UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

 

(X)   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended MARCH 31, 2014

 

(  )    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

 

 

NORFOLK SOUTHERN CORPORATION

(Exact name of registrant as specified in its charter)

 

Virginia (State or other jurisdiction of incorporation)	52-1188014 (IRS Employer Identification No.)
Three Commercial Place Norfolk, Virginia (Address of principal executive offices)	23510-2191 (Zip Code)
(757) 629-2680 (Registrant’s telephone number, including area code)
No Change (Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 Exchange Act).

Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding at March 31, 2014
Common Stock ($1.00 par value per share)		309,646,086 (excluding 20,320,777 shares held by the registrant’s consolidated subsidiaries)

TABLE OF CONTENTS
NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES (NS)
				Page
Part I.	Financial Information:
	Item 1.	Financial Statements:
		Consolidated Statements of Income First Quarters of 2014 and 2013		3
		Consolidated Statements of Comprehensive Income First Quarters of 2014 and 2013		4
		Consolidated Balance Sheets At March 31, 2014 and December 31, 2013		5
		Consolidated Statements of Cash Flows First Quarters of 2014 and 2013		6
		Notes to Consolidated Financial Statements		7
		Report of Independent Registered Public Accounting Firm		17
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		27
	Item 4.	Controls and Procedures		27
Part II.	Other Information:
	Item 1.	Legal Proceedings		28
	Item 1A.	Risk Factors		28
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		29
	Item 6.	Exhibits		29
Signatures				30
Exhibit Index				31

PART 1. FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

 

Norfolk Southern Corporation and Subsidiaries

Consolidated Statements of Income

(Unaudited)

 

	First Quarter
	2014			2013
	($ in millions, except per
	share amounts)
Railway operating revenues	$	2,689		$	2,738
Railway operating expenses
Compensation and benefits		740			780
Purchased services and rents		392			393
Fuel		432			429
Depreciation		237			227
Materials and other		221			218
Total railway operating expenses		2,022			2,047
Income from railway operations		667			691
Other income – net		26			135
Interest expense on debt		139			129
Income before income taxes		554			697
Provision for income taxes		186			247
Net income	$	368		$	450
Per share amounts
Net income:
Basic	$	1.18		$	1.43
Diluted		1.17			1.41
Dividends		0.54			0.50

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

Norfolk Southern Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

	First Quarter
	2014			2013
	($ in millions)
Net income	$	368		$	450
Other comprehensive income, before tax:
Pension and other postretirement benefits		299			36
Other comprehensive income of equity investees		3			1
Other comprehensive income, before tax		302			37
Income tax expense related to items of other
comprehensive income		(114)			(14)
Other comprehensive income, net of tax		188			23
Total comprehensive income	$	556		$	473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

Norfolk Southern Corporation and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

 

	March 31,			December 31,
	2014			2013
	($ in millions)
Assets
Current assets:
Cash and cash equivalents	$	1,522		$	1,443
Short-term investments		10			118
Accounts receivable – net		1,109			1,024
Materials and supplies		240			223
Deferred income taxes		179			180
Other current assets		70			87
Total current assets		3,130			3,075
Investments		2,466			2,439
Properties less accumulated depreciation of $10,512 and
$10,387, respectively		26,768			26,645
Other assets		336			324
Total assets	$	32,700		$	32,483
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	1,194		$	1,265
Short-term debt		-			100
Income and other taxes		323			225
Other current liabilities		359			270
Current maturities of long-term debt		445			445
Total current liabilities		2,321			2,305
Long-term debt		8,909			8,903
Other liabilities		1,130			1,444
Deferred income taxes		8,647			8,542
Total liabilities		21,007			21,194
Stockholders’ equity:
Common stock $1.00 per share par value, 1,350,000,000 shares
authorized; outstanding 309,646,086 and 308,878,402 shares,
respectively, net of treasury shares		311			310
Additional paid-in capital		2,085			2,021
Accumulated other comprehensive loss		(193)			(381)
Retained income		9,490			9,339
Total stockholders’ equity		11,693			11,289
Total liabilities and stockholders’ equity	$	32,700		$	32,483

 

 

See accompanying notes to consolidated financial statements.

Norfolk Southern Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

	First Quarter
	2014			2013
	($ in millions)
Cash flows from operating activities
Net income	$	368		$	450
Reconciliation of net income to net cash provided by operating activities:
Depreciation		238			228
Deferred income taxes		(8)			74
Gains and losses on properties and investments		(2)			(99)
Changes in assets and liabilities affecting operations:
Accounts receivable		(85)			(49)
Materials and supplies		(17)			(30)
Other current assets		17			17
Current liabilities other than debt		86			96
Other – net		(9)			36
Net cash provided by operating activities		588			723
Cash flows from investing activities
Property additions		(381)			(379)
Property sales and other transactions		22			19
Investments, including short-term		(3)			(5)
Investment sales and other transactions		108			(1)
Net cash used in investing activities		(254)			(366)
Cash flows from financing activities
Dividends		(167)			(157)
Common stock issued – net		62			55
Purchase and retirement of common stock		(50)			(33)
Debt repayments		(100)			(203)
Net cash used in financing activities		(255)			(338)
Net increase in cash and cash equivalents		79			19
Cash and cash equivalents
At beginning of period		1,443			653
At end of period	$	1,522		$	672
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest (net of amounts capitalized)	$	75		$	62
Income taxes (net of refunds)		60			23

 

 

 

 

 

See accompanying notes to consolidated financial statements.

Norfolk Southern Corporation and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

 

In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly Norfolk Southern Corporation (Norfolk Southern) and subsidiaries’ (collectively, NS, we, us, and our) financial condition at March 31, 2014, and December 31, 2013, our results of operations, comprehensive income, and cash flows for the first quarters of 2014 and 2013 in conformity with U.S. generally accepted accounting principles (GAAP).

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in our latest Annual Report on Form 10-K.

 

1.  Stock-Based Compensation

 

During the first quarter of 2014, a committee of non-employee directors of our Board of Directors granted stock options, restricted stock units (RSUs) and performance share units (PSUs) pursuant to the Long-Term Incentive Plan (LTIP) and granted stock options pursuant to the Thoroughbred Stock Option Plan (TSOP) as discussed below. Stock-based compensation expense was $32 million and $37 million during the first quarters of 2014 and 2013, respectively. The total tax effects recognized in income in relation to stock-based compensation were net benefits of $10 million and $12 million for the first quarters of 2014 and 2013, respectively.

 

Stock Options

 

In the first quarter of 2014, 515,240 options were granted under LTIP and 181,070 options were granted under TSOP. In each case, the grant price was $94.17, which was the greater of the average fair market value of Norfolk Southern common stock (Common Stock) or the closing price of Common Stock on the effective date of the grant, and the options have a term of ten years. The options granted under LTIP and TSOP in 2014 may not be exercised prior to the fourth and third anniversaries of the date of grant, respectively. Holders of the 2014 options granted under LTIP who remain actively employed receive cash dividend equivalent payments for four years in an amount equal to the regular quarterly dividends paid on Common Stock. Dividend equivalent payments are not made on TSOP options.

 

The fair value of each option award in 2014 was measured on the date of grant using a lattice-based option valuation model. Expected volatilities are based on implied volatilities from traded options on, and historical volatility of, Common Stock. Historical data is used to estimate option exercises and employee terminations within the valuation model. The average expected option life is derived from the output of the valuation model and represents the period of time that all options granted are expected to be outstanding, including the branches of the model that result in options expiring unexercised. The average risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. For options granted that include dividend equivalent payments, a dividend yield of zero was used. A dividend yield of 2.29% was used for LTIP options for periods where no dividend equivalent payments are made as well as for TSOP options, which do not receive dividend equivalents.

 

The assumptions for the 2014 LTIP and TSOP grants are shown in the following table:

 

Expected volatility range	23% - 27%
Average expected volatility	25%
Average risk-free interest rate	2.79%
Average expected option term LTIP	8.9 years
Per-share grant-date fair value LTIP	$29.87
Average expected option term TSOP	8.8 years
Per-share grant-date fair value TSOP	$24.38

 

For the first quarter of 2014, options relating to 880,744 shares were exercised, yielding $40 million of cash proceeds and $11 million of tax benefit recognized as additional paid-in capital. For the first quarter of 2013, options relating to 1,024,614 shares were exercised, yielding $35 million of cash proceeds and $13 million of tax benefit recognized as additional paid-in capital.

 

Restricted Stock Units

 

During the first quarter of 2014, there were 113,505 RSUs granted with a grant-date fair value of $94.17 and a five-year restriction period. The RSUs granted in 2014 will be settled through the issuance of shares of Common Stock.

 

During the first quarter of 2014, 318,150 of the RSUs granted in 2009 vested, with 187,449 shares of Common Stock issued net of withholding taxes.  For the first quarter of 2013, 298,400 of the RSUs granted in 2008 vested, with 178,250 shares of Common Stock issued net of withholding taxes.  The total related tax benefits recognized as additional paid-in capital were $6 million and $2 million for the first quarters of 2014 and 2013, respectively.

 

Performance Share Units

 

PSUs provide for awards based on achievement of certain predetermined corporate performance goals at the end of a three-year cycle and are paid in the form of shares of Common Stock. During the first quarter of 2014, there were 399,530 PSUs granted.  PSUs will earn out based on the achievement of a return on average invested capital target (a performance condition) and a total shareholder return target (a market condition).  The grant-date fair values of the PSUs associated with the performance and market conditions were $94.17 and $50.31, respectively, with the market condition fair value measured on the date of grant using a Monte Carlo simulation model.

 

During the first quarter of 2014, 374,099 of the PSUs granted in 2011 were earned, with 223,253 shares of Common Stock issued net of withholding taxes.  For the first quarter of 2013, 577,585 of the PSUs granted in 2010 were earned, with 348,189 shares of Common Stock issued net of withholding taxes. The total related tax benefits recognized as additional paid-in capital were $5 million for the first quarter of both 2014 and 2013.

2.  Income Taxes

 

There have been no material changes to the balance of unrecognized tax benefits reported at December 31, 2013.  IRS examinations have been completed for all years prior to 2011, and we are not currently under audit for subsequent years.

 

3.  Earnings Per Share

 

	Basic						Diluted
	First Quarter
	2014			2013			2014			2013
	($ in millions except per share amounts,
	shares in millions)
Net income	$	368		$	450		$	368		$	450
Dividend equivalent payments		(2)			(2)			(1)			(1)
Income available to common stockholders		366			448			367			449
Weighted-average shares outstanding		309.5			314.5			309.5			314.5
Dilutive effect of outstanding options
and share-settled awards								3.1			3.6
Adjusted weighted-average shares outstanding								312.6			318.1
Earnings per share	$	1.18		$	1.43		$	1.17		$	1.41

 

During the first quarters of 2014 and 2013, dividend equivalent payments were made to holders of stock options and RSUs. For purposes of computing basic earnings per share, dividend equivalent payments made to holders of stock options and RSUs were deducted from net income to determine income available to common stockholders. For purposes of computing diluted earnings per share, we evaluate on a grant-by-grant basis those stock options and RSUs receiving dividend equivalent payments under the two-class and treasury stock methods to determine which method is the more dilutive for each grant. For those grants for which the two-class method was more dilutive, net income was reduced by dividend equivalent payments to determine income available to common stockholders. The diluted calculations exclude options having exercise prices exceeding the average market price of Common Stock as follows: 0.7 million for 2014 and 0.8 million for 2013.

 

4.  Stockholders’ Equity

 

Common Stock

 

Common Stock is reported net of shares held by our consolidated subsidiaries (Treasury Shares). Treasury Shares at March 31, 2014, and December 31, 2013, amounted to 20,320,777 shares, with a cost of $19 million at both dates.

Accumulated Other Comprehensive Loss

 

“Accumulated other comprehensive loss” reported in the Consolidated Balance Sheets consisted of the following:

 

				Accumulated
	Pensions			Other			Accumulated
	and Other			Comprehensive			Other
	Postretirement			Loss of Equity			Comprehensive
	Benefits			Investees			Loss
	($ in millions)
December 31, 2013	$	(310)		$	(71)		$	(381)
Other comprehensive income (loss):
Prior service benefit		367			-			367
Amounts reclassified into net income		12	(1)		-			12
Net gain (loss)		(80)			3			(77)
Tax expense		(114)			-			(114)
Other comprehensive income		185			3			188
March 31, 2014	$	(125)		$	(68)		$	(193)

 

				Accumulated
	Pensions			Other			Accumulated
	and Other			Comprehensive			Other
	Postretirement			Loss of Equity			Comprehensive
	Benefits			Investees			Loss
	($ in millions)
December 31, 2012	$	(999)		$	(110)		$	(1,109)
Other comprehensive income (loss):
Amounts reclassified into net income		36	(1)		-			36
Net gain		-			1			1
Tax expense		(14)			-			(14)
Other comprehensive income		22			1			23
March 31, 2013	$	(977)		$	(109)		$	(1,086)

 

(1) These items are included in the computation of net periodic pension and postretirement benefit costs. See               

     Note 7, “Pensions and Other Postretirement Benefits” for additional information.

 

5.  Stock Repurchase Program

 

We repurchased and retired 0.5 million shares of Common Stock in each of the first quarters of 2014 and 2013 at a cost of $50 million and $33 million, respectively. The timing and volume of purchases is guided by our assessment of market conditions and other pertinent factors. Any near-term share repurchases are expected to be made with internally generated cash, cash on hand, or proceeds from borrowings. Since the beginning of 2006, we have repurchased and retired 137.3 million shares at a total cost of $8.2 billion.

 

6.  Investment in Conrail

 

Through a limited liability company, we and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primary subsidiary is Consolidated Rail Corporation (CRC). We have a 58% economic and 50% voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests. Our investment in Conrail was $1.1 billion at both March 31, 2014 and December 31, 2013.

 

CRC owns and operates certain properties (the Shared Assets Areas) for the joint and exclusive benefit of Norfolk Southern Railway Company (NSR) and CSX Transportation, Inc. (CSXT). The costs of operating the Shared Assets Areas are borne by NSR and CSXT based on usage. In addition, NSR and CSXT pay CRC a fee for access to the Shared Assets Areas. “Purchased services and rents” and “Fuel” include expenses for the use of the Shared Assets Areas totaling $34 million for both the first quarter of 2014 and 2013.  Our equity in the earnings of Conrail, net of amortization, included in “Purchased services and rents” was $6 million the first quarter of 2014.  For the first quarter of 2013, this amounted to $9 million and was included in “Other income – net.”

 

“Accounts payable” includes $193 million at March 31, 2014, and $187 million at December 31, 2013, due to Conrail for the operation of the Shared Assets Areas. In addition, “Other liabilities” includes $133 million at both March 31, 2014, and December 31, 2013, for long-term advances from Conrail, maturing 2035, that bear interest at an average rate of 4.4%.

 

7.  Pensions and Other Postretirement Benefits

 

We have both funded and unfunded defined benefit pension plans covering principally salaried employees. We also provide specific health care and life insurance benefits to eligible retired employees; these plans can be amended or terminated at our option.  Under our self-insured retiree health care plan, a defined percentage of health care expenses is covered for retired employees and their dependents, reduced by any deductibles, coinsurance, and, in some cases, coverage provided under other group insurance policies. 

 

							Other Postretirement
	Pension Benefits						Benefits
	First Quarter
	2014			2013			2014			2013
	($ in millions)
Service cost	$	9		$	10		$	2		$	4
Interest cost		23			20			8			13
Expected return on plan assets		(38)			(35)			(4)			(4)
Amortization of net losses		14			22			-			14
Amortization of prior service benefit		-			-			(2)			-
Net cost	$	8		$	17		$	4		$	27

 

In the first quarter of 2014, we amended our retiree medical plan for participants who are Medicare eligible resulting in a remeasurement of our plan assets and obligations.  Effective July 1, 2014, participants who are Medicare-eligible will not be covered under the self-insured retiree health care plan but instead will be provided with an employer-funded health reimbursement account which can be used for reimbursement of health insurance premiums or eligible out-of-pocket medical expenses.  As required, the discount rate assumption was revised as a result of the remeasurement to 3.90% from 4.65% at December 31, 2013, and there were no significant changes to the expected return on plan assets, asset mix, mortality rates, or health care trend rates.   The prior service benefit associated with the plan amendment was $367 million and the actuarial losses associated with the change in discount rate were $80 million, resulting in a decrease in the benefit obligation of $287 million.  The estimated prior service benefit for the other postretirement benefit plans that will be amortized from accumulated other comprehensive loss into net periodic cost during the remainder of the year is $18 million.

For the remainder of 2014, we expect to contribute approximately $39 million to our other postretirement benefit plans for retiree health and life insurance benefits.  Benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:

 

	Other
	Postretirement
	Benefits
	($ in millions)
Remainder of 2014	$	39
2015		47
2016		46
2017		45
2018		44
Years 2019 - 2023		201

 

8.  Fair Value

 

Fair Value Measurements

 

The Financial Accounting Standards Board (FASB) Accounting Standards Codifications (ASC) 820-10, “Fair Value Measurements,” established a framework for measuring fair value and a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:

 

Level 1	Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that we have the ability to access.
Level 2	Inputs to the valuation methodology include:
	•         quoted prices for similar assets or liabilities in active markets; •         quoted prices for identical or similar assets or liabilities in inactive markets; •         inputs other than quoted prices that are observable for the asset or liability; •         inputs that are derived principally from or corroborated by observable market data by correlation or other means.
	If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.
Level 3	Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

The asset’s or liability’s fair value measurement level is based on the lowest level of any input that is significant to the fair value measurement. Other than those assets and liabilities described below that approximate fair value, there were no assets or liabilities measured at fair value on a recurring basis at March 31, 2014 or December 31, 2013.

 

Fair Values of Financial Instruments

 

We have evaluated the fair values of financial instruments and methods used to determine those fair values. The fair values of “Cash and cash equivalents,” “Short-term investments,” “Accounts receivable,” “Accounts payable,” and “Short-term debt” approximate carrying values because of the short maturity of these financial instruments. The carrying value of corporate-owned life insurance is recorded at cash surrender value and, accordingly, approximates fair value. The carrying amounts and estimated fair values for the remaining financial instruments, excluding investments accounted for under the equity method, consisted of the following:

 

	March 31, 2014						December 31, 2013
	Carrying			Fair			Carrying			Fair
	Amount			Value			Amount			Value
	($ in millions)
Long-term investments	$	149		$	180		$	148		$	177
Long-term debt, including current maturities		(9,354)			(10,989)			(9,348)			(10,673)

 

Underlying net assets were used to estimate the fair value of investments with the exception of notes receivable, which are based on future discounted cash flows. The fair values of long-term debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, company rating, and remaining maturity.

 

The following table sets forth the fair value of long-term investment and long-term debt balances disclosed above by valuation technique level, within the fair value hierarchy (there were no level 3 valued assets or liabilities).

 

	Level 1			Level 2			Total
	($ in millions)
March 31, 2014
Long-term investments	$	49		$	131		$	180
Long-term debt, including current maturities		(10,763)			(226)			(10,989)
December 31, 2013
Long-term investments	$	47		$	130		$	177
Long-term debt, including current maturities		(10,449)			(224)			(10,673)

 

9.  Commitments and Contingencies

 

Lawsuits

 

We and/or certain subsidiaries are defendants in numerous lawsuits and other claims relating principally to railroad operations.  When we conclude that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, it is accrued through a charge to earnings.  While the ultimate amount of liability incurred in any of these lawsuits and claims is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payment of such liability and claims.  However, the final outcome of any of these lawsuits and claims cannot be predicted with certainty, and unfavorable or unexpected outcomes could result in additional accruals that could be significant to results of operations in a particular year or quarter.  Any adjustments to the recorded liability will be reflected in earnings in the periods in which such adjustments are known.

 

Two of our customers, DuPont and Sunbelt Alkai Partnership (Sunbelt), filed rate reasonableness complaints before the Surface Transportation Board (STB) alleging that our tariff rates for transportation of regulated movements are unreasonable.  Since June 1, 2009, in the case of DuPont, and since April 1, 2011, in the case of Sunbelt, we have been billing and collecting amounts based on the challenged tariff rates.  On March 14, 2014,

the STB resolved DuPont’s rate reasonableness complaint in our favor.  The STB’s findings in the DuPont rate case remain subject to technical corrections, requests for reconsideration, and appeal.  We dispute the allegations of the Sunbelt complaint and presently expect resolution of that case to occur in 2014.  With respect to the Sunbelt case, we believe the estimate of 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 estimable.

 

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.  A lawsuit containing similar allegations against us and four other major railroads that was filed on March 25, 2008, in the U.S. District Court for the District of Minnesota, was voluntarily dismissed by the plaintiff subject to a tolling agreement entered into in August 2008, and most recently extended in August 2013.

 

Casualty Claims

 

Casualty claims include employee personal injury and occupational claims as well as third-party claims, all exclusive of legal costs.  To aid in valuing our personal injury liability and determining the amount to accrue with respect to such claims during the year, we utilize studies prepared by an independent consulting actuarial firm.  Job-related accidental injury and occupational claims are subject to the Federal Employers’ Liability Act (FELA), which is applicable only to railroads.  FELA’s fault-based system produces results that are unpredictable and inconsistent as compared with a no-fault workers’ compensation system.  The variability inherent in this system could result in actual costs being different from the liability recorded.  While the ultimate amount of claims incurred is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payments of claims and is supported by the most recent actuarial study.  In all cases, we record a liability when the expected loss for the claim is both probable and estimable.

 

Employee personal injury claims – The largest component of casualties and other claims expense is employee personal injury costs.  The independent actuarial firm engaged by us provides quarterly studies to aid in valuing our employee personal injury liability and estimating personal injury expense.  The actuarial firm studies our historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences.  The actuarial firm uses the results of these analyses to estimate the ultimate amount of liability, which includes amounts for incurred but unasserted claims. We adjust the liability quarterly based upon our assessment and the results of the study. Our estimate of loss liabilities is subject to inherent limitation given the difficulty of predicting future events such as jury decisions, court interpretations, or legislative changes and as such the actual loss may vary from the estimated liability recorded.

 

Occupational claims – Occupational claims (including asbestosis and other respiratory diseases, as well as conditions allegedly related to repetitive motion) are often not caused by a specific accident or event but rather allegedly result from a claimed exposure over time.  Many such claims are being asserted by former or retired employees, some of whom have not been employed in the rail industry for decades.  The independent actuarial firm provides an estimate of the occupational claims liability based upon our history of claim filings, severity, payments, and other pertinent facts.  The liability is dependent upon judgments we make as to the specific case reserves as well as judgments of the actuarial firm in the quarterly studies.  The actuarial firm’s estimate of ultimate loss includes a provision for those claims that have been incurred but not reported.  This provision is derived by analyzing industry data and projecting our experience into the future as far as can be reasonably determined.  We adjust the liability quarterly based upon our assessment and the results of the study.  However, it is possible that the recorded liability may not be adequate to cover the future payment of claims.  Adjustments to the recorded liability are reflected in operating expenses in the periods in which such adjustments become known.

 

Third-party claims – We record a liability for third-party claims including those for highway crossing accidents, trespasser and other injuries, automobile liability, property damage, and lading damage.  The actuarial firm assists us with the calculation of potential liability for third-party claims, except lading damage, based upon our experience including the number and timing of incidents, amount of payments, settlement rates, number of open claims, and legal defenses. The actuarial estimate includes a provision for claims that have been incurred but not reported. We adjust the liability quarterly based upon our assessment and the results of the study.  Given the inherent uncertainty in regard to the ultimate outcome of third-party claims, it is possible that the actual loss may differ from the estimated liability recorded.

 

Environmental Matters

 

We are subject to various jurisdictions’ environmental laws and regulations.  We record a liability where such liability or loss is probable and its amount can be estimated reasonably.  Claims, if any, against third parties, for recovery of cleanup costs we have incurred are reflected as receivables (when collection is probable) in the Consolidated Balance Sheets and are not netted against the associated liability.  Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates.  We have an Environmental Policy Council, composed of senior managers, to oversee and interpret our environmental policy.

 

Our Consolidated Balance Sheets include liabilities for environmental exposures of $57 million at March 31, 2014, and $58 million at December 31, 2013 (of which $15 million is classified as a current liability at the end of each period). At March 31, 2014, the liability represents our estimate of the probable cleanup, investigation, and remediation costs based on available information at 145 known locations and projects compared with 142 locations and projects at December 31, 2013. At March 31, 2014, eleven sites accounted for $30 million of the liability, and no individual site was considered to be material. We anticipate that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period.

 

At 12 locations, one or more of our subsidiaries in conjunction with a number of other parties have been identified as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 or comparable state statutes that impose joint and several liability for cleanup costs.  We calculate our estimated liability for these sites based on facts and legal defenses applicable to each site and not solely on the basis of the potential for joint liability.

 

With respect to known environmental sites (whether identified by us or by the Environmental Protection Agency (EPA) or comparable state authorities), estimates of our ultimate potential financial exposure for a given site or in the aggregate for all such sites are necessarily imprecise because of the widely varying costs of currently available cleanup techniques, unpredictable contaminant recovery and reduction rates associated with available cleanup technologies, the likely development of new cleanup technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant’s share of any estimated loss (and that participant’s ability to bear it), and evolving statutory and regulatory standards governing liability.

 

The risk of incurring environmental liability – for acts and omissions, past, present, and future – is inherent in the railroad business.  Some of the commodities we transport, particularly those classified as hazardous materials, pose special risks that we work diligently to minimize.  In addition, several of our subsidiaries own, or have owned, land used as operating property, or which is leased and operated by others, or held for sale.  Because environmental problems that are latent or undisclosed may exist on these properties, there can be no assurance that we will not incur environmental liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time.  Moreover, lawsuits and claims involving these and potentially other unidentified environmental sites and matters are likely to arise from time to time.  The resulting liabilities could have a significant effect on our financial position, results of operations, or liquidity in a particular year or quarter.

 

Based on our assessment of the facts and circumstances now known, we believe we have recorded the probable and reasonably estimable costs for dealing with those environmental matters of which we are aware.  Further, we believe that it is unlikely that any known matters, either individually or in the aggregate, will have a material adverse effect on our financial position, results of operations, or liquidity.

 

Insurance

 

We obtain on behalf of ourself and our subsidiaries insurance for potential losses for third-party liability and first-party property damages.  We are currently self-insured up to $50 million and above $1.0 billion per occurrence and/or policy year for bodily injury and property damage to third parties and up to $25 million and above $175 million per occurrence and/or policy year for property owned by us or in our care, custody, or control.

 

Purchase Commitments

 

At March 31, 2014, we had outstanding purchase commitments totaling approximately $656 million for freight cars and containers, locomotives, track material, vehicle fleet additions, and track and yard expansion projects in connection with our capital programs through 2018 as well as long-term service contracts through 2018.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Norfolk Southern Corporation:

 

We have reviewed the accompanying consolidated balance sheet of Norfolk Southern Corporation and subsidiaries as of March 31, 2014, and the related consolidated statements of income, comprehensive income and cash flows for the three‑month periods ended March 31, 2014 and 2013. These consolidated financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

 

/s/KPMG LLP

KPMG LLP

Norfolk, Virginia
April 23, 2014

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Norfolk Southern Corporation and Subsidiaries

 

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes.

 

OVERVIEW

 

We are one of the nation’s premier transportation companies.  Our Norfolk Southern Railway Company subsidiary operates approximately 20,000 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. 

 

Reflecting the absence of the gain from the sale of certain assets to the Michigan Department of Transportation in 2013, in addition to lower coal volumes and the impact of severe weather on our network in the current year, our net income decreased 18% in the first quarter of 2014, compared with the same period of 2013, and earnings per share declined 17%. 

 

Cash provided by operating activities for the first quarter of 2014 totaled $588 million, which along with cash on hand allowed for property additions, dividends, debt repayments, and share repurchases. In the first quarter of 2014, we repurchased 0.5 million shares of Norfolk Southern common stock (Common Stock) at a total cost of $50 million. Since inception of our stock repurchase program in 2006, we have repurchased and retired 137.3 million shares of Common Stock at a total cost of $8.2 billion. At March 31, 2014, cash, cash equivalents, and short-term investments totaled $1.5 billion.

 

SUMMARIZED RESULTS OF OPERATIONS

 

First quarter 2014 net income was $368 million, down $82 million, or 18%, compared with the same period last year. The prior year reflected the gain from the sale of certain assets to the Michigan Department of Transportation, which benefited net income by $60 million and earnings per share by $0.19.  First quarter 2014 net income reflected a $24 million, or 3%, decrease in income from railway operations, primarily due to a $49 million, or 2%, decline in railway operating revenues, as softness in our coal markets and the effects of severe weather on our operations overshadowed growth in our intermodal and general merchandise businesses.  The railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) rose to 75.2% for the first quarter of 2014, compared with 74.8% for the first quarter of 2013.

 

Oil prices affect our results of operations in a variety of ways and can have an overall favorable or unfavorable impact in any particular period. In addition to the impact of oil prices on general economic conditions, volume, and supplier costs, oil prices directly affect our revenues through market-based fuel surcharges and contract escalators (see “Railway Operating Revenues”) and also affect fuel costs (see “Railway Operating Expenses”).  For the first quarter of 2014, excluding the impact of consumption, fuel surcharge revenue increased, whereas fuel expense decreased.  Future changes in oil prices may cause volatility in operating results that could be material to a particular year or quarter.