10-K 1 nsc1231201610-k.htm 10-K Document

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
 
(X)       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the fiscal year ended DECEMBER 31, 2016
 
(   )      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 

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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
Registrant’s telephone number, including area code:
 
(757) 629-2680
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Title of each Class
 
Name of each exchange on which registered
Norfolk Southern Corporation
 
 
Common Stock (Par Value $1.00)
 
New 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. Yes (X)  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 (  )  No (X)
 
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 Regulations 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  (X)
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of  “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer (X)        Accelerated filer (  )        Non-accelerated filer (  )        Smaller reporting company (  )
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes (  )   No (X)
 
The aggregate market value of the voting common equity held by non-affiliates at June 30, 2016, was $24,959,609,647 (based on the closing price as quoted on the New York Stock Exchange on that date).
 
The number of shares outstanding of each of the registrant’s classes of common stock, at January 31, 2017: 290,553,713 (excluding 20,320,777 shares held by the registrant’s consolidated subsidiaries).
 
DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Registrant’s definitive proxy statements to be filed electronically pursuant to Regulation 14A not later than 120 days after the end of the fiscal year, are incorporated herein by reference in Part III.



TABLE OF CONTENTS

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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PART I
 
NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES
 
Item 1. Business and Item 2. Properties
 
GENERAL – Our company, Norfolk Southern Corporation, 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.nscorp.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
Categorical Independence Standards for Directors
Norfolk Southern Corporation Bylaws


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RAILROAD OPERATIONS At December 31, 2016, our railroad operated approximately 19,500 miles of road 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.
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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)
Cleveland to Kansas City
Birmingham to Meridian
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:
 
 
Mileage Operated at December 31, 2016
 
Miles
of
Road
 
Second
and
Other
Main
Track
 
Passing
Track,
Crossovers
and
Turnouts
 
Way and
Yard
Switching 
 
Total 
 
 
 
 
 
 
 
 
 
 
Owned
14,713

 
2,735

 
1,950

 
8,311

 
27,709

Operated under lease, contract or trackage
 
 
 
 
 
 
 
 


rights
4,756

 
1,916

 
398

 
836

 
7,906

 
 
 
 
 
 
 
 
 
 
Total
19,469

 
4,651

 
2,348

 
9,147

 
35,615

 
The following table sets forth certain statistics relating to our railroads’ operations for the past five years:
 
 
Years ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
Revenue ton miles (billions)
191

 
200

 
205

 
194

 
186

Revenue per thousand revenue ton miles
$
51.91

 
$
52.63

 
$
56.70

 
$
58.10

 
$
59.47

Revenue ton miles (thousands) per employee
6,838

 
6,645

 
7,054

 
6,517

 
6,078

Ratio of railway operating expenses to railway operating
 
 
 
 
 
 
 
 
 
 revenues
68.9%

 
72.6%

 
69.2%

 
71.0%

 
71.7%


RAILWAY OPERATING REVENUES Total railway operating revenues were $9.9 billion in 2016.  Following is an overview of our three major market groups. See the discussion of merchandise revenues by commodity group, intermodal revenues, and coal revenues and tonnage in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
MERCHANDISE Our merchandise market group is composed of five major commodity groupings: 
Chemicals includes sulfur and related chemicals, petroleum products (including crude oil), chlorine and bleaching compounds, plastics, rubber, industrial chemicals, and chemical wastes.  
Agriculture, consumer products, and government includes soybeans, wheat, corn, fertilizer, livestock and poultry feed, food oils, flour, beverages, canned goods, sweeteners, consumer products, ethanol, transportation equipment, and items for the U.S. military.  
Metals and construction includes steel, aluminum products, machinery, scrap metals, cement, aggregates, sand, and minerals.
Automotive includes finished vehicles for BMW, FCA, Ford, General Motors, Honda, Hyundai, Mercedes-Benz, Mitsubishi, Subaru, Toyota, and Volkswagen, and auto parts for BMW, FCA, Ford, General Motors, Honda, Hyundai, Mercedes-Benz, Nissan, Tesla, and Toyota.
Paper, clay and forest products includes lumber and wood products, pulp board and paper products, wood fibers, wood pulp, scrap paper, and clay.

Merchandise carloads handled in 2016 were 2.5 million, the revenues from which accounted for 63% of our total railway operating revenues.


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INTERMODAL Our intermodal market group consists of shipments moving in trailers, domestic and international containers, and RoadRailer® equipment.  These shipments are handled on behalf of intermodal marketing companies, international steamship lines, truckers, and other shippers.  Intermodal units handled in 2016 were 3.9 million, the revenues from which accounted for 22% of our total railway operating revenues.
 
COAL  Revenues from coal accounted for about 15% of our total railway operating revenues in 2016.  We handled 100 million tons, or 0.9 million carloads, in 2016, 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 78 coal generation plants, as well as the export, 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.
 
In 2016, our railroad was found by the U.S. Surface Transportation Board (STB), the regulatory board that has broad jurisdiction over railroad practices, to not be “revenue adequate” on an annual basis based on results for the year 2015.  The STB has not made its revenue adequacy determination for the year 2016 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. 
 
PASSENGER OPERATIONS Amtrak operates regularly scheduled passenger trains on our lines between the following locations:
Alexandria and Lynchburg, Virginia
Alexandria, Virginia and New Orleans, Louisiana
Alexandria and Orange, Virginia
Petersburg and Norfolk, Virginia
Raleigh and Charlotte, North Carolina
Selma and Charlotte, North Carolina
Chicago, Illinois, and Porter, Indiana
Chicago, Illinois, and Cleveland, Ohio
Chicago, Illinois, and Pittsburgh, Pennsylvania
Pittsburgh and Harrisburg, Pennsylvania
 
A consortium of two transportation commissions of the Commonwealth of Virginia operate commuter trains on our line between Manassas and Alexandria.
 
We lease the Chicago to Manhattan, Illinois, line to the Commuter Rail Division of the Regional Transportation Authority of Northeast Illinois (METRA). 

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
Michigan Department of Transportation

Amtrak and various commuter agencies conduct passenger operations over trackage owned by Conrail Inc. (Conrail) in the Shared Assets Areas (Note 5 to the Consolidated Financial Statements).   


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NONCARRIER OPERATIONS Our noncarrier subsidiaries engage principally in the leasing or sale of rail property and equipment; the development of commercial real estate; telecommunications; and the acquisition, leasing, and management of coal, oil, gas and minerals.  In 2016, no such noncarrier subsidiary or industry segment grouping of noncarrier subsidiaries met the requirements for a reportable business segment under relevant authoritative accounting guidance. 
 
RAILWAY PROPERTY
 
Our railroad infrastructure makes us capital intensive with net property of approximately $30 billion on a historical cost basis.

Property Additions Property additions for the past five years were as follows:
 
2016
 
2015
 
2014
 
2013
 
2012
 
($ in millions)
 
 
 
 
 
 
 
 
 
 
Road and other property
$
1,292

 
$
1,514

 
$
1,406

 
$
1,421

 
$
1,465

Equipment
595

 
658

 
712

 
550

 
776

Delaware & Hudson acquisition

 
213

 

 

 

 
 
 
 
 
 
 
 
 
 
Total
$
1,887

 
$
2,385

 
$
2,118

 
$
1,971

 
$
2,241


Our capital spending and replacement programs are and have been designed to assure the ability to provide safe, efficient, and reliable rail transportation services.  For 2017, we have budgeted $1.9 billion of property additions. See further discussion of our planned capital spending and replacement programs in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the subheading “Financial Condition, Liquidity, and Capital Resources.”
 


K 7


Equipment At December 31, 2016, we owned or leased the following units of equipment:
 
 
Owned
 
Leased
 
Total
 
Capacity of
Equipment
Locomotives:
 

 
 

 
 

 
(Horsepower)

Multiple purpose
4,041

 

 
4,041

 
15,215,400

Auxiliary units
172

 

 
172

 

Switching
55

 

 
55

 
82,050

 
 
 
 
 
 
 
 
Total locomotives
4,268

 

 
4,268

 
15,297,450

 
 
 
 
 
 
 
 
Freight cars:
 

 
 

 
 

 
(Tons)
Gondola
27,964

 
2,653

 
30,617

 
3,353,749

Hopper
12,042

 

 
12,042

 
1,352,882

Covered hopper
10,065

 
85

 
10,150

 
1,122,115

Box
9,997

 
1,362

 
11,359

 
964,680

Flat
1,900

 
1,485

 
3,385

 
325,861

Other
1,718

 
12

 
1,730

 
80,050

 
 
 
 
 
 
 
 
Total freight cars
63,686

 
5,597

 
69,283

 
7,199,337

 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
Chassis
28,710

 

 
28,710

 
 
Containers
19,210

 
1,738

 
20,948

 
 
Work equipment
5,824

 
258

 
6,082

 
 
Vehicles
3,842

 

 
3,842

 
 
Miscellaneous
2,418

 
27

 
2,445

 
 
 
 
 
 
 
 
 
 
Total other
60,004

 
2,023

 
62,027

 
 
 
 
 
 
 
 
 
 
 


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The following table indicates the number and year built for locomotives and freight cars owned at December 31, 2016:
 
 
2016
 
2015
 
2014
 
2013
 
2012
 
2007-
2011
 
2002-
2006
 
2001 &
Before
 
Total
Locomotives:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
No. of units
66
 
8
 
83
 
50
 
60
 
259

 
536

 
3,206

 
4,268

% of fleet
2
%
 
1
%
 
2
%
 
1
%
 
1
%
 
6
%
 
12
%
 
75
%
 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Freight cars:
 
 
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

No. of units
776

 
2,093

 
900

 

 
2,017

 
8,109

 
468

 
49,323

 
63,686

% of fleet
1
%
 
3
%
 
1
%
 
%
 
3
%
 
13
%
 
1
%
 
78
%
 
100
%

The following table shows the average age of our owned locomotive and freight car fleets at December 31, 2016, and information regarding 2016 retirements:
 
 
Locomotives
 
Freight Cars 
Average age – in service
24.1 years 
 
28.6 years 
Retirements
130 units 
 
7,894 units 
Average age – retired
37.2 years 
 
37.3 years 

Track Maintenance Of the approximately 35,600 total miles of track on which we operate, we are responsible for maintaining approximately 28,500 miles, with the remainder being operated under trackage rights from other parties responsible for maintenance.
 
Over 83% 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 43% of our lines, excluding rail operated pursuant to trackage rights, carried 20 million or more gross tons per track mile during 2016.
 
The following table summarizes several measurements regarding our track roadway additions and replacements during the past five years:
 
2016
 
2015
 
2014
 
2013
 
2012
Track miles of rail installed
518

 
523

 
507

 
549

 
509

Miles of track surfaced
4,984

 
5,074

 
5,248

 
5,475

 
5,642

New crossties installed (millions)
2.3

 
2.4

 
2.7

 
2.5

 
2.6


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 “Personal Injury, Environmental, and Legal Liabilities” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations;” and Note 16 to the Consolidated Financial Statements.
 

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EMPLOYEES The following table shows the average number of employees and the average cost per employee for wages and benefits: 
 
2016
 
2015
 
2014
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
Average number of employees
28,044

 
30,456

 
29,482

 
30,103

 
30,943

Average wage cost per employee
$
76,000

 
$
77,000

 
$
76,000

 
$
72,000

 
$
69,000

Average benefit cost per employee
$
35,000

 
$
32,000

 
$
35,000

 
$
40,000

 
$
38,000


Approximately 80% of our railroad employees are covered by collective bargaining agreements with various labor unions. See the discussion of “Labor Agreements” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 
 
GOVERNMENT REGULATION In addition to environmental, safety, securities, and other regulations generally applicable to all business, our railroads are subject to regulation by the 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 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 2017.  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 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.

Our primary rail competitor is CSX Corporation (CSX); both railroads operate throughout much of the same territory. Other railroads also operate in parts of the territory.  We also 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 enable railroads to compete more effectively in specific markets. 

SECURITY OF OPERATIONS – We continue to take measures 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

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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 as a terrorist threat 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 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, and is integrated into hazardous material training programs.  Additionally, location-specific security plans are in place for certain metropolitan areas and each of the six port facilities we serve.  With respect to the ports, each facilitys security plan has been approved by the applicable Captain of the Port and remains subject to inspection by the U.S. Coast Guard (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, and various state Homeland Security offices.  Similarly, we follow guidance from DHS and DOT regarding rail corridors in High Threat Urban Areas (HTUA). Particular attention is aimed at reducing risk in 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) substantially 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.  

In 2016, through participation in the Transportation Community Awareness and Emergency Response (TRANSCAER) Program, we provided rail accident response training to approximately 5,573 emergency responders, such as local police and fire personnel. Our other training efforts throughout 2016 included participation in drills 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. 

Item 1A. Risk Factors

The risks set forth in the following risk factors could have a materially adverse effect on our financial condition, 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 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.


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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 (RSIA), the Surface Transportation Extension Act of 2015, and the implementing regulations promulgated by the FRA require us and each other Class I railroad to implement an interoperable positive train control system (PTC) on certain of our respective lines by December 31, 2018.

Full implementation of PTC in compliance with RSIA 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 could negatively affect the markets we serve and our customers, including those related to GHGs. 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 and property (including environmental) damage, and compromise critical parts of our rail network. The cost of a catastrophic rail accident involving hazardous materials could exceed our insurance coverage. We have obtained insurance for potential losses for third-party liability and first-party property damages (see Note 16 to the Consolidated Financial Statements); 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.

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 training requirements, particularly for engineers and conductors, could have a negative impact on our ability to meet demand for rail service. Unpredicted increases in demand for rail services may exacerbate such risks.


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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. Accordingly, 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 collective bargaining 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 national labor agreements, or renegotiation of labor agreements or provisions of labor agreements, could significantly increase our costs for healthcare, 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 very 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 (see Note 16 to the Consolidated Financial Statements); however, insurance is available

K 13


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.

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 462 million gallons of diesel fuel in 2016. Fuel availability could be affected by any limitation in the fuel supply or by any imposition of mandatory allocation or rationing regulations. A severe fuel supply shortage arising from production curtailments, increased demand in existing 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. From time-to-time we rely on the capital markets to provide some of our capital requirements, including the issuance of long-term debt instruments and commercial paper, 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 condition 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 condition, 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.

K 14


Item 3. Legal Proceedings
 
On November 6, 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. On June 21, 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. 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.


K 15


Executive Officers of the Registrant
 
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, 2017, relating to our officers.
 
Name, Age, Present Position
Business Experience During Past Five Years
 
 
James A. Squires, 55,
Chairman, President and Chief Executive Officer
 
 
 
Present position since October 1, 2015.
Served as CEO since June 1, 2015. Served as President since June 1, 2013. Served as Executive Vice President – Administration from August 1, 2012 to June 1, 2013. Served as Executive Vice President – Finance and Chief Financial Officer from July 1, 2007 to August 1, 2012.  
 
 
Cynthia C. Earhart, 55,
Executive Vice President –
Administration and Chief Information Officer
Present position since October 1, 2015.
Served as Executive Vice President - Administration since June 1, 2013. Served as Vice President Human Resources from March 1, 2007 to June 1, 2013.
 
 
Alan H. Shaw, 49
Executive Vice President and
Chief Marketing Officer
Present position since May 16, 2015.
Served as Vice President Intermodal Operations from
November 1, 2013 to May 15, 2015. Served as Group Vice President Industrial Products from November 16, 2009 to October 31, 2013.
 
 
Marta R. Stewart, 59,
Executive Vice President –
Finance and Chief Financial Officer
Present position since November 1, 2013.
Served as Vice President and Treasurer from April 1, 2009
to November 1, 2013. 
 
 
Michael J. Wheeler, 54,
Executive Vice President and
Chief Operating Officer
Present position since February 1, 2016.
Served as Senior Vice President Operations October 1, 2015 to January 31, 2016. Served as Vice President Engineering November 1, 2012 to September 30, 2015. Served as Vice President Transportation February 1, 2009 to October 31, 2012.
 
 
William A. Galanko, 60,
Senior Vice President –
Law and Corporate Communications
Present position since December 1, 2016.
Served as Vice President Law from April 1, 2006 to November 30, 2016.
 
 
Thomas E. Hurlbut, 52,
Vice President and Controller
Present position since November 1, 2013.
Served as Vice President Audit and Compliance from   
February 1, 2010 to November 1, 2013. 


K 16


PART II
 
NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

STOCK PRICE AND DIVIDEND INFORMATION
 
Common Stock is owned by 27,288 stockholders of record as of December 31, 2016, and is traded on the New York Stock Exchange under the symbol “NSC.”   The following table shows the high and low sales prices as reported by Bloomberg L.P. on its internet-based service and dividends per share, by quarter, for 2016 and 2015.
 
 
Quarter
2016
1st
 
2nd
 
3rd
 
4th
Market Price
 
 
 
 
 
 
 
High
$
85.37

 
$
93.15

 
$
96.83

 
$
110.52

Low
66.41

 
78.93

 
83.89

 
90.77

Dividends per share
0.59

 
0.59

 
0.59

 
0.59

 
 
 
 
 
 
 
 
2015
1st
 
2nd
 
3rd
 
4th
Market Price
 
 
 
 
 
 
 
High
$
111.63

 
$
106.47

 
$
88.03

 
$
97.07

Low
100.14

 
87.24

 
73.57

 
77.19

Dividends per share
0.59

 
0.59

 
0.59

 
0.59

 
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, 2016
 
680,891

 
$
94.73

 
680,891

 
16,007,556

November 1-30, 2016
 
680,714

 
100.05

 
677,148

 
15,330,408

December 1-31, 2016
 
625,893

 
108.24

 
625,893

 
14,704,515

 
 
 
 
 
 
 
 
 
Total
 
1,987,498

 
 

 
1,983,932

 
 

 
(1) 
Of this amount, 3,566 represents shares tendered by employees in connection with the exercise of stock options under the stockholder-approved Long-Term Incentive Plan.
(2) 
Our Board of Directors authorized a share repurchase program, pursuant to which up to 50 million shares of Common Stock through December 31, 2017.

K 17


Item 6. Selected Financial Data
 
FIVE-YEAR FINANCIAL REVIEW
 
 
2016
 
2015
 
2014
 
2013
 
2012
 
($ in millions, except per share amounts)
 
 
 
 
 
 
 
 
 
 
RESULTS OF OPERATIONS
 
 
 
 
 
 
 
 
 
Railway operating revenues
$
9,888

 
$
10,511

 
$
11,624

 
$
11,245

 
$
11,040

Railway operating expenses
6,814

 
7,627

 
8,049

 
7,988

 
7,916

Income from railway operations
3,074

 
2,884

 
3,575

 
3,257

 
3,124

 
 
 
 
 
 
 
 
 
 
Other income – net
71

 
103

 
104

 
233

 
129

Interest expense on debt
563

 
545

 
545

 
525

 
495

Income before income taxes
2,582

 
2,442

 
3,134

 
2,965

 
2,758

 
 
 
 
 
 
 
 
 
 
Provision for income taxes
914

 
886

 
1,134

 
1,055

 
1,009

 
 
 
 
 
 
 
 
 
 
Net income
$
1,668

 
$
1,556

 
$
2,000

 
$
1,910

 
$
1,749

 
 
 
 
 
 
 
 
 
 
PER SHARE DATA
 

 
 

 
 

 
 

 
 

Net income     – basic
$
5.66

 
$
5.13

 
$
6.44

 
$
6.10

 
$
5.42

– diluted
5.62

 
5.10

 
6.39

 
6.04

 
5.37

Dividends
2.36

 
2.36

 
2.22

 
2.04

 
1.94

Stockholders’ equity at year end
42.73

 
40.93

 
40.26

 
36.55

 
31.08

 
 
 
 
 
 
 
 
 
 
FINANCIAL POSITION
 

 
 

 
 

 
 

 
 

Total assets
$
34,892

 
$
34,139

 
$
33,033

 
$
32,259

 
$
30,135

Total debt
10,212

 
10,093

 
8,985

 
9,404

 
8,642

Stockholders’ equity
12,409

 
12,188

 
12,408

 
11,289

 
9,760

 
 
 
 
 
 
 
 
 
 
OTHER
 

 
 

 
 

 
 

 
 

Property additions
$
1,887

 
$
2,385

 
$
2,118

 
$
1,971

 
$
2,241

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average number of shares outstanding (thousands)
293,943

 
301,873

 
309,367

 
311,916

 
320,864

Number of stockholders at year end
27,288

 
28,443

 
29,575

 
30,990

 
32,347

Average number of employees:
 
 
 
 
 

 
 

 
 

Rail
27,856

 
30,057

 
29,063

 
29,698

 
30,543

Nonrail
188

 
399

 
419

 
405

 
400

 
 
 
 
 
 
 
 
 
 
Total
28,044

 
30,456

 
29,482

 
30,103

 
30,943

 
See accompanying consolidated financial statements and notes thereto.

K 18


Item 7. 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, serves 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. 

Our 2016 results reflect our progress and commitment to achieving the goals set forth in our strategic plan. Through a disciplined cost-control focus, we achieved a record-setting railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) of 68.9% and delivered approximately $250 million of productivity savings, despite the economic challenges that continue to affect our industry. Operational improvements allowed us to maintain near all-time best service levels and achieve high levels of network fluidity, which improved train performance and asset utilization. In addition to these improvements, the implementation of multiple cost-control initiatives drove savings in operating expenses across all categories.

In 2017, we expect to maintain high levels of service and see continued improvement in our operating ratio. Railway operating revenues are expected to increase, driven by volume growth in our coal and intermodal markets, in addition to higher average revenue per unit, a result of pricing gains and fuel surcharge revenue increases largely driven by higher expected fuel prices. Railway operating expenses are expected to increase next year, driven in large part by medical and wage inflation as well as volume-related expenses, offset in part by the continuation of targeted expense reductions as we balance resources with the demand for our high-quality rail service. We continue to focus on executing our strategic plan and remain committed to maintaining our strong levels of rail service, generating higher returns on capital, and increasing the efficiency of our resources.

SUMMARIZED RESULTS OF OPERATIONS
 
 
 
 
 
 
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
$ in millions, except per share amounts
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Income from railway operations
$
3,074

 
$
2,884

 
$
3,575

 
7
%
 
(19
%)
 
Net income
$
1,668

 
$
1,556

 
$
2,000

 
7
%
 
(22
%)
 
Diluted earnings per share
$
5.62

 
$
5.10

 
$
6.39

 
10
%
 
(20
%)
 
Railway operating ratio
68.9

 
72.6

 
69.2

 
(5
%)
 
5
%
 

The increase in net income for 2016, compared to 2015, was driven by higher income from railway operations, as railway operating expense decreases (down $813 million, or 11%) more than offset declines in railway operating revenues (down $623 million, or 6%). The decrease in net income for 2015, compared to 2014, reflected lower income from railway operations, driven by a sharp decline in railway operating revenues (down $1.1 billion, or 10%) offset in part by lower railway operating expenses (down $422 million, or 5%). The 2015 results include $93 million of costs associated with the restructuring of our Triple Crown Services (TCS) subsidiary and the closure of our Roanoke, Virginia corporate office, which reduced net income by $58 million, or $0.19 per diluted share.

K 19


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 market group. 
 
Revenues
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
$ in millions
 
% change
 
Merchandise:
 
 
 
 
 
 
 
 
 
 
Chemicals
$
1,648

 
$
1,760

 
$
1,863

 
(6
%)
 
(6
%)
 
Agr./consumer/gov’t.
1,548

 
1,516

 
1,498

 
2
%
 
1
%
 
Metals/construction
1,267

 
1,263

 
1,521

 
 
(17
%)
 
Automotive
975

 
969

 
1,004

 
1
%
 
(3
%)
 
Paper/clay/forest
744

 
771

 
794

 
(4
%)
 
(3
%)
 
Merchandise
6,182

 
6,279

 
6,680

 
(2
%)
 
(6
%)
 
Intermodal
2,218

 
2,409

 
2,562

 
(8
%)
 
(6
%)
 
Coal
1,488

 
1,823

 
2,382

 
(18
%)
 
(23
%)
 
Total
$
9,888

 
$
10,511

 
$
11,624

 
(6
%)
 
(10
%)
 

 
Units
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
in thousands
 
% change
 
Merchandise:
 
 
 
 
 
 
 
 
 
 
Chemicals
475.7

 
527.6

 
502.6

 
(10
%)
 
5
%
 
Agr./consumer/gov’t.
601.2

 
609.0

 
603.8

 
(1
%)
 
1
%
 
Metals/construction
685.8

 
672.4

 
725.6

 
2
%
 
(7
%)
 
Automotive
440.5

 
429.3

 
410.1

 
3
%
 
5
%
 
Paper/clay/forest
284.0

 
299.9

 
303.2

 
(5
%)
 
(1
%)
 
Merchandise
2,487.2

 
2,538.2

 
2,545.3

 
(2
%)
 
 
Intermodal
3,870.4

 
3,861.0

 
3,845.2

 
 
 
Coal
902.1

 
1,079.7

 
1,284.4

 
(16
%)
 
(16
%)
 
Total
7,259.7

 
7,478.9

 
7,674.9

 
(3
%)
 
(3
%)
 

 
Revenue per Unit
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
$ per unit
 
% change
 
Merchandise:
 
 
 
 
 
 
 
 
 
 
Chemicals
$
3,465

 
$
3,335

 
$
3,707

 
4
%
 
(10
%)
 
Agr./consumer/gov’t.
2,575

 
2,489

 
2,481

 
3
%
 
 
Metals/construction
1,847

 
1,879

 
2,096

 
(2
%)
 
(10
%)
 
Automotive
2,213

 
2,258

 
2,447

 
(2
%)
 
(8
%)
 
Paper/clay/forest
2,620

 
2,573

 
2,619

 
2
%
 
(2
%)
 
Merchandise
2,486

 
2,474

 
2,624

 
 
(6
%)
 
Intermodal
573

 
624

 
666

 
(8
%)
 
(6
%)
 
Coal
1,650

 
1,688

 
1,855

 
(2
%)
 
(9
%)
 
Total
1,362

 
1,405

 
1,515

 
(3
%)
 
(7
%)
 


K 20


Revenues decreased $623 million in 2016 and $1.1 billion in 2015.  As reflected in the table below, both declines resulted from lower average revenue per unit and reduced volume. In 2016, the effects of reduced fuel surcharges and changes in traffic mix more than offset price increases. Volume decreases were primarily driven by reductions in energy-related markets and the restructuring of our TCS subsidiary. For 2015, a large drop in fuel surcharge revenues more than offset pricing gains to drive average revenue per unit lower. The volume decline was driven by continued weakness in the coal markets.
 
Revenue Variance Analysis
(Decrease)
 
 2016 vs. 2015
 
 2015 vs. 2014
 
$ in millions
 
 
 
 
Revenue per unit
$
(315
)
 
$
(816
)
Volume (units)
(308
)
 
(297
)
 
 
 
 
Total
$
(623
)
 
$
(1,113
)
 
 
 
 
Fuel surcharge revenues
$
(241
)
 
$
(852
)
 
Most of our contracts include negotiated fuel surcharges, typically tied to either West Texas Intermediate Crude Oil (WTI) or On-Highway Diesel (OHD). Approximately 90% of our revenue base is covered by these negotiated fuel surcharges, with more than half tied to OHD. For 2016, 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 fuel surcharges totaled $236 million, $477 million, and $1,329 million in 2016, 2015, and 2014, respectively.

MERCHANDISE revenues decreased for both 2016 and 2015, compared with the years before. In 2016, the effects of lower volume were offset in part by a slight increase in average revenue per unit. Price increases were tempered by reduced fuel surcharge revenues (which lowered average revenue per unit by $31) and unfavorable changes in traffic mix. The 2015 decline reflected lower average revenue per unit, the result of lower fuel surcharge revenues (which reduced average revenue per unit by $185) that offset the effects of higher rates. Volume was relatively flat in 2015 compared to 2014.

For 2017, merchandise revenues are expected to increase, primarily the result of pricing gains and higher fuel surcharge revenues.

Chemicals revenues were lower year-over-year in 2016 and 2015. The 2016 decline was due to lower traffic volume, reflecting fewer shipments of crude oil originated from the Bakken oil fields, in addition to lower chlor-alkali and rock salt traffic, the result of market consolidations and softened demand. These declines were offset in part by higher average revenue per unit due to favorable mix, as increased volumes of higher-rated plastics more than offset reduced fuel surcharge revenues.
 
In 2015, the decline was the result of lower average revenue per unit, driven by reduced fuel surcharge revenues and negative mix resulting from increased shipments of lower-rated liquefied petroleum gas, which more than offset the effect of higher rates. Volumes increased for the year, largely driven by liquefied petroleum gas volume gains as well as strong demand for shipments of polypropylene due to lower feedstock prices. These volume increases were partially offset by fewer shipments of crude oil from the Bakken oil fields.
 
For 2017, chemicals revenues are anticipated to increase, as average revenue per unit is expected to be higher, largely the effect of favorable mix, driven by increased volumes of higher-rated plastics, and pricing gains. However, we expect these gains to be mitigated by lower shipments of crude oil from the Bakken oil fields and liquefied petroleum gas in the Utica Shale region.

K 21


One of our chemical customers, Sunbelt Chlor Alkali Partnership (Sunbelt), filed a rate reasonableness complaint before the 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. In June 2016, the STB resolved petitions for reconsideration.  The matter remains decided in our favor; however, the findings are still subject to appeal. We believe the estimate of any reasonably possible loss will not have a material effect on our financial position, results of operations, or liquidity. With regard to rate cases, we record adjustments to revenues in the periods if and when such adjustments are probable and reasonably estimable.

Agriculture, consumer products, and government revenues increased for both years, compared with the years before. The improvement in 2016 was driven by higher average revenue per unit primarily the result of pricing gains, offset in part by lower fuel surcharge revenues. Volumes decreased for the year driven by weaker demand for feed shipments and the effects of customer sourcing changes on corn volumes, offset in part by an increase in soybean export shipments and higher food oil volumes driven by service improvements.

The increase in 2015 was the result of more ethanol shipments due to higher gasoline consumption, offset in part by lower fuel surcharge revenues and fewer revenue shipments of empty rail cars as part of the conclusion of a hopper re-body program.

For 2017, agriculture, consumer products, and government revenues are expected to increase, driven by more shipments of corn and feed products, and by increased average revenue per unit, primarily a result of pricing gains.

Metals and construction revenues were up slightly in 2016 after falling in 2015, compared with the prior years. The increase in 2016 was driven by higher demand for aggregates and iron and steel shipments, and more coil steel traffic due to customer sourcing changes. These increases were offset in part by lower demand for materials used in natural gas and oil drilling as a result of depressed commodity prices. Average revenue per unit declined for the year, driven by lower fuel surcharge revenues and changes in traffic mix.

In 2015, the decline was driven by a drop in average revenue per unit, largely the result of lower fuel surcharge revenues partially offset by pricing gains, and a decrease in carloads. The volume decline was the result of lower demand for materials used in the construction of pipe for drilling activity, fewer shipments of fractionating sand and ceramic proppant used in natural gas drilling, and declines in scrap metal and coil shipments, resulting from declines in steel production due to global over-supply. These decreases were offset in part by increased shipments of aggregates as a result of higher demand in the Southeast for project work and strong highway and construction related markets.

For 2017, metals and construction revenues are expected to increase, as average revenue per unit is expected to be higher, primarily due to changes in the mix of traffic. We also expect volumes to increase next year, driven by growth in steel related products, in addition to higher cement shipments driven by increased construction activity.

Automotive revenues rose in 2016 after falling in 2015, compared with the prior years. For 2016, volumes increased as a result of higher automotive parts shipments and growth in the production of North American light vehicles. Average revenue per unit declined for the year, driven by lower fuel surcharge revenues offset in part by pricing gains.

The decline in 2015 reflected a drop in average revenue per unit primarily due to lower fuel surcharge revenues, offset in part by pricing gains. Volumes increased for the year, driven by gains in production of North American light vehicles.
 
For 2017, automotive revenues are expected to decrease as a result of volume declines related to extended retooling at several NS-served assembly plants and expected decreases in U.S. vehicle production, offset in part by higher average revenue per unit driven by pricing gains and higher fuel surcharge revenues.


K 22


Paper, clay and forest products revenues were down in both 2016 and 2015, compared to the prior years. The decline in 2016 reflected volume decreases in our pulpboard and woodchip markets due to customer sourcing changes, in addition to lower paper shipments as a result of decreased demand and further contraction of the paper market. Average revenue per unit increased for the year driven by pricing gains, offset in part by lower fuel surcharge revenues.

In 2015, both average revenue per unit and volumes decreased. The decline in average revenue per unit was driven primarily by lower fuel surcharge revenues and negative mix (fewer higher-rated kaolin shipments) offset by pricing gains. Volume changes reflected lower waste, kaolin, woodchip, and graphic paper volumes as a result of customer sourcing changes, softened demand, and mill closures, offset by higher carloads of pulpboard, lumber, and pulp due to continued recovery of the housing market.

For 2017, paper, clay, and forest products revenues are anticipated to increase, as we expect average revenue per unit to be higher, largely due to pricing gains. Additionally, we expect volume to increase next year, driven by growth in our miscellaneous waste and lumber markets as a result of higher construction activity, and increased pulp volumes driven by growth in consumer demand. These volume increases will be partially offset by lower pulpboard shipments due to customer sourcing changes, weaker export demand for kaolin shipments, and further contraction of the paper market.

INTERMODAL revenues decreased in both years, a result of lower average revenue per unit that more than offset small volume increases. In 2016, reduced fuel surcharge revenues and the effects of the TCS subsidiary restructuring (which together lowered average revenue per unit $57) offset the effects of price increases. Volume was up slightly for the year as growth in our domestic and international business offset the losses from the restructuring of our TCS subsidiary. In 2015, lower average revenue per unit was the result of lower fuel surcharges (which decreased average revenue per unit by $51). Volume gains in international shipments were almost fully offset by declines in domestic shipments.

For 2017, we expect higher intermodal revenues due to increased volumes and average revenue per unit, primarily driven by higher fuel surcharge revenues and pricing gains.

Intermodal units by market were as follows:
 
 
 
 
 
 
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
units in thousands
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Domestic (excluding Triple Crown)
2,348.7

 
2,250.4

 
2,277.7

 
4
%
 
(1
%)
 
Triple Crown
67.5

 
250.0

 
288.5

 
(73
%)
 
(13
%)
 
Total Domestic
2,416.2

 
2,500.4

 
2,566.2

 
(3
%)
 
(3
%)
 
International
1,454.2

 
1,360.6

 
1,279.0

 
7
%
 
6
%
 
 
 
 
 
 
 
 
 
 
 
 
Total
3,870.4

 
3,861.0

 
3,845.2

 
 
 


K 23


Total domestic volume decreased in both years, driven by the restructuring of our TCS subsidiary. In 2016, domestic volumes excluding TCS increased due to growth from new and existing accounts that exceeded the negative effects of increased trucking capacity. In 2015, volumes were also affected by ongoing service challenges during the first three quarters of the year, an increase in available trucking capacity, and weaker overall demand, all partially offset by growth from continued highway conversions.

For 2017, we expect higher domestic volumes driven from continued highway conversions and growth associated with new and existing customers.

International volume increased in both years reflecting increased demand from existing customers and market share gains.
 
For 2017, we expect continued growth in our international volume largely driven by more traffic from both new and existing customers.

COAL revenues decreased in each of 2016 and 2015, compared with the prior years. Both declines reflected lower carload volumes and decreased average revenue per unit, primarily due to reduced fuel surcharge revenues, which lowered average revenue per unit by $34 in 2016 and $134 in 2015.

For 2017, coal revenues are expected to increase driven largely by higher utility and export volumes, in addition to an improved average revenue per unit, primarily the result of pricing gains in our export market and higher fuel surcharges.

As shown in the following table, tonnage decreased in all markets both years.
 
 
 
 
 
 
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
tons in thousands
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Utility
65,033

 
81,137

 
93,884

 
(20
%)
 
(14
%)
 
Export
14,608

 
16,193

 
23,218

 
(10
%)
 
(30
%)
 
Domestic metallurgical
13,884

 
14,450

 
16,130

 
(4
%)
 
(10
%)
 
Industrial
6,152

 
8,201

 
8,599

 
(25
%)
 
(5
%)
 
 
 
 
 
 
 
 
 
 
 
 
Total
99,677

 
119,981

 
141,831

 
(17
%)
 
(15
%)
 

Utility coal tonnage in 2016 reflected residual stockpile overhang and limited coal burn due to milder weather and sustained lower natural gas prices. For 2015, the decline was driven by reduced coal burn as significantly lower natural gas prices caused utilities to shift away from coal generation. In addition, volumes were adversely affected by coal plant retirements and mild weather during the last half of 2015.

For 2017, we expect utility tonnage to increase driven by higher natural gas prices and weather-related normalization, in addition to market share gains.

Export coal tonnage also decreased both years, a result of strong competition faced by U.S. coal suppliers as excess coal supply, weak seaborne coal prices, and a strong U.S. dollar reduced demand for export coal. Volume through Norfolk was down 1.7 million tons, or 15%, in 2016, following a drop of 5.5 million tons, or 33%, in 2015. Volume through Baltimore was up slightly in 2016 but was down 1.5 million tons, or 23%, in 2015.
 
For 2017, we expect export coal tonnage to increase, as higher prices from a tightening of the international coal supply, a continued trend from the last quarter of 2016, is expected to drive incremental production increases.
 

K 24


Domestic metallurgical coal tonnage was down in both years, compared with the prior periods. The 2016 decline was largely driven by softness in the metallurgical market, offset in part by customer-specific gains. The 2015 decrease reflected volume losses related to plant curtailments and sourcing shifts resulting from steel producers looking for opportunities to reduce costs that were offset in part by market share gains.

For 2017, domestic metallurgical coal tonnage is expected to remain relatively flat as customer-specific gains will offset losses from sourcing shifts and supply issues driven by increased demand in export markets.

Industrial coal tonnage dropped in both years, compared with the prior periods. Both years reflected volume losses related to natural gas conversions and decreased coal burn, both of which accelerated in 2016. In addition, 2016 volumes were further affected by a partial plant closure that took place in the first half of the year.
 
For 2017, industrial coal tonnage is expected to decrease driven by continued pressure from natural gas conversions and customer sourcing changes.

Railway Operating Expenses

Railway operating expenses summarized by major classifications were as follows:
 
 
 
 
 
 
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
$ in millions
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Compensation and benefits
$
2,743

 
$
2,911

 
$
2,897

 
(6
%)
 
 
Purchased services and rents
1,548

 
1,752

 
1,687

 
(12
%)
 
4
%
 
Fuel
698

 
934

 
1,574

 
(25
%)
 
(41
%)
 
Depreciation
1,026

 
1,054

 
951

 
(3
%)
 
11
%
 
Materials and other
799

 
976

 
940

 
(18
%)
 
4
%
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
6,814

 
$
7,627

 
$
8,049

 
(11
%)
 
(5
%)
 

In 2016, we experienced decreases across all categories driven largely from cost-control initiatives, lower fuel expense, the absence of restructuring costs incurred in 2015, and service improvements. In 2015, decreases in fuel costs and incentive compensation were offset in part by costs associated with the TCS restructuring and closure of our Roanoke, Virginia corporate office, in addition to higher wage rates.


K 25


Compensation and benefits decreased in 2016, compared to 2015, reflecting changes in:
employee levels, including decreased overtime and trainees (down $184 million),
pension costs (down $38 million)
payroll taxes (down $27 million),
labor agreement payments in 2015 ($24 million),
pay rates (up $34 million),
health and welfare benefit costs for agreement employees (up $35 million), which reflected higher rates, offset in part by favorability from reduced headcount, and
bonus accruals (up $59 million).

In 2015, compensation and benefits increased slightly, a result of changes in:
pay rates (up $83 million),
payroll taxes (up $37 million),
labor agreement payments ($24 million),
employee levels, including overtime and increased trainees (up $21 million), and
incentive compensation (down $151 million).

Our employment averaged 28,044 in 2016, compared with 30,456 in 2015, and 29,482 in 2014. Looking forward to 2017, we expect higher compensation and benefit expenses, a result of wage increases, medical cost inflation and higher levels of incentive compensation. We anticipate that cost-control initiatives will keep employment levels flat notwithstanding expected volume increases.

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.  

 
 
 
 
 
 
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
$ in millions
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Purchased services
$
1,242

 
$
1,433

 
$
1,394

 
(13
%)
 
3
%
 
Equipment rents
306

 
319

 
293

 
(4
%)
 
9
%
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
1,548

 
$
1,752

 
$
1,687

 
(12
%)
 
4
%
 

The 2016 decrease in purchased services expense reflected lower TCS operational costs, reduced repair and maintenance expenses, and decreased transportation activity costs, offset in part by higher volume-related costs in intermodal operations. The increase in 2015 reflected higher costs associated with intermodal operations, information technology, maintenance and repair, and the Roanoke, Virginia corporate office closure, partially offset by TCS restructuring-related savings.

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 2016 largely from improved network velocity, offset in part by higher rates and conventional intermodal volumes. The 2015 increase was principally due to higher automotive and intermodal rates and volumes.

Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, decreased in both 2016 and 2015 compared with the prior years. Both declines were principally the result of lower locomotive fuel prices (down 18% in 2016 and 40% in 2015). Locomotive fuel consumption decreased 5% in 2016 and 1% in 2015. We consumed approximately 462 million gallons of diesel fuel in 2016, compared with 487 million gallons in 2015 and 494 million gallons in 2014.

K 26


Depreciation expense decreased in 2016, but increased in 2015, compared to prior years, a result of the effects of the TCS restructuring. In 2015 we recognized $63 million in accelerated depreciation on TCS assets as a result of the restructuring. Both periods also reflect growth in our roadway and equipment capital base as we continue to invest in our infrastructure and rolling stock.

Materials and other expenses decreased in 2016 but increased in 2015, as shown in the following table.
 
 
 
 
 
 
 
2016
 
2015
 
 
2016
 
2015
 
2014
 
vs. 2015
 
vs. 2014
 
 
$ in millions
 
% change
 
 
 
 
 
 
 
 
 
 
 
 
Materials
$
364

 
$
469

 
$
470

 
(22
%)
 
 
Casualties and other claims
150

 
137

 
135

 
9
%
 
1
%
 
Other
285

 
370

 
335

 
(23
%)
 
10
%
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
799

 
$
976

 
$
940

 
(18
%)
 
4
%
 
 
In 2016, lower materials and other expenses more than offset higher costs for casualties and other claims. Material usage costs declined for the year primarily driven by lower locomotive, roadway and freight car repair costs associated with cost-control initiatives and improved asset utilization.

Casualties and other claims expenses include the estimates of costs related to personal injury, property damage, and environmental matters. The increase in 2016 was primarily driven by higher derailment expenses. The small rise in 2015 reflected less favorable personal injury reserve adjustments for prior years’ claim amounts, offset in part by reduced environmental remediation costs as a result of less unfavorable development for our environmental liability.

Other expense this year reflected $37 million of gains from the sale of operating land. Both year-over-year variances were affected by higher than normal expenses in 2015 relocating employees in connection with the closure of our Roanoke, Virginia office. The 2015 increase also included higher travel costs for train service employees and higher property taxes.
 
Income Taxes
 
The effective income tax rate was 35.4% in 2016, compared with 36.3% in 2015 and 36.2% in 2014. The decrease in 2016 reflects favorable tax benefits associated with stock-based compensation and higher returns from corporate-owned life insurance. All three years benefited from favorable reductions in deferred taxes for state tax law changes and certain business tax credits.

Internal Revenue Service (IRS) examinations have been completed for all years prior to 2013. We are not currently under audit by the IRS.


K 27


FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
 
Cash provided by operating activities, our principal source of liquidity, was $3.0 billion in 2016 and $2.9 billion in both 2015 and 2014. The increase in 2016 was primarily the result of improved operating results. Lower cash from operations in 2015 compared with 2014 was offset by reduced tax payments. We had a working capital deficit of $48 million at December 31, 2016, compared with working capital of $281 million at December 31, 2015. Cash and cash equivalents totaled $1.0 billion and $1.1 billion at December 31, 2016 and 2015, respectively, and were invested in accordance with our corporate investment policy.  The portfolio contains securities that are subject to market risk.  There are no limits or restrictions on our access to these assets.  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, 2016, were comprised of interest on fixed-rate long-term debt, long-term debt (Note 8), unconditional purchase obligations (Note 16), operating leases (Note 9), long-term advances from Conrail and agreements with Consolidated Rail Corporation (CRC) (Note 5), and unrecognized tax benefits (Note 3):
 
 
Total
 
2017
 
2018 -
2019
 
2020 -
2021
 
2022 and
Subsequent
 
Other
 
$ in millions
 
 
 
 
 
 
 
 
 
 
 
 
Interest on fixed-rate long-term debt
$
13,403

 
$
533

 
$
955

 
$
832

 
$
11,083

 
$

Long-term debt principal
10,598

 
550

 
1,185

 
898

 
7,965

 

Unconditional purchase obligations
1,283

 
519

 
349

 
281

 
134

 

Operating leases
614

 
78

 
127

 
104

 
305

 

Long-term advances from Conrail
280

 

 

 

 
280

 

Agreements with CRC
276

 
37

 
74

 
74

 
91

 

Unrecognized tax benefits*
27

 

 

 

 

 
27

 
 
 
 
 
 
 
 
 
 
 
 
Total
$
26,481

 
$
1,717

 
$
2,690

 
$
2,189

 
$
19,858

 
$
27

 
* This amount is shown in the Other column because the year of settlement cannot be reasonably estimated.
 
Off balance sheet arrangements consist of obligations related to operating leases, which are included in the table of contractual obligations above and disclosed in Note 9.
 
Cash used in investing activities was $1.8 billion in 2016, compared with $2.1 billion in 2015, and $2.0 billion in 2014.  Both year-over-year comparisons reflected higher cash outflows for property additions in 2015, including approximately $215 million for the acquisition of the Delaware and Hudson Railway Co. line. In addition, 2015 included higher proceeds from corporate-owned life insurance investments.

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 2017, we have budgeted $1.9 billion for property additions.  The anticipated spending includes $930 million for the normalized replacement of rail, ties, and ballast, the improvement or replacement of bridges and other maintenance of way items.  Planned equipment spending of $340 million includes new and rebuilt locomotives, mill gondolas, automobile multilevel recertifications, and covered hoppers. Investments in facilities and terminals are anticipated to be $170 million and include terminals and equipment to add capacity to our intermodal network, expanded bulk transfer facilities, improvements to vehicle distribution facilities, and upgrades and expansions of our mechanical service shops.  For 2017, we have budgeted $240 million for the continued implementation of PTC and expect post-2017 PTC-related property additions to total approximately $300 million.  Technology and other

K 28


investments of $110 million are planned for new or upgraded systems and computers. We also expect to spend $80 million on infrastructure improvements to increase mainline capacity and to accommodate business growth.

Cash used in financing activities was $1.3 billion in 2016, compared with $693 million in 2015, and $1.4 billion in 2014.  The increase in 2016 was driven primarily by higher debt repayments and lower proceeds from borrowing, partially offset by lower share repurchase activity.  The decrease in 2015 was driven primarily by higher proceeds from borrowings and lower debt repayments, partially offset by higher share repurchase activity. 

Share repurchases totaled $803 million in 2016, $1.1 billion in 2015, and $318 million in 2014 for the purchase and retirement of 9.2 million, 11.3 million, and 3.1 million shares, respectively.  On August 1, 2012, our Board of Directors authorized the repurchase of up to an additional 50 million shares of Common Stock through December 31, 2017, and 14.7 million shares remain under this authority as of December 31, 2016.  The timing and volume of future 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.
 
We discuss our credit agreement and our accounts receivable securitization program in Note 8 of our Notes to Consolidated Financial Statements, and we have authority from our Board of Directors to issue an additional $1.2 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 45.1% at December 31, 2016, compared with 45.3% at December 31, 2015.
 
Upcoming annual debt maturities are relatively modest (Note 8).  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 ESTIMATES
 
The preparation of financial statements in accordance with U.S. Generally Accepted Accounting Principles (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 significant 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.  We regularly discuss the development, selection, and disclosures concerning critical accounting estimates with the Audit Committee of the Board of Directors.
 
Pensions and Other Postretirement Benefits
 
Accounting for pensions and other postretirement benefit plans requires us to make several estimates and assumptions (Note 11).  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 $21 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

K 29


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.
 
Properties and Depreciation
 
Most of our assets are long-lived railway properties (Note 6).  As disclosed in Note 1, the primary depreciation method for our asset base is group life.  Units of production is the principal method of depreciation for rail in high density corridors.  Remaining properties are depreciated generally using the straight-line method over the lesser of estimated service or lease lives. See Note 1 for a more detailed discussion of the assumptions and estimates in this area.
 
Depreciation expense for 2016 totaled $1.0 billion.  Our composite depreciation rates for 2016 are disclosed in
Note 6; a one-tenth percentage point increase (or decrease) in these rates would have resulted in a $39 million increase (or decrease) to depreciation expense.  For 2016, roadway depreciation rates ranged from 0.83% to 14.86% and equipment depreciation rates ranged from 1.38% to 30.18%.
 
Personal Injury, Environmental, and Legal Liabilities
 
Casualties and other claims expense, included in “Materials and other” in the Consolidated Statements of Income, consists primarily of our accrual for personal injury liabilities and environmental remediation costs.  
 
To aid in valuing our personal injury liability and determining the amount to accrue during each period, 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.
 
We are subject to various jurisdictions’ environmental laws and regulations.  We record a liability where such liability or loss is probable and its amount can be estimated reasonably.  Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates. Additionally, our Environmental Policy Council (composed of senior managers) oversees and interprets our environmental policy.

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.

For a more detailed discussion of the assumptions and estimates in accounting for personal injury and environmental matters see Note 16.

K 30


Income Taxes
 
Our net deferred tax liability totaled $9.1 billion at December 31, 2016 (Note 3).  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 $39 million valuation allowance on $628 million of deferred tax assets as of December 31, 2016, 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 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 the various unions exchanged new proposals to begin the current round of national negotiations.  The unions have formed three separate bargaining coalitions and negotiations with each are ongoing with the assistance of mediators from the National Mediation Board.  Separately, in January 2015 we reached an agreement covering wages and work rules through 2019 with the Brotherhood of Locomotive Engineers and Trainmen (BLET), which represents approximately 20% of our union workforce.  Changes to the BLET benefit plan will be bargained nationally through the NCCC.
 
Market Risks
 
We manage overall exposure to fluctuations in interest rates by issuing both fixed- and floating-rate debt instruments. At December 31, 2016, debt subject to interest rate fluctuations totaled $200 million. A one-percentage point increase in interest rates would increase total annual interest expense related to all variable debt by approximately $2 million. 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

K 31


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 Part II, 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.  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 Department by calling 757-629-2861.
 
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 
The information required by this item is included in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Market Risks.”
 

K 32


Item 8. Financial Statements and Supplementary Data
 
INDEX TO FINANCIAL STATEMENTS

K 33


Report of Management
 
February 6, 2017
 
To the Stockholders
Norfolk Southern Corporation
 
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, 2016.  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, 2016.
 
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, 2016.
 
/s/ James A. Squires
 
/s/ Marta R. Stewart
 
/s/ Thomas E. Hurlbut
James A. Squires
 
Marta R. Stewart
 
Thomas E. Hurlbut
Chairman, President and
 
Executive Vice President Finance
 
Vice President and
Chief Executive Officer
 
and Chief Financial Officer
 
Controller

K 34


Report of Independent Registered Public Accounting Firm

 
The Board of Directors and Stockholders
Norfolk Southern Corporation:
 
We have audited Norfolk Southern Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  Norfolk Southern Corporation’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 conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  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 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.
 
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.
 
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.
 
In our opinion, Norfolk Southern Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, 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), the consolidated balance sheets of Norfolk Southern Corporation and subsidiaries as of December 31, 2016 and 2015, and 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, 2016, and our report dated February 6, 2017 expressed an unqualified opinion on those consolidated financial statements.


/s/ KPMG LLP
KPMG LLP
Norfolk, Virginia
February 6, 2017

K 35


Report of Independent Registered Public Accounting Firm

 
The Board of Directors and Stockholders
Norfolk Southern Corporation:
 
We have audited the accompanying consolidated balance sheets of Norfolk Southern Corporation and subsidiaries as of December 31, 2016 and 2015, and 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, 2016.  In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule of valuation and qualifying accounts as listed in Item 15(A)2. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norfolk Southern Corporation and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.  Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Norfolk Southern Corporation’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 6, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.


/s/ KPMG LLP
KPMG LLP
Norfolk, Virginia
February 6, 2017

K 36


Norfolk Southern Corporation and Subsidiaries
Consolidated Statements of Income
 
 
Years ended December 31,
 
2016
 
2015
 
2014
 
($ in millions, except per share amounts)
 
 
 
 
 
 
Railway operating revenues
$
9,888

 
$
10,511

 
$
11,624

 
 
 
 
 
 
Railway operating expenses:
 

 
 

 
 

Compensation and benefits
2,743

 
2,911

 
2,897

Purchased services and rents
1,548

 
1,752

 
1,687

Fuel
698

 
934

 
1,574

Depreciation
1,026

 
1,054

 
951

Materials and other
799

 
976

 
940

 
 
 
 
 
 
Total railway operating expenses
6,814

 
7,627

 
8,049

 
 
 
 
 
 
Income from railway operations
3,074

 
2,884

 
3,575

 
 
 
 
 
 
Other income – net
71

 
103

 
104

Interest expense on debt
563

 
545

 
545

 
 
 
 
 
 
Income before income taxes
2,582

 
2,442

 
3,134

 
 
 
 
 
 
Provision for income taxes
914

 
886

 
1,134

 
 
 
 
 
 
Net income
$
1,668

 
$
1,556

 
$
2,000