ in millions)
 
 
 
 
 
 
 
 
Long-term investments
$
21

 
$
38

 
$
26

 
$
43

Long-term debt, including current maturities
(9,646
)
 
(10,894
)
 
(9,736
)
 
(11,771
)
 
Underlying net assets and future discounted cash flows were used to estimate the fair value of investments. The fair values of long-term debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, credit rating, and remaining maturity.
 
The following table sets forth the fair value of long-term investment and long-term debt balances disclosed above by valuation technique level, within the fair value hierarchy (there were no level 3 valued assets or liabilities).
 
 
Level 1
 
Level 2
 
Total
 
($ in millions)
 
 
 
 
 
 
June 30, 2018
 
 
 
 
 
Long-term investments
$

 
$
38

 
$
38

Long-term debt, including current maturities
(10,801
)
 
(93
)
 
(10,894
)
 
 
 
 
 
 
December 31, 2017
 

 
 

 
 

Long-term investments
$
4

 
$
39

 
$
43

Long-term debt, including current maturities
(11,676
)
 
(95
)
 
(11,771
)
 
10.  Commitments 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 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

14


adjustments to the recorded liability will be reflected in earnings in the periods in which such adjustments become known.

One of our chemical customers, Sunbelt Chlor Alkali Partnerships (Sunbelt), filed in 2011 a rate reasonableness complaint before the Surface Transportation Board (STB) alleging that our tariff rates for transportation of regulated movements are unreasonable. Since April 1, 2011, we have been billing and collecting amounts based on the challenged tariff rates. In 2014, the STB resolved this rate reasonableness complaint in our favor and, in June 2016, the STB resolved petitions for reconsideration. Sunbelt’s appeal of the STB’s decision to the United States Court of Appeal for the 11th Circuit was denied on January 26, 2018. This matter did not have a material effect on our financial position, results of operations, or liquidity.

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 findings are subject to appeal. 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 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 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 (including asbestosis and other respiratory diseases, as well as conditions allegedly related to repetitive motion) are often not caused by a specific accident or event but rather allegedly result from a claimed exposure over time.  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

15


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, automobile liability, property damage, and lading damage.  The actuarial firm assists us with the calculation 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 engineers 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 $58 million at both June 30, 2018, and December 31, 2017, (of which $15 million is classified as a current liability at both dates). At June 30, 2018, the liability represents our estimates of the probable cleanup, investigation, and remediation costs based on available information at 125 known locations and projects compared with 127 locations and projects at December 31, 2017. At June 30, 2018, 17 sites accounted for $38 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 five years; however, some costs will be paid out over a longer period.

At twelve 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 our 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.

16


 
Insurance
 
We obtain, on behalf of ourself and our subsidiaries, insurance for potential losses for third-party liability and first-party property damages.  We are currently self-insured up to $50 million and above $1.1 billion ($1.5 billion for specific perils) per occurrence and/or policy year for bodily injury and property damage to third parties and up to $25 million and above $200 million per occurrence and/or policy year for property owned by us or in our care, custody, or control.
 
11. New Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, “Leases.”  This update, effective for our annual and interim reporting periods beginning January 1, 2019, will replace existing lease guidance in GAAP and will require lessees to recognize lease assets and lease liabilities on the balance sheet for leases greater than twelve months and disclose key information about leasing arrangements. When implemented, lessees will be required to measure and record leases at the present value of the remaining lease payments. In March 2018, the FASB approved amendments that permit the use of the effective date as the date of initial application (simplified approach), or a modified retrospective transition approach with application in all comparative periods presented. Although the amendments are not yet codified, we expect to adopt the simplified approach.  We disclosed $660 million in undiscounted operating lease obligations in our lease commitments footnote in our most recent 10-K, and have evaluated those contracts. We continue to evaluate other existing arrangements to determine if they qualify for lease accounting under the new standard. We are in the process of implementing a lease management system to support the new reporting requirements. We do not anticipate a material impact on our results of operations, and we will not adopt the standard early.

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. The new standard is effective as of January 1, 2020, and early adoption is permitted as of January 1, 2019. 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.




17


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Norfolk Southern Corporation and Subsidiaries
 
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 miles of road in 22 states and the District of Columbia, with service to every major container port in the eastern United States, and provides efficient connections to other rail carriers.  We operate the most extensive intermodal network in the East and are a major transporter of coal, automotive, and industrial products. 

Record-setting second-quarter results highlight the commitment to our strategic plan. We achieved a record low second-quarter operating ratio (a measure of the amount of operating revenues consumed by operating expenses) of 64.6%, in addition to an all-time record for income from railway operations and second-quarter records for net income and diluted earnings per share. We remain focused on strategies that deliver financial performance that benefits shareholders and service that benefits customers.

SUMMARIZED RESULTS OF OPERATIONS
($ in millions, except per share amounts)
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
Income from railway operations
$
1,026

 
$
872

 
18%
 
$
1,861

 
$
1,629

 
14%
Net income
$
710

 
$
497

 
43%
 
$
1,262

 
$
930

 
36%
Diluted earnings per share
$
2.50

 
$
1.71

 
46%
 
$
4.43

 
$
3.18

 
39%
Railway operating ratio (percent)
64.6

 
66.9

 
(3%)
 
66.9

 
68.7

 
(3%)

Growth in income from railway operations in both periods was a result of increased railway operating revenues. Traffic volume was up 6% in the second quarter and 4% for the first six months. Average revenue per unit growth was driven by pricing gains and higher fuel surcharge revenues, partially offset by mix-related impacts due to increased intermodal volume. The increase in revenues was offset in part by increased railway operating expenses, driven by higher fuel prices, higher incentive compensation, and increased costs associated with overall lower network velocity, partially offset by refund claims for prior years’ employment taxes paid on equity awards. Net income and diluted earnings per share also benefited from a lower effective tax rate, primarily due to the enactment of tax reform in late 2017.


18


DETAILED RESULTS OF OPERATIONS
 
Railway Operating Revenues
 
The following tables present a comparison of revenues ($ in millions), volumes (units in thousands), and average revenue per unit ($ per unit) by commodity group.
 
 
Second Quarter
 
First Six Months
Revenues
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
Merchandise:
 
 
 
 
 
 
 
 
 
 
 
 
Chemicals
 
$
452

 
$
406

 
11%
 
$
895

 
$
833

 
7%
Agr./consumer/gov’t
 
423

 
384

 
10%
 
816

 
768

 
6%
Metals/construction
 
389

 
371

 
5%
 
727

 
711

 
2%
Automotive
 
253

 
249

 
2%
 
496

 
495

 
Paper/clay/forest
 
201

 
187

 
7%
 
389

 
374

 
4%
Merchandise
 
1,718

 
1,597

 
8%
 
3,323

 
3,181

 
4%
Intermodal
 
714

 
593

 
20%
 
1,392

 
1,164

 
20%
Coal
 
466

 
447

 
4%
 
900

 
867

 
4%
Total
 
$
2,898

 
$
2,637

 
10%
 
$
5,615

 
$
5,212

 
8%
Units
 
 
 
 
 
 
 
 
Merchandise:
 
 
 
 
 
 
 
 
 
 
 
 
Chemicals
 
127.1

 
114.8

 
11%
 
247.9

 
233.4

 
6%
Agr./consumer/gov’t
 
158.3

 
145.7

 
9%
 
306.6

 
295.2

 
4%
Metals/construction
 
193.7

 
193.4

 
 
358.3

 
361.8

 
(1%)
Automotive
 
104.7

 
111.4

 
(6%)
 
207.5

 
221.9

 
(6%)
Paper/clay/forest
 
71.7

 
70.3

 
2%
 
141.3

 
140.9

 
Merchandise
 
655.5

 
635.6

 
3%
 
1,261.6

 
1,253.2

 
1%
Intermodal
 
1,091.8

 
1,009.1

 
8%
 
2,141.0

 
1,978.5

 
8%
Coal
 
273.6

 
266.1

 
3%
 
522.7

 
525.7

 
(1%)
Total
 
2,020.9

 
1,910.8

 
6%
 
3,925.3

 
3,757.4

 
4%
Revenue per Unit
 
 
 
 
 
 
 
 
Merchandise:
 
 
 
 
 
 
 
 
 
 
 
 
Chemicals
 
$
3,557

 
$
3,536

 
1%
 
$
3,609

 
$
3,568

 
1%
Agr./consumer/gov’t
 
2,675

 
2,637

 
1%
 
2,663

 
2,602

 
2%
Metals/construction
 
2,008

 
1,919

 
5%
 
2,029

 
1,966

 
3%
Automotive
 
2,421

 
2,244

 
8%
 
2,392

 
2,232

 
7%
Paper/clay/forest
 
2,795

 
2,653

 
5%
 
2,750

 
2,652

 
4%
Merchandise
 
2,621

 
2,514

 
4%
 
2,634

 
2,538

 
4%
Intermodal
 
654

 
587

 
11%
 
650

 
588

 
11%
Coal
 
1,704

 
1,679

 
1%
 
1,723

 
1,649

 
4%
Total
 
1,434

 
1,380

 
4%
 
1,430

 
1,387

 
3%











19


Railway operating revenues increased $261 million in the second quarter and $403 million for the first six months compared with the same periods last year. The table below reflects the components of the revenue change by major commodity group ($ in millions).

 
Second Quarter
 
First Six Months
 
Increase
 
Increase (Decrease)
 
 
 
 
 
 
 
 
 
 
 
 
 
Merchandise
 
Intermodal
 
Coal
 
Merchandise
 
Intermodal
 
Coal
 
 
 
 
 
 
 
 
 
 
 
 
Volume
$
50

 
$
49

 
$
13

 
$
21

 
$
96

 
$
(5
)
Fuel surcharge
 
 
 
 
 
 
 
 
 
 
 
revenue
25

 
45

 
2

 
43

 
76

 
4

Rate, mix and
 
 
 
 
 
 
 
 
 
 
 
other
46

 
27

 
4

 
78

 
56

 
34

 
 
 
 
 
 
 
 
 
 
 
 
Total
$
121

 
$
121

 
$
19

 
$
142

 
$
228

 
$
33

 
Most of our contracts include negotiated fuel surcharges, typically tied to either On-Highway Diesel (OHD) or West Texas Intermediate Crude Oil (WTI).  Approximately 90% of our revenue base is covered by these negotiated fuel surcharges, with almost 75% tied to OHD. In the second quarter and first six months of 2018, contracts tied to OHD accounted for about 90% of our fuel surcharge revenue, as price levels were below most of our surcharge trigger points in contracts tied to WTI. Revenues associated with these surcharges totaled $157 million and $85 million in the second quarters of 2018 and 2017, respectively, and $288 million and $165 million for the first six months of 2018 and 2017, respectively.
 
Merchandise
 
Merchandise revenue grew in both periods. Second quarter volume increased in all commodity groups with the exception of automotive. Growth in average revenue per unit for both periods was driven by pricing gains and increased fuel surcharge revenue.

Chemicals volume grew significantly, driven by increased shipments of crude oil, liquefied petroleum gas, and plastics. Lower shipments of coal ash, particularly in the first quarter, tempered volume growth in the first six months.

Agriculture, consumer products, and government volume rose in both periods as increases in ethanol and fertilizer shipments were partially offset by fewer corn shipments.

Metals and construction volume was relatively flat in the second quarter, but down slightly in the first six months reflecting lower aggregates volume as well as decreases in iron, steel and aluminum products traffic. These decreases were partially offset by increased frac sand shipments for use in natural gas drilling in the Marcellus and Utica regions.

Automotive volume fell in both periods, driven by shortages in availability of multilevel equipment, automotive parts supplier production interruptions, and scheduled automotive plant downtime.

Paper, clay, and forest products volume increased in the second quarter and was relatively flat for the first six months. Increases in pulpboard and municipal waste shipments, a result of tightened truck capacity and growth with existing customers, respectively, were partially offset by decreases in woodchip volumes due to customer sourcing changes and lower graphic paper traffic volume.


20


Merchandise revenues for the remainder of the year are expected to continue to increase year over year, reflecting higher average revenue per unit, driven by pricing gains and higher fuel surcharge revenues as well as higher volumes.

Intermodal
 
Intermodal revenues increased in both periods driven by higher average revenue per unit, a result of increased fuel surcharge revenues and pricing gains, and volume growth.

Intermodal units (in thousands) by market were as follows:
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Domestic
706.5

 
627.1

 
13%
 
1,378.2

 
1,228.0

 
12%
International
385.3

 
382.0

 
1%
 
762.8

 
750.5

 
2%
 
 
 
 
 
 
 
 
 
 
 
 
Total
1,091.8

 
1,009.1

 
8%
 
2,141.0

 
1,978.5

 
8%

Domestic volumes rose in both periods as a result of continued highway conversions due to tighter capacity in the truck market, higher truckload pricing, and growth in existing accounts. International volume rose due to increased demand from existing accounts.

Intermodal revenues for the remainder of the year are expected to continue to increase compared to last year, driven by greater volume in addition to higher average revenue per unit due to increased fuel surcharge revenues and pricing gains.

Coal
 
Coal revenues rose in both periods. The second quarter increase was the result of traffic increases and higher average revenue per unit, reflecting pricing gains, offset in part by negative mix. For the first six months, higher average revenue per unit, largely due to pricing gains, was partially offset by decreased volumes.
 
Coal tonnage (in thousands) by market was as follows:
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Utility
16,695

 
17,587

 
(5%)
 
32,560

 
35,189

 
(7%)
Export
7,916

 
6,566

 
21%
 
15,154

 
12,909

 
17%
Domestic metallurgical
4,251

 
3,982

 
7%
 
7,398

 
7,349

 
1%
Industrial
1,457

 
1,331

 
9%
 
2,717

 
2,802

 
(3%)
 
 
 
 
 
 
 
 
 
 
 
 
Total
30,319

 
29,466

 
3%
 
57,829

 
58,249

 
(1%)
 
Utility coal tonnage declined in both periods, driven by lower network velocity and weakened demand due to sustained low natural gas prices and, for the first six months, inclement weather in the first quarter. Export coal tonnage grew considerably over both prior periods, a result of strong seaborne pricing and higher demand for U.S. coal. Domestic metallurgical coal tonnage rose in both periods due to increased market demand; however, volume for the first six months was tempered by customer sourcing changes. Industrial coal tonnage rose in the second quarter, but declined in the first six months. The second quarter increase was driven by heightened customer demand, but could not offset the overall decline in the first six months driven by customer sourcing changes and pressure from natural gas conversions.
 

21


Coal revenues for the remainder of the year are expected to continue to increase compared to last year, a result of increased volumes, primarily in the export market, and higher average revenue per unit largely due to favorable mix and pricing gains.

Railway Operating Expenses

Railway operating expenses summarized by major classifications were as follows ($ in millions):
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Compensation and benefits
$
706

 
$
719

 
(2%)
 
$
1,443

 
$
1,478

 
(2%)
Purchased services and rents
430

 
392

 
10%
 
831

 
769

 
8%
Fuel
272

 
190

 
43%
 
538

 
403

 
33%
Depreciation
273

 
264

 
3%
 
545

 
523

 
4%
Materials and other
191

 
200

 
(5%)
 
397

 
410

 
(3%)
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
1,872

 
$
1,765

 
6%
 
$
3,754

 
$
3,583

 
5%

Compensation and benefits expense decreased in both periods, as follows:

employment tax refund ($31 million benefit for both the quarter and first six months),
employment levels (down $17 million for the quarter and $41 million for the first six months),
health and welfare benefit rates for agreement employees (down $9 million for the quarter and $17 million for the first six months),
overtime and recrews (up $13 million for the quarter and $32 million for the first six months), and
incentive and stock-based compensation (up $34 million for the quarter and $26 million for the first six months).

Average rail headcount for the quarter was down by about 550 compared with the second quarter 2017, and up about 100 sequentially as we have increased our train and engine employee hiring while decreasing headcount in other areas. We expect average headcount to continue to trend sequentially up slightly in the last half of the year.

Purchased services and rents increased as follows ($ in millions):
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Purchased services
$
342

 
$
318

 
8%
 
$
660

 
$
622

 
6%
Equipment rents
88

 
74

 
19%
 
171

 
147

 
16%
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
430

 
$
392

 
10%
 
$
831

 
$
769

 
8%

The increase in purchased services in both periods was largely the result of higher intermodal volume-related costs, more track and bridge repairs, and increased transportation costs for train and engine employees. Equipment rents rose in both periods, the result of higher volume-related costs and lower network velocity.

Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, increased due primarily to higher locomotive fuel prices (up 38% in the second quarter and 29% in the first six months) which increased expenses $71 million and $114 million, respectively, as well as increased consumption (up 5% in the second quarter and 3% in the first six months).


22



Materials and other expenses declined as follows ($ in millions):  
 
Second Quarter
 
First Six Months
 
2018
 
2017
 
% change
 
2018
 
2017
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Materials
$
92

 
$
87

 
6%
 
$
182

 
$
179

 
2%
Casualties and other claims
38

 
35

 
9%
 
85

 
75

 
13%
Other
61

 
78

 
(22%)
 
130

 
156

 
(17%)
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
191

 
$
200

 
(5%)
 
$
397

 
$
410

 
(3%)

Materials costs increased in both periods, due primarily to locomotive repairs. Casualties and other claims expenses increased in the second quarter, largely due to higher environmental remediation costs. For the first six months, the increase was primarily the result of higher damages related to derailments. Other expense decreased in both periods, reflecting the inclusion of $20 million and $38 million for the second quarter and first six months, respectively, of net rental income from operating property previously included in “Other income – net.”

Other Income – Net

Other income – net decreased $19 million in the second quarter and $51 million for the first six months. The decline in both periods was driven by the absence of net rental income as discussed above. The first six months were additionally impacted by lower returns on corporate-owned life insurance during the first quarter.

Income Taxes
 
The second-quarter and year-to-date effective income tax rates were 23.2% and 22.6%, respectively, compared with 36.3% and 35.2% for the same periods last year, respectively. The declines resulted from the effects of the enactment of tax reform in late 2017 that lowered the federal corporate income tax rate.  The current year-to-date effective tax rate also benefited from certain 2017 tax credits that were retroactively enacted by the Bipartisan Budget Act of 2018, which was signed into law in early 2018.

FINANCIAL CONDITION AND LIQUIDITY
 
Cash provided by operating activities, our principal source of liquidity, was $1.8 billion for the first six months of 2018, compared with $1.6 billion for the same period of 2017, primarily a reflection of improved operating results. We had working capital deficits of $448 million at June 30, 2018, compared with $396 million at December 31, 2017. Cash and cash equivalents totaled $430 million at June 30, 2018. We expect cash on hand combined with cash provided by operating activities will be sufficient to meet our ongoing obligations.

During the first quarter of 2018, we issued $500 million of 4.15% senior notes due 2048. Other than this item, there have been no material changes to the information on future contractual obligations contained in our Form 10-K for the year ended December 31, 2017.

Cash used in investing activities was $786 million for the first six months of 2018, compared with $824 million in the same period last year, reflecting lower property additions.

Cash used in financing activities was $1.3 billion in the first six months of 2018, compared with $1.1 billion in the same period last year, largely the result of higher repurchases of Common Stock, debt repayments, and dividend payments partially offset by increased proceeds from borrowings. We repurchased 4.8 million shares of Common Stock, totaling $700 million, in the first six months of 2018, compared to 3.4 million shares, totaling $402 million, in the same period last year.  The timing and volume of future share repurchases will be guided by our assessment of

23


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. 

Our total debt-to-total capitalization ratio was 36.8% at June 30, 2018, and 37.5% at December 31, 2017.

We have in place and available a $750 million credit agreement expiring in May 2021, which provides for borrowings at prevailing rates and includes covenants. We had no amounts outstanding under this facility at both June 30, 2018, and December 31, 2017, and are in compliance with all of its covenants. In June 2018, we renewed and amended our accounts receivable securitization program from $350 million to $400 million on a 364-day term expiring in May 2019. We had no amounts outstanding under this program at June 30, 2018 and $100 million outstanding at December 31, 2017


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.  There have been no significant changes to the application of the critical accounting policies disclosure contained in our Form 10-K at December 31, 2017

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 (NCCC).  Moratorium provisions in the labor agreements govern when the railroads and unions may propose changes to the agreements.

Beginning in late 2014, the NCCC and 12 rail unions exchanged new proposals to begin the current round of national negotiations.  The NCCC has now reached agreements with all but one of those unions. The agreements that we have reached are final and cover 95% of our unionized employees. The NCCC and the International Association of Machinists and Aerospace Workers (IAM) remain in mediation under the auspices of the National Mediation Board. In accordance with the Railway Labor Act, current agreements will remain in effect during the statutory bargaining process.  All of the newly negotiated agreements have moratorium  provisions that will reopen the agreements for negotiation beginning January 1, 2020.

New Accounting Pronouncements

For a detailed discussion of new accounting pronouncements, see Note 11.

24


Inflation

In preparing financial statements, GAAP requires the use of historical cost that disregards the effects of inflation on the replacement cost of property.  We are a capital-intensive company with 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 under “Risk Factors” in our latest Form 10-K and herein, as well as our subsequent filings with the Securities and Exchange Commission, 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.  Copies of our press releases and additional information about us is available at www.norfolksouthern.com, or you can contact Norfolk Southern Corporation Investor Relations by calling 757-629-2861.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.
 
The information required by this item is included in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Financial Condition and Liquidity.”
 
Item 4.  Controls and Procedures.
 
Evaluation of 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 June 30, 2018.  Based on such evaluation, our officers have concluded that, at June 30, 2018, our disclosure controls and procedures were effective in alerting them on a timely basis to material information required to be included in our periodic filings under the Exchange Act.

Changes in Internal Control Over Financial Reporting
 
During the second quarter of 2018, we have not identified any changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


25


PART II. OTHER INFORMATION
 
Item 1.  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 findings are subject to appeal. 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 1A. Risk Factors.
 
The risk factors included in our 2017 Form 10-K remain unchanged and are incorporated herein by reference with the exception of the following:

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 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 also has jurisdiction over the consolidation, merger, or acquisition of control of and by rail common carriers. Additional economic regulation of the rail industry by Congress or the STB, whether under new or existing laws, could have a significant negative impact on our ability to determine prices for rail services and on the efficiency of our operations. This potential material adverse effect could 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 Department of Transportation and the Department of Homeland Security (which regulate most aspects of our operations) related to safety and security. The Rail Safety Improvement Act of 2008 (RSIA), the Surface Transportation Extension Act of 2015, and the implementing regulations promulgated by the Federal Railroad Association (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 toxic inhalation hazardous materials are 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. The PTC laws and regulations require us to install all hardware and to implement the PTC system on some of those rail lines by December 31, 2018, and to implement such system 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.

26



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.


Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.
 
 
 
(a) Total
Number
of Shares
(or Units)
 
(b) Average
Price Paid
per Share
 
(c) Total
Number of
Shares
(or Units)
Purchased
as Part of
Publicly
Announced
Plans or
 
(d) Maximum
Number (or
Approximate
Dollar Value)
of Shares (or Units)
that may yet be
purchased under
the Plans or
 
Period
 
Purchased (1)
 
(or Unit)
 
Programs (2)
 
Programs (2)
 
 
 
 
 
 
 
 
 
 
 
April 1-30, 2018
 
750,953

 
136.16

 
747,376

 
53,636,520

 
May 1-31, 2018
 
1,021,696

 
149.62

 
1,019,707

 
52,616,813

 
June 1-30, 2018
 
954,605

 
152.60

 
954,513

 
51,662,300

 
 
 
 
 
 
 
 
 
 
 
Total
 
2,727,254