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, moving goods and materials that help drive the U.S. economy. We connect customers to markets and communities to economic opportunity with safe, reliable, and cost-effective shipping solutions. Our Norfolk Southern Railway Company subsidiary operates in 22 states and the District of Columbia. We are a major transporter of industrial products, including agriculture, forest and consumer products, chemicals, and metals and construction materials. In addition, in the East we serve every major container port and operate the most extensive intermodal network. We are also a principal carrier of coal, automobiles, and automotive parts.
In 2022, revenue growth led to year-over-year improvements in income from operations, net income and diluted earnings per share. Throughout the year, we focused on efforts to increase our network fluidity and improve service for our customers. These efforts included the hiring of new conductors in a tight labor market and evolving our operating plan, which collectively drove improvements in our network performance as we concluded the year and is providing strong momentum going into 2023. Additionally, new labor agreements were secured by December 2022 which provided retroactive pay and other benefits for our craft employees. As we head into 2023, we are focused on providing reliable and resilient service and delivering smart sustainable revenue growth that will deliver long-term value to our customers and shareholders.
SUMMARIZED RESULTS OF OPERATIONS
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| | | | | | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| ($ in millions, except per share amounts) | | (% change) | |
| | | | | | | | | | |
Income from railway operations | $ | 4,809 | | | $ | 4,447 | | | $ | 3,002 | | | 8 | % | | 48 | % | |
Net income | $ | 3,270 | | | $ | 3,005 | | | $ | 2,013 | | | 9 | % | | 49 | % | |
Diluted earnings per share | $ | 13.88 | | | $ | 12.11 | | | $ | 7.84 | | | 15 | % | | 54 | % | |
Railway operating ratio (percent) | 62.3 | | | 60.1 | | | 69.3 | | | 4 | % | | (13 | %) | |
Income from railway operations increased in 2022 compared to 2021, driven by higher railway operating revenues. Revenue growth was the result of higher fuel surcharge revenues and pricing gains, which more than offset the impact of volume declines. The rise in revenues was partly offset by increased railway operating expenses, driven by higher fuel prices, other inflationary pressures, service-related costs, increased labor-related costs primarily resulting from labor union negotiations, and higher claims-related expenses. Incremental expenses incurred in 2022 that resulted from finalized labor agreements for wages earned in 2021 and prior periods lowered diluted earnings per share by $0.18. Additionally, net income includes a $136 million deferred tax benefit resulting from a corporate income tax rate change in the Commonwealth of Pennsylvania, which increased diluted earnings per share by $0.58. Our share repurchase activity resulted in the percentage increase in diluted earnings per share that exceeded that of net income. Railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) increased to 62.3 percent.
Income from railway operations increased in 2021 compared to 2020, the result of a 14% increase in railway operating revenues and a 1% reduction in railway operating expenses. Revenue growth was driven by increased average revenue per unit and higher volumes, the result of improved customer demand. The decline in railway
operating expenses was largely due to the absence of two charges, as 2020 results were adversely impacted by a $385 million loss on asset disposal related to locomotives and a $99 million impairment charge related to an equity method investment. For more information on these charges, see Notes 7 and 6, respectively. Higher fuel costs, purchased services, and compensation and benefits expense mostly offset the reduction associated with these charges. Additionally, gains on the sale of operating properties increased compared to 2020. The 48% increase in income from railway operations drove comparable increases in net income and diluted earnings per share. Our railway operating ratio decreased to 60.1 percent.
The following tables adjust our 2020 U.S. Generally Accepted Accounting Principles (GAAP) financial results to exclude the effects of the loss on asset disposal and investment impairment. The income tax effects on these non-GAAP adjustments were calculated based on the applicable tax rates to which the non-GAAP adjustments relate. We use these non-GAAP financial measures internally and believe this information provides useful supplemental information to investors to facilitate making period-to-period comparisons by excluding the 2020 charges. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant to be considered in isolation from, or as a substitute for, the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similar measures presented by other companies.
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| Non-GAAP Reconciliation for 2020 |
| Reported (GAAP) | | Loss on Asset Disposal | | Investment Impairment | | Adjusted (non-GAAP) |
| ($ in millions, except per share amounts) |
| | | | | | | |
Railway operating expenses | $ | 6,787 | | | $ | (385) | | | $ | (99) | | | $ | 6,303 | |
Income from railway operations | $ | 3,002 | | | $ | 385 | | | $ | 99 | | | $ | 3,486 | |
Income before income taxes | $ | 2,530 | | | $ | 385 | | | $ | 99 | | | $ | 3,014 | |
Income taxes | $ | 517 | | | $ | 97 | | | $ | 25 | | | $ | 639 | |
Net income | $ | 2,013 | | | $ | 288 | | | $ | 74 | | | $ | 2,375 | |
Diluted earnings per share | $ | 7.84 | | | $ | 1.12 | | | $ | 0.29 | | | $ | 9.25 | |
Railway operating ratio (percent) | 69.3 | | | (3.9) | | | (1.0) | | | 64.4 | |
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In the table below, references to 2020 results and related comparisons use the adjusted, non-GAAP results from the table above.
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| | | | | | | | | 2021 |
| | | | | Adjusted | | 2022 | | vs. Adjusted |
| | | | | 2020 | | vs. | | 2020 |
| 2022 | | 2021 | | (non-GAAP) | | 2021 | | (non-GAAP) |
| ($ in millions, except per share amounts) | | (% change) |
| | | | | | | | | |
Railway operating expenses | $ | 7,936 | | | $ | 6,695 | | | $ | 6,303 | | | 19 | % | | 6 | % |
Income from railway operations | $ | 4,809 | | | $ | 4,447 | | | $ | 3,486 | | | 8 | % | | 28 | % |
Income before income taxes | $ | 4,130 | | | $ | 3,878 | | | $ | 3,014 | | | 6 | % | | 29 | % |
Income taxes | $ | 860 | | | $ | 873 | | | $ | 639 | | | (1 | %) | | 37 | % |
Net income | $ | 3,270 | | | $ | 3,005 | | | $ | 2,375 | | | 9 | % | | 27 | % |
Diluted earnings per share | $ | 13.88 | | | $ | 12.11 | | | $ | 9.25 | | | 15 | % | | 31 | % |
Railway operating ratio (percent) | 62.3 | | | 60.1 | | | 64.4 | | | 4 | % | | (7 | %) |
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 commodity group. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Revenues | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| ($ in millions) | | (% change) | |
Merchandise: | | | | | | | | | | |
Agriculture, forest and consumer products | $ | 2,493 | | | $ | 2,251 | | | $ | 2,116 | | | 11 | % | | 6 | % | |
Chemicals | 2,148 | | | 1,951 | | | 1,809 | | | 10 | % | | 8 | % | |
Metals and construction | 1,652 | | | 1,562 | | | 1,333 | | | 6 | % | | 17 | % | |
Automotive | 1,038 | | | 905 | | | 830 | | | 15 | % | | 9 | % | |
Merchandise | 7,331 | | | 6,669 | | | 6,088 | | | 10 | % | | 10 | % | |
Intermodal | 3,681 | | | 3,163 | | | 2,654 | | | 16 | % | | 19 | % | |
Coal | 1,733 | | | 1,310 | | | 1,047 | | | 32 | % | | 25 | % | |
Total | $ | 12,745 | | | $ | 11,142 | | | $ | 9,789 | | | 14 | % | | 14 | % | |
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| Units | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| (in thousands) | | (% change) | |
Merchandise: | | | | | | | | | | |
Agriculture, forest and consumer products | 723.0 | | | 725.5 | | | 704.4 | | | — | % | | 3 | % | |
Chemicals | 540.1 | | | 529.7 | | | 482.0 | | | 2 | % | | 10 | % | |
Metals and construction | 634.6 | | | 669.0 | | | 601.2 | | | (5 | %) | | 11 | % | |
Automotive | 339.1 | | | 345.4 | | | 329.7 | | | (2 | %) | | 5 | % | |
Merchandise | 2,236.8 | | | 2,269.6 | | | 2,117.3 | | | (1 | %) | | 7 | % | |
Intermodal | 3,913.1 | | | 4,104.1 | | | 3,992.1 | | | (5 | %) | | 3 | % | |
Coal | 684.6 | | | 658.0 | | | 574.1 | | | 4 | % | | 15 | % | |
Total | 6,834.5 | | | 7,031.7 | | | 6,683.5 | | | (3 | %) | | 5 | % | |
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| Revenue per Unit | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| ($ per unit) | | (% change) | |
Merchandise: | | | | | | | | | | |
Agriculture, forest and consumer products | $ | 3,448 | | | $ | 3,102 | | | $ | 3,004 | | | 11 | % | | 3 | % | |
Chemicals | 3,978 | | | 3,684 | | | 3,753 | | | 8 | % | | (2 | %) | |
Metals and construction | 2,604 | | | 2,334 | | | 2,216 | | | 12 | % | | 5 | % | |
Automotive | 3,059 | | | 2,621 | | | 2,518 | | | 17 | % | | 4 | % | |
Merchandise | 3,277 | | | 2,938 | | | 2,875 | | | 12 | % | | 2 | % | |
Intermodal | 941 | | | 771 | | | 665 | | | 22 | % | | 16 | % | |
Coal | 2,532 | | | 1,991 | | | 1,824 | | | 27 | % | | 9 | % | |
Total | 1,865 | | | 1,584 | | | 1,465 | | | 18 | % | | 8 | % | |
Revenues increased $1.6 billion in 2022 and $1.4 billion in 2021 compared to the prior years. Higher revenue for 2022 was the result of increased average revenue per unit, driven by higher fuel surcharge revenue, pricing gains, improved mix, and increased intermodal storage service charges, partially offset by volume declines. In 2021, higher revenue was the result of increased average revenue per unit, driven by pricing gains, higher fuel surcharge revenue, increased intermodal storage service charges and improved mix, as well as volume growth.
The table below reflects the components of the revenue change by major commodity group.
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| 2022 vs. 2021 | | 2021 vs. 2020 |
| Increase (Decrease) | | Increase (Decrease) |
| ($ in millions) |
| Merchandise | | Intermodal | | Coal | | Merchandise | | Intermodal | | Coal |
| | | | | | | | | | | |
Volume | $ | (96) | | | $ | (147) | | | $ | 53 | | | $ | 438 | | | $ | 75 | | | $ | 153 | |
Fuel surcharge | | | | | | | | | | | |
revenue | 455 | | | 417 | | | 79 | | | 91 | | | 178 | | | 4 | |
Rate, mix and | | | | | | | | | | | |
other | 303 | | | 248 | | | 291 | | | 52 | | | 256 | | | 106 | |
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Total | $ | 662 | | | $ | 518 | | | $ | 423 | | | $ | 581 | | | $ | 509 | | | $ | 263 | |
Approximately 95% of our revenue base is covered by contracts that include negotiated fuel surcharges. Fuel surcharge revenues totaled $1.6 billion, $622 million, and $349 million in 2022, 2021, and 2020, respectively. The increase in fuel surcharge revenues in 2022 and 2021 was driven by higher fuel commodity prices.
For 2023, we expect that revenue growth will be a challenge, as there is substantial economic uncertainty. Additionally, we expect revenue headwinds resulting from lower fuel prices, softening coal pricing, and declining storage service charges. In this difficult environment, we will continue to fight to increase revenue by recapturing truck-competitive freight and achieving pricing gains.
MERCHANDISE revenues increased in both 2022 and 2021 compared with the prior years. In 2022, revenues rose due to higher average revenue per unit, driven by higher fuel surcharge revenue and increased pricing, partially offset by lower volume. Decreased volumes in metal and construction and automotive shipments more than offset higher chemical shipments. In 2021, revenues rose due to increased volume and higher average revenue per unit driven by increased fuel surcharge revenue and pricing. Volumes increased in all merchandise commodity groups, reflecting economic recovery following the onset of the COVID-19 pandemic.
Agriculture, forest and consumer products revenues increased in both 2022 and 2021 compared with the prior years. In 2022, the rise was the result of increased average revenue per unit, the result of higher fuel surcharge revenue and pricing gains, while volumes were nearly flat. Declines in pulpboard, fertilizer, and pulp, were offset by increases in soybeans, feed, and corn. Pulpboard and pulp shipments declined due to decreased demand, equipment availability, service disruptions, and production down time. Lower fertilizer shipments were driven by high fertilizer prices causing customers to draw down on existing inventories or delay purchases as well as production disruptions. Soybean volumes were higher due to increased opportunity for exports. Feed shipments were higher due to increased customer demand. Increased corn shipments were due to improved equipment cycle times. In 2021, higher revenues were the result of higher volume across almost all markets, as the economy improved from the early months of the pandemic in 2020, and increased average revenue per unit, the result of pricing gains and higher fuel surcharge revenue. Gains in ethanol, pulpboard, beverages, lumber and wood, and woodchips more than offset declines in soybeans and pulp.
Chemicals revenues increased in both 2022 and 2021 compared with the prior years. In 2022, the increase was the result of higher average revenue per unit, driven by fuel surcharge revenue and pricing gains, and volume growth.
Increases in sand and solid waste shipments were partially offset by declines in plastics, inorganic chemicals, organic chemicals, and natural gas liquids. The increase in sand was due to greater demand resulting from sustained high natural gas prices. Solid waste shipments increased due to growth with existing customers. Plastics shipments decreased due to softening of the housing market. Declines in inorganic chemicals, organic chemicals, and natural gas liquids shipments were due to decreased demand and reduced production. In 2021, the increase was the result of volume growth partially offset by lower average revenue per unit, driven by mix of traffic. The increase in volume was due to economic and production recovery since the beginning of the pandemic, despite ongoing challenges in the energy markets. The markets with the largest gains were solid waste, industrial chemicals, sand, natural gas liquids, and plastics.
Metals and construction revenues were higher in both 2022 and 2021 compared with the prior years. In 2022, revenue growth was driven by higher average revenue per unit, the result of higher fuel surcharge revenue and pricing gains, partially offset by lower volume. Volumes fell largely as a result of decreased shipments of coil steel, iron and steel, and scrap metal driven by service disruptions and slower equipment cycle times. In 2021, revenue growth was driven by increased volumes and higher average revenue per unit, the result of pricing gains and higher fuel surcharge revenue. Volume increased across almost all markets due to economic improvement since the beginning of the pandemic. The commodities serving the metal production industry, including coil steel, scrap metal, and iron and steel, experienced the largest gains.
Automotive revenues rose in both 2022 and 2021 compared with the prior years. The increase in revenues in 2022 was driven by higher average revenue per unit, due to higher fuel surcharge revenue and pricing gains, partially offset by volume declines. Volume declines were the result of slower equipment cycle times partially offset by fewer parts supply issues due to easing supply chain congestion when compared to the prior year. In 2021, the increase in revenues was driven by volume growth and higher average revenue per unit, a result of an increase in fuel surcharge revenue and pricing gains. Automotive volumes were higher due primarily to increased retail demand and the impact of prior-year pandemic-induced production shutdowns. This was partially offset by the impact of the microchip shortage on production.
INTERMODAL revenues increased in both 2022 and 2021 compared with the prior years. The increase in 2022 was the result of higher average revenue per unit, driven by higher fuel surcharge revenue, pricing gains, and increased storage service charges, partially offset by decreased volume. The rise in 2021 was primarily the result of higher average revenue per unit driven by increased storage service charges, higher fuel surcharge revenue and pricing gains.
Intermodal units by market were as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| (units in thousands) | | (% change) | |
| | | | | | | | | | |
Domestic | 2,573.6 | | | 2,630.6 | | | 2,568.7 | | | (2 | %) | | 2 | % | |
International | 1,339.5 | | | 1,473.5 | | | 1,423.4 | | | (9 | %) | | 4 | % | |
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Total | 3,913.1 | | | 4,104.1 | | | 3,992.1 | | | (5 | %) | | 3 | % | |
Domestic volume decreased in 2022 but increased in 2021 compared with the prior years. In 2022, volume declined due to service disruptions, terminal congestion, strong over-the-road competition, and increased truck availability. In 2021, volume rose due to strong consumer demand which was partially offset by overall supply chain congestion, including equipment availability issues.
International volume fell in 2022 but rose in 2021. The decline in 2022 was the result of supply chain constraints, chassis shortages, and excess retail inventory. The increase in 2021 was the result of strong import demand despite being limited by various supply chain constraints, including chassis availability issues.
COAL revenues increased in both 2022 and 2021 compared with the prior years. The increase in 2022 was due to higher average revenue per unit, driven by pricing gains and higher fuel surcharge revenue, and increased volumes. The increase in 2021 was due to increased volumes and higher average revenue per unit driven by pricing gains and positive mix.
As shown in the following table, total tonnage increased in both 2022 and 2021.
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| | | | | | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| (tons in thousands) | | (% change) | |
| | | | | | | | | | |
Utility | 35,705 | | | 33,169 | | | 32,479 | | | 8 | % | | 2 | % | |
Export | 25,887 | | | 24,886 | | | 18,900 | | | 4 | % | | 32 | % | |
Domestic metallurgical | 11,307 | | | 11,804 | | | 9,441 | | | (4 | %) | | 25 | % | |
Industrial | 3,765 | | | 3,595 | | | 3,566 | | | 5 | % | | 1 | % | |
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Total | 76,664 | | | 73,454 | | | 64,386 | | | 4 | % | | 14 | % | |
Utility coal tonnage increased in both 2022 and 2021 compared with the prior years. The increase in 2022 was due to increased demand and service improvements. The increase in 2021 was due to higher natural gas prices and increased demand from coal-sourced electrical generation.
Export coal tonnage increased in both periods compared with prior years. The increase in 2022 was a result of strong global demand and increased coal supply. The increase in 2021 was a result of strong seaborne pricing, improved global economic conditions, and greater global demand.
Domestic metallurgical coal tonnage decreased in 2022 but increased in 2021 compared with the prior years. The decrease in 2022 was the result of reduced coke shipments related to customer sourcing changes and idled customer facilities. The increase in 2021 was the result of strong recovery in the steel market.
Industrial coal tonnage increased in both 2022 and 2021 compared with the prior year as a result of increased demand.
Railway Operating Expenses
Railway operating expenses summarized by major classifications were as follows:
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| | | | | | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| ($ in millions) | | (% change) | |
| | | | | | | | | | |
Compensation and benefits | $ | 2,621 | | | $ | 2,442 | | | $ | 2,373 | | | 7 | % | | 3 | % | |
Purchased services and rents | 1,922 | | | 1,726 | | | 1,687 | | | 11 | % | | 2 | % | |
Fuel | 1,459 | | | 799 | | | 535 | | | 83 | % | | 49 | % | |
Depreciation | 1,221 | | | 1,181 | | | 1,154 | | | 3 | % | | 2 | % | |
Materials and other | 713 | | | 547 | | | 653 | | | 30 | % | | (16 | %) | |
Loss on asset disposal | — | | | — | | | 385 | | | | | | |
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Total | $ | 7,936 | | | $ | 6,695 | | | $ | 6,787 | | | 19 | % | | (1 | %) | |
In 2022, expenses increased primarily as a result of higher fuel prices, other inflationary pressures, service-related costs, increased labor-related costs resulting from labor union negotiations, and higher claims expenses. In 2021, expenses declined primarily as a result of the absence of the 2020 loss on asset disposal and the equity method investment impairment charge, which is included in purchased services and rents. This was partially offset by higher fuel costs, increased other purchased services, and higher compensation and benefits expense.
Compensation and benefits increased in 2022, reflecting changes in:
•increased pay rates (up $188 million),
•employee activity levels (up $51 million),
•overtime (up $18 million),
•incentive and stock-based compensation (down $79 million), and
•other (up $1 million).
The increase in pay rates in 2022 includes payments in excess of amounts previously estimated in 2021 and 2020 for retroactive wage increases and other benefits under our labor agreements. In 2022, compensation and benefits includes $54 million and purchased services includes $2 million of additional expenses pertaining to compensation earned in those periods.
In 2021, compensation and benefits increased, a result of changes in:
•incentive and stock-based compensation (up $128 million),
•overtime and recrews (up $47 million),
•increased pay rates (up $41 million),
•health and welfare benefits for craft employees (down $19 million),
•employee activity levels (down $154 million), and
•other (up $26 million).
Our employment averaged 18,900 in 2022, compared with 18,500 in 2021, and 20,200 in 2020.
Purchased services and rents includes the costs of services purchased from external vendors and contractors, including the net costs of operating joint (or leased) facilities with other railroads and the net cost of equipment rentals.
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| | | | | | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| ($ in millions) | | (% change) | |
| | | | | | | | | | |
Purchased services | $ | 1,565 | | | $ | 1,409 | | | $ | 1,387 | | | 11 | % | | 2 | % | |
Equipment rents | 357 | | | 317 | | | 300 | | | 13 | % | | 6 | % | |
| | | | | | | | | | |
Total | $ | 1,922 | | | $ | 1,726 | | | $ | 1,687 | | | 11 | % | | 2 | % | |
The increase in purchased services in 2022 was due to inflationary pressures which resulted in higher intermodal-related expenses, and increased operational and transportation expenses, as well as higher technology-related costs. The increase in purchased services in 2021 was due to increased technology costs, higher intermodal-related expenses, and increased Conrail, Inc. (Conrail) costs. This was partially offset by the absence of a prior year $99 million impairment related to an equity method investment.
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, increased in both periods. In 2022, the increase was the result of lower network fluidity which led to greater time-and-mileage expenses, increased automotive and
intermodal equipment expenses, and higher short-term locomotive resource costs. In 2021, equipment rents were higher for general-use equipment due to decreased network velocity and increased volume. These increases were partially offset by lower intermodal costs and higher equity in TTX earnings.
Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, increased in both periods. The change in both years was due to higher locomotive fuel prices (up 87% in 2022 and 43% in 2021) which increased expenses by $634 million in 2022 and $224 million in 2021. Locomotive fuel consumption decreased 2% in 2022, but increased 4% in 2021. We consumed 376 million gallons of diesel fuel in 2022, compared with 384 million gallons in 2021 and 368 million gallons in 2020.
Depreciation expense increased in both periods, a reflection of reinvestment in our infrastructure, rolling stock, and technology.
Materials and other expenses increased in 2022 but decreased in 2021 as shown in the following table.
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| | | | | | | 2022 | | 2021 | |
| 2022 | | 2021 | | 2020 | | vs. 2021 | | vs. 2020 | |
| ($ in millions) | | (% change) | |
| | | | | | | | | | |
Materials | $ | 283 | | | $ | 250 | | | $ | 274 | | | 13 | % | | (9 | %) | |
Claims | 270 | | | 165 | | | 179 | | | 64 | % | | (8 | %) | |
Other | 160 | | | 132 | | | 200 | | | 21 | % | | (34 | %) | |
| | | | | | | | | | |
Total | $ | 713 | | | $ | 547 | | | $ | 653 | | | 30 | % | | (16 | %) | |
Materials expense increased in 2022 but decreased in 2021. The increase in 2022 is due to increased locomotive, freight car, and track materials costs. In 2021, the decrease was due primarily to lower maintenance requirements as a result of fewer locomotives and freight cars in service.
Claims expense includes costs related to personal injury, property damage, and environmental matters. The increase in 2022 was primarily the result of higher costs associated with unfavorable personal injury case development, increased environmental remediation expenses, and higher lading and property damage costs. The decrease in 2021 was primarily the result of lower costs associated with derailments and personal injuries.
Other expense increased in 2022, primarily due to higher travel-related expenses, increased non-income based taxes, and lower gains from sales of operating property, partially offset by lower relocation expenses. In 2021, other expense decreased primarily due to higher gains from sales of operating property. Gains from operating property sales amounted to $76 million, $82 million, and $26 million in 2022, 2021, and 2020, respectively.
Loss on asset disposal
During 2020, we recorded a $385 million charge related to the disposal of 703 locomotives. For more information on the impact of the charge, see Note 7.
Other income – net
Other income – net decreased in both 2022 and 2021. Other income fell in 2022 due to lower net returns on corporate-owned life insurance (COLI) partially offset by a higher net pension benefit and increased interest income. The decrease in 2021 was driven by lower net returns on COLI and lower gains on sales of non-operating property.
Income taxes
The effective income tax rate was 20.8% in 2022, compared with 22.5% in 2021 and 20.4% in 2020. The current year benefited by $136 million due to an enacted reduction to the Pennsylvania corporate income tax rate while 2021 benefited by $34 million due to various state law changes (see Note 4). All years experienced favorable benefits associated with stock-based compensation, while 2021 and 2020 benefited from COLI returns.
For 2023, we expect an effective income tax rate between 23% and 24%.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Cash provided by operating activities, our principal source of liquidity, was $4.2 billion in 2022, $4.3 billion in 2021, and $3.6 billion in 2020. The decrease in 2022 reflected changes in working capital, offset in part by improved operating results. The increase in 2021 was primarily the result of improved operating results. We had negative working capital of $642 million at December 31, 2022 and $354 million at December 31, 2021. Cash and cash equivalents totaled $456 million and $839 million at December 31, 2022, and 2021, respectively. We expect that cash on hand combined with cash provided by operating activities will be sufficient to meet our ongoing obligations. In addition, we believe our currently-available borrowing capacity, access to additional financing, and ability to reduce property additions and shareholder distributions, including share repurchases, provides us additional flexibility to meet our ongoing obligations.
Contractual obligations at December 31, 2022, including those that may have material cash requirements, include interest on fixed-rate long-term debt, long-term debt (Note 9), unconditional purchase obligations (Note 17), long-term advances from Conrail (Note 6), operating leases (Note 10), agreements with Consolidated Rail Corporation (CRC) (Note 6), and unrecognized tax benefits (Note 4).
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | 2023 | | 2024 - 2025 | | 2026 - 2027 | | 2028 and Subsequent |
| ($ in millions) |
| | | | | | | | | |
Interest on fixed-rate long-term debt | $ | 17,085 | | | $ | 643 | | | $ | 1,239 | | | $ | 1,144 | | | $ | 14,059 | |
Long-term debt principal | 16,012 | | | 603 | | | 957 | | | 1,223 | | | 13,229 | |
Unconditional purchase obligations | 1,650 | | | 757 | | | 736 | | | 80 | | | 77 | |
Long-term advances from Conrail | 534 | | | — | | | — | | | — | | | 534 | |
Operating leases | 462 | | | 103 | | | 182 | | | 96 | | | 81 | |
Agreements with CRC | 272 | | | 42 | | | 84 | | | 84 | | | 62 | |
Unrecognized tax benefits* | 22 | | | — | | | — | | | — | | | 22 | |
| | | | | | | | | |
Total | $ | 36,037 | | | $ | 2,148 | | | $ | 3,198 | | | $ | 2,627 | | | $ | 28,064 | |
* This amount is shown in the 2028 and Subsequent column because the year of settlement cannot be reasonably estimated.
Off balance sheet arrangements consist primarily of unrecognized obligations, including unconditional purchase obligations and future interest payments on fixed-rate long-term debt, which are included in the table above.
Cash used in investing activities was $1.6 billion in 2022, and $1.2 billion in both 2021 and 2020. The increase in 2022 is due to higher property additions partially offset by increased proceeds from property sales. In 2021, lower proceeds from property sales were mostly offset by reduced COLI policy loan repayments and lower property additions.
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 2023, we expect property additions will be approximately $2.1 billion.
In November 2022, we entered into an asset purchase and sale agreement with the Board of Trustees of the Cincinnati Southern Railway to purchase approximately 337 miles of railway line that extends from Cincinnati, Ohio to Chattanooga, Tennessee which we currently operate under a lease agreement. The total purchase price for the line and other associated real and personal property included in the transaction is approximately $1.6 billion. The agreement is conditioned upon (i) certain changes to Ohio state law applicable to the use of the related sale proceeds, (ii) approval by the voters of the City of Cincinnati, and (iii) the receipt of regulatory approval from the STB. The agreement includes various termination provisions including termination at any time prior to closing by the mutual written consent of the parties, termination at any time after December 31, 2024 by the mutual written consent of the parties, termination by us if the STB takes action that we deem unsatisfactory, and termination by either party if Cincinnati voter approval is not obtained on or before the later of June 30, 2025 and the calendar date on which the polls are open for the 2025 Cincinnati primary election.
Cash used in financing activities was $3.0 billion in 2022, compared with $3.3 billion in 2021, and $1.9 billion in 2020. The decrease in 2022 reflects lower repurchases of Common Stock, and increased proceeds from borrowings, partially offset by higher dividends. In 2021, the increase reflects higher repurchases of Common Stock and debt repayments, partially offset by increased proceeds from borrowings.
Share repurchases of $3.1 billion in 2022, $3.4 billion in 2021, and $1.4 billion in 2020 resulted in the retirement of 12.6 million, 12.7 million, and 7.4 million shares, respectively. On March 29, 2022, our Board of Directors authorized a new program for the repurchase of up to an additional $10.0 billion of Common Stock beginning April 1, 2022. Our previous share repurchase program terminated on March 31, 2022. As of December 31, 2022, $7.5 billion remains authorized by our Board of Directors for repurchase. The timing and volume of future share repurchases will be guided by our assessment of market conditions and other pertinent factors. Repurchases may be executed in the open market, through derivatives, accelerated repurchase and other negotiated transactions and through plans designed to comply with Rule 10b5-1(c) and Rule 10b-18 under the Securities and Exchange Act of 1934. Any near-term purchases under the program are expected to be made with internally-generated cash, cash on hand, or proceeds from borrowings.
In June 2022, we issued $750 million of 4.55% senior notes due 2053.
In February 2022, we issued $600 million of 3.00% senior notes due 2032 and $400 million of 3.70% senior notes due 2053.
In May 2022, we renewed our accounts receivable securitization program with a maximum borrowing capacity of $400 million. The term expires in May 2023. We had $100 million in borrowings outstanding under this program and our available borrowing capacity was $300 million at December 31, 2022 and $400 million at December 31, 2021.
We also have in place and available an $800 million credit agreement expiring in March 2025, which provides for borrowings at prevailing rates and includes covenants. We had no amounts outstanding under this facility at either December 31, 2022 or December 31, 2021, and we are in compliance with all of its covenants.
In addition, we have investments in general purpose COLI policies and had the ability to borrow against these policies up to $610 million and $715 million at December 31, 2022 and December 31, 2021, respectively.
Our debt-to-total capitalization ratio was 54.4% at December 31, 2022, compared with 50.4% at December 31, 2021. We discuss our credit agreement and our accounts receivable securitization program in Note 9. Subsequent to December 31, 2022, we issued $500 million in fixed rate debt securities. These senior notes, issued February 2, 2023, carry an interest rate of 4.45% and mature in 2033. After this issuance, we have authority from our Board of
Directors to issue an additional $800 million of debt or equity securities through public or private sale, all of which provide for access to additional liquidity should the need arise.
Upcoming annual debt maturities are disclosed in Note 9. Overall, our goal is to maintain a capital structure with appropriate leverage to support our business strategy and provide flexibility through business cycles.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions may require judgment about matters that are inherently uncertain, and future events are likely to occur that may require us to make changes to these estimates and assumptions. Accordingly, we regularly review these estimates and assumptions based on historical experience, changes in the business environment, and other factors we believe to be reasonable under the circumstances. The following critical accounting estimates are a subset of our significant accounting policies described in Note 1.
Pensions and Other Postretirement Benefits
Accounting for pensions and other postretirement benefit plans requires us to make several estimates and assumptions (Note 12). These include the expected rate of return from investment of the plans’ assets and the expected retirement age of employees as well as their projected earnings and mortality. In addition, the amounts recorded are affected by changes in the interest rate environment because the associated liabilities are discounted to their present value. We make these estimates based on our historical experience and other information 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.
For 2022, we assumed a long-term investment rate of return of 8.0%, which was supported by our long-term total rate of return on pension 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 $26 million change in annual pension expense. We review assumptions related to our defined benefit plans annually, and while changes are likely to occur in assumptions concerning retirement age, projected earnings, and mortality, they are not expected to have a material effect on our net pension expense or net pension liability in the future. The net pension liability is recorded at net present value using discount rates that are based on the current interest rate environment in light of the timing of expected benefit payments. We utilize analyses in which the projected annual cash flows from the pension and postretirement benefit plans are matched with yield curves based on an appropriate universe of high-quality corporate bonds. We use the results of the yield curve analyses to select the discount rates that match the payment streams of the benefits in these plans. A one-percentage point change to this discount rate assumption would result in a $3 million change in annual pension expense.
Properties and Depreciation
Most of our assets are long-lived railway properties (Note 7). “Properties” are stated principally at cost and are depreciated using the group method whereby assets with similar characteristics, use, and expected lives are grouped together in asset classes and depreciated using a composite depreciation rate. See Note 1 for a more detailed discussion of assumptions and estimates.
Expenditures, including those on leased assets, that extend an asset’s useful life or increase its utility are capitalized. Expenditures capitalized include those that are directly related to a capital project and may include materials, labor, and other direct costs, in addition to an allocable portion of indirect costs that relate to a capital project. A significant portion of our annual capital spending relates to self-constructed assets. Costs related to repairs and
maintenance activities that, in our judgment, do not extend an asset’s useful life or increase its utility are expensed when such repairs are performed.
Depreciation expense for 2022 totaled $1.2 billion. Our composite depreciation rates for 2022 are disclosed in Note 7; a one-year increase (or decrease) in the estimated average useful lives of depreciable assets would have resulted in an approximate $44 million decrease (or increase) to annual depreciation expense.
Personal Injury
Claims expense, included in “Materials and other” in the Consolidated Statements of Income, includes our estimate of costs for personal injuries.
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 actuarial consulting 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. The accuracy of our estimate of the liability 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.
See Note 17 for a more detailed discussion of the assumptions and estimates we use for personal injury.
Income Taxes
Our net deferred tax liability totaled $7.3 billion at December 31, 2022 (Note 4). This liability is estimated based on the expected future tax consequences of items recognized in the financial statements. After application of the federal statutory tax rate to book income, judgment is required with respect to the timing and deductibility of expenses in our income tax returns. For state income and other taxes, judgment is also required with respect to the apportionment among the various jurisdictions. A valuation allowance is recorded if we expect that it is more likely than not that deferred tax assets will not be realized. We have a $41 million valuation allowance on $373 million of deferred tax assets as of December 31, 2022, reflecting the expectation that substantially 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 (RLA), these agreements remain in effect until new agreements are reached, or until the bargaining procedures mandated by the RLA are completed. Moratorium provisions in the labor agreements govern when the railroads and unions may propose changes to the agreements. We largely bargain nationally in concert with other major railroads, represented by the National Carriers’ Conference Committee.
After management and the unions served their formal proposals in November 2019 for changes to the collective bargaining agreements, negotiations began in 2020 following the expiration of the last moratorium. On June 17, 2022, the National Mediation Board notified the parties that all practical methods of ending the dispute had been exhausted without effecting a settlement and that its mediation services had been terminated. Shortly thereafter, President Biden created Presidential Emergency Board (PEB) No. 250, effective July 18, 2022, to investigate the facts of the dispute and make recommendations. The PEB issued its recommendations on August 16, 2022, and the parties engaged in further negotiations. By December 2022, agreements based on the PEB’s recommendations had either been ratified or enacted through legislative action for all twelve unions.
While the parties are engaged in additional discussions to conclude the implementation of the recently finalized agreements, neither party can compel mandatory bargaining around any new proposals until November 1, 2024. That said, we understand the imperative to continue improving quality of life for our craft employees and are actively engaged in voluntary discussions (which carry no risk of a work stoppage) with all of our unions on this important issue.
Market Risks
We manage overall exposure to fluctuations in interest rates by issuing both fixed- and floating- rate debt instruments. At December 31, 2022, debt subject to interest rate fluctuations totaled $100 million. A one-percentage point increase in interest rates would increase total annual interest expense related to all variable debt by approximately $1 million. Market risk for fixed-rate debt is estimated as the potential increase in fair value resulting from a one-percentage point decrease in interest rates as of December 31, 2022 and amounts to an increase of approximately $1.3 billion to the fair value of our debt at December 31, 2022. We consider it unlikely that interest rate fluctuations applicable to these instruments will result in a material adverse effect on our financial position, results of operations, or liquidity.
New Accounting Pronouncements
For a detailed discussion of new accounting pronouncements, see Note 1.
Inflation
In preparing financial statements, GAAP requires the use of historical cost that disregards the effects of inflation on the replacement cost of property. As a capital-intensive company, we have most of our capital invested in long-lived assets. The replacement cost of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical cost.
FORWARD-LOOKING STATEMENTS
Certain statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations are “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or our achievements or those of our industry to be materially different from those expressed or implied by any forward-looking statements. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “project,” “consider,” “predict,” “potential,” “feel,” or other comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates, beliefs, and projections. While we believe these expectations, assumptions, estimates, beliefs, and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which involve factors or circumstances that are beyond our control. These and other important factors, including those discussed in Item 1A “Risk Factors,” may cause actual results, performance, or achievements to differ materially from those expressed or implied by these forward-looking statements. The forward-looking statements herein are made only as of the date they were first issued, and unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Additional Information
Investors and others should note that we routinely use the Investor Relations, Performance Metrics and Sustainability sections of our website (www.norfolksouthern.com/content/nscorp/en/investor-relations.html, http://www.nscorp.com/content/nscorp/en/investor-relations/performance-metrics.html, & www.nscorp.com/content/nscorp/en/about-ns/sustainability.html) to post presentations to investors and other important information, including information that may be deemed material to investors. Information about us, including information that may be deemed material, may also be announced by posts on our social media channels, including Twitter (www.twitter.com/nscorp) and LinkedIn (www.linkedin.com/company/norfolk-southern). We may also use our website and social media channels for the purpose of complying with our disclosure obligations under Regulation FD. As a result, we encourage investors, the media, and others interested in Norfolk Southern to review the information posted on our website and social media channels. The information posted on our website and social media channels is not incorporated by reference in this Annual Report on Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is included in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Market Risks.”
Properties
“Properties” are stated principally at cost and are depreciated using the group method whereby assets with similar characteristics, use, and expected lives are grouped together in asset classes and depreciated using a composite depreciation rate. This methodology treats each asset class as a pool of resources, not as singular items. We use approximately 75 depreciable asset classes.
Depreciation expense is based on our assumptions concerning expected service lives of our properties as well as the expected net salvage that will be received upon their retirement. In developing these assumptions, we utilize periodic depreciation studies that are performed by an independent outside firm of consulting engineers and approved by the STB. Our depreciation studies are conducted about every three years for equipment and every six years for track assets and other roadway property. The frequency of these studies is consistent with guidelines established by the STB. We adjust our rates based on the results of these studies and implement the changes prospectively. The studies may also indicate that the recorded amount of accumulated depreciation is deficient (or in excess) of the amount indicated by the study. Any such deficiency (or excess) is amortized as a component of depreciation expense over the remaining service lives of the affected class of property, as determined by the study.
Key factors that are considered in developing average service life and salvage estimates include:
•statistical analysis of historical retirement data and surviving asset records,
•review of historical salvage received and current market rates,
•review of our operations including expected changes in technology, customer demand, maintenance practices and asset management strategies,
•review of accounting policies and assumptions, and
•industry review and analysis.
The composite depreciation rate for rail in high density corridors is derived based on consideration of annual gross tons as compared to the total or ultimate capacity of rail in these corridors. Our experience has shown that traffic density is a leading factor in the determination of the expected service life of rail in high density corridors. In developing the respective depreciation rate, consideration is also given to several rail characteristics including age, weight, condition (new or second-hand) and type (curved or straight).
We capitalize interest on major projects during the period of their construction. Expenditures, including those on leased assets, that extend an asset’s useful life or increase its utility are capitalized. Expenditures capitalized include those that are directly related to a capital project and may include materials, labor, and other direct costs, in addition to an allocable portion of indirect costs that relate to a capital project. A significant portion of our annual capital spending relates to self-constructed assets. Removal activities occur in conjunction with replacement and are estimated based on the average percentage of time employees replacing assets spend on removal functions. Costs related to repairs and maintenance activities that, in our judgment, do not extend an asset’s useful life or increase its utility are expensed when such repairs are performed.
When depreciable operating road and equipment assets are sold or retired in the ordinary course of business, the cost of the assets, net of sales proceeds or salvage, is charged to accumulated depreciation, and no gain or loss is recognized in earnings. Actual historical cost values are retired when available, such as with most equipment assets. The use of estimates in recording the retirement of certain roadway assets is necessary based on the impracticality of tracking individual asset costs. When retiring rail, ties and ballast, we use statistical curves that indicate the relative distribution of the age of the assets retired. The historical cost of other roadway assets is estimated using a combination of inflation indices specific to the rail industry and those published by the U.S. Bureau of Labor Statistics. The indices are applied to the replacement value based on the age of the retired assets. These indices are used because they closely correlate with the costs of roadway assets. Gains and losses on disposal of operating land are included in “Materials and other” expenses. Gains and losses on disposal of non-operating land and non-rail assets are included in “Other income – net” since such income is not a product of our railroad operations.
A retirement is considered abnormal if it does not occur in the ordinary course of business, if it relates to disposition of a large segment of an asset class and if the retirement varies significantly from the retirement profile identified through our depreciation studies, which inherently consider the impact of normal retirements on expected service lives and depreciation rates. Gains or losses from abnormal retirements are recognized in income from railway operations.
We review the carrying amount of properties whenever events or changes in circumstances indicate that such carrying amount may not be recoverable based on future undiscounted cash flows. Assets that are deemed impaired as a result of such review are recorded at the lower of carrying amount or fair value.
New Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2019-12, “Simplifying the Accounting for Income Taxes,” which added new guidance to simplify the accounting for income taxes, changed the accounting for certain income tax transactions, and made other minor changes. We adopted the standard on January 1, 2021 and there was no material impact to the financial statements upon adoption.
In November 2021, the FASB issued ASU 2021-10, “Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance,” which requires annual disclosures when an entity has received government assistance. Entities are required to disclose the types of government assistance received, the accounting treatment for that government assistance, and the effect of the government assistance on the financial statements. We adopted the new standard on January 1, 2022 and there was no material impact to the financial statements upon adoption.
2. Railway Operating Revenues
The following table disaggregates our revenues by major commodity group: | | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 | | 2020 |
| | ($ in millions) |
Merchandise: | | | | |
Agriculture, forest and consumer products | | $ | 2,493 | | | $ | 2,251 | | | $ | 2,116 | |
Chemicals | | 2,148 | | | 1,951 | | | 1,809 | |
Metals and construction | | 1,652 | | | 1,562 | | | 1,333 | |
Automotive | | 1,038 | | | 905 | | | 830 | |
Merchandise | | 7,331 | | | 6,669 | | | 6,088 | |
Intermodal | | 3,681 | | | 3,163 | | | 2,654 | |
Coal | | 1,733 | | | 1,310 | | | 1,047 | |
| | | | | | |
Total | | $ | 12,745 | | | $ | 11,142 | | | $ | 9,789 | |
We recognize the amount of revenues to which we expect to be entitled for the transfer of promised goods or services to customers. A performance obligation is created when a customer under a transportation contract or public tariff submits a bill of lading to us for the transport of goods. These performance obligations are satisfied as the shipments move from origin to destination. As such, transportation revenues are recognized proportionally as a shipment moves, and related expenses are recognized as incurred. These performance obligations are generally short-term in nature with transit days averaging approximately one week or less for each commodity group. The customer has an unconditional obligation to pay for the service once the service has been completed. Estimated revenues associated with in-process shipments at period-end are recorded based on the estimated percentage of service completed. We had no material remaining performance obligations at December 31, 2022 and 2021.
We may provide customers ancillary services, such as switching, demurrage and other incidental activities, under their transportation contracts. The revenues associated with these distinct performance obligations are recognized when the services are performed or as contractual obligations are met. These revenues are included within each of the commodity groups and represent approximately 7%, 7% and 5%, respectively, of total “Railway operating revenues” on the Consolidated Statements of Income for the years ended December 31, 2022, 2021, and 2020.
Revenues related to interline transportation services that involve another railroad are reported on a net basis. Therefore, the portion of the amount that relates to another party is not reflected in revenues.
Under the typical terms of our freight contracts, payment for services is due within fifteen days of billing the customer, thus there are no significant financing components. “Accounts receivable – net” on the Consolidated Balance Sheets includes both customer and non-customer receivables as follows:
| | | | | | | | | | | | | | |
| | December 31, |
| | 2022 | | 2021 |
| | ($ in millions) |
| | | | |
Customer | | $ | 895 | | | $ | 741 | |
Non-customer | | 253 | | | 235 | |
| | | | |
Accounts receivable – net | | $ | 1,148 | | | $ | 976 | |
Non-customer receivables include non-revenue-related amounts due from other railroads, governmental entities, and others. There were no non-current customer receivables at December 31, 2022, while “Other assets” on the
Consolidated Balance Sheets included $23 million at December 31, 2021. We do not have any material contract assets or liabilities at December 31, 2022 and 2021.
3. Other Income – Net
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
Pension and other postretirement benefits (Note 12) | $ | 126 | | | $ | 102 | | | $ | 91 | |
COLI – net | (77) | | | 17 | | | 85 | |
Other | (36) | | | (42) | | | (23) | |
| | | | | |
Total | $ | 13 | | | $ | 77 | | | $ | 153 | |
4. Income Taxes
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
Current: | | | | | |
Federal | $ | 645 | | | $ | 553 | | | $ | 307 | |
State | 132 | | | 136 | | | 68 | |
Total current taxes | 777 | | | 689 | | | 375 | |
| | | | | |
Deferred: | | | | | |
Federal | 206 | | | 186 | | | 111 | |
State | (123) | | | (2) | | | 31 | |
Total deferred taxes | 83 | | | 184 | | | 142 | |
| | | | | |
Income taxes | $ | 860 | | | $ | 873 | | | $ | 517 | |
Reconciliation of Statutory Rate to Effective Rate
“Income taxes” on the Consolidated Statements of Income differs from the amounts computed by applying the statutory federal corporate tax rate as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Amount | | % | | Amount | | % | | Amount | | % |
| ($ in millions) |
| | | | | | | | | | | |
Federal income tax at statutory rate | $ | 867 | | | 21.0 | | | $ | 814 | | | 21.0 | | | $ | 531 | | | 21.0 | |
State income taxes, net of federal tax effect | 146 | | | 3.5 | | | 143 | | | 3.6 | | | 85 | | | 3.3 | |
State law changes | (136) | | | (3.3) | | | (34) | | | (0.8) | | | — | | | — | |
Excess tax benefits on stock-based compensation | (18) | | | (0.4) | | | (25) | | | (0.6) | | | (39) | | | (1.5) | |
Other, net | 1 | | | — | | | (25) | | | (0.7) | | | (60) | | | (2.4) | |
| | | | | | | | | | | |
Income taxes | $ | 860 | | | 20.8 | | | $ | 873 | | | 22.5 | | | $ | 517 | | | 20.4 | |
On July 8, 2022, House Bill 1342 was signed into law in the Commonwealth of Pennsylvania, which reduced its corporate income tax rate from 9.99% to 4.99%, through a series of phased reductions beginning each tax year from
January 1, 2023 through January 1, 2031. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. As a result, in 2022, we recognized a $136 million benefit in “Income taxes” with a corresponding reduction in “Deferred income taxes.”
Deferred Tax Assets and Liabilities
Certain items are reported in different periods for financial reporting and income tax purposes. Deferred tax assets and liabilities are recorded in recognition of these differences. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| ($ in millions) |
Deferred tax assets: | | | |
Accruals, including casualty and other claims | $ | 110 | | | $ | 92 | |
Compensation and benefits, including postretirement benefits | 99 | | | 181 | |
Other | 164 | | | 188 | |
Total gross deferred tax assets | 373 | | | 461 | |
Less valuation allowance | (41) | | | (60) | |
Net deferred tax assets | 332 | | | 401 | |
| | | |
Deferred tax liabilities: | | | |
Property | (7,050) | | | (7,016) | |
Other | (547) | | | (550) | |
Total deferred tax liabilities | (7,597) | | | (7,566) | |
| | | |
Deferred income taxes | $ | (7,265) | | | $ | (7,165) | |
Except for amounts for which a valuation allowance has been provided, we believe that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The valuation allowance at the end of each year primarily relates to subsidiary state income tax net operating losses and state investment tax credits that may not be utilized prior to their expiration. The total valuation allowance decreased by $19 million in 2022 and increased $3 million in both 2021 and 2020.
Uncertain Tax Positions
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| ($ in millions) |
| | | |
Balance at beginning of year | $ | 21 | | | $ | 22 | |
| | | |
Additions based on tax positions related to the current year | 3 | | | 3 | |
Additions for tax positions of prior years | 1 | | | 3 | |
Settlements with taxing authorities | (2) | | | (5) | |
Lapse of statutes of limitations | (1) | | | (2) | |
| | | |
Balance at end of year | $ | 22 | | | $ | 21 | |
Included in the balance of unrecognized tax benefits at December 31, 2022 are potential benefits of $18 million that would affect the effective tax rate if recognized. Unrecognized tax benefits are adjusted in the period in which new information about a tax position becomes available or the final outcome differs from the amount recorded.
The statute of limitations on Internal Revenue Service examinations has expired for all years prior to 2019. State income tax returns are generally subject to examination for a period of three to four years after the return. In addition, we are generally obligated to report changes in taxable income arising from federal income tax examinations to the states within a period of up to two years from the date the federal examination is final. We have various state income tax returns either under examination, administrative appeal, or litigation.
5. Fair Value Measurements
FASB Accounting Standards Codification (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, and • inputs that are derived principally from or corroborated by observable market data by correlation or other means. |
| |
| If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability. |
| |
Level 3 | Inputs to the valuation methodology are unobservable and significant to the fair value measurement. |
The asset or liability’s fair value measurement level within the hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Fair Values of Financial Instruments
The fair values of “Cash and cash equivalents,” “Accounts receivable – net,” “Accounts payable,” and “Short-term debt” approximate carrying values because of the short maturity of these financial instruments. The carrying value of COLI is recorded at cash surrender value and, accordingly, approximates fair value. There are no other assets or liabilities measured at fair value on a recurring basis at December 31, 2022 or 2021. The carrying amounts and estimated fair values, based on Level 1 inputs, of long-term debt consist of the following at December 31:
| | | | | | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 |
| Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
| ($ in millions) |
| | | | | | | |
Long-term debt, including current maturities | $ | (15,082) | | | $ | (13,846) | | | $ | (13,840) | | | $ | (17,033) | |
6. Investments
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| ($ in millions) |
Long-term investments: | | | |
Equity method investments: | | | |
Conrail | $ | 1,584 | | | $ | 1,526 | |
TTX Company | 918 | | | 851 | |
Other | 421 | | | 420 | |
Total equity method investments | 2,923 | | | 2,797 | |
| | | |
COLI at net cash surrender value | 752 | | | 885 | |
Other investments | 19 | | | 25 | |
| | | |
Total long-term investments | $ | 3,694 | | | $ | 3,707 | |
Investment in Conrail
Through a limited liability company, we and CSX jointly own Conrail, whose primary subsidiary is 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. We are amortizing the excess of the purchase price over Conrail’s net equity using the principles of purchase accounting, based primarily on the estimated useful lives of Conrail’s depreciable property and equipment, including the related deferred tax effect of the differences in book and tax accounting bases for such assets, as all of the purchase price at acquisition was allocable to Conrail’s tangible assets and liabilities. At December 31, 2022, our investment in Conrail exceeds our share of Conrail’s underlying net equity by $480 million.
CRC owns and operates certain properties (the Shared Assets Areas) for the joint and exclusive benefit of NSR and CSX Transportation, Inc. (CSXT). The costs of operating the Shared Assets Areas are borne by NSR and CSXT based on usage. In addition, NSR and CSXT pay CRC a fee for access to the Shared Assets Areas. “Purchased services and rents” and “Fuel” include expenses payable to CRC for operation of the Shared Assets Areas totaling $156 million in 2022, $147 million in 2021, and $129 million in 2020. Future payments for access fees due to CRC under the Shared Assets Areas agreements are as follows: $42 million in each of 2023 through 2027 and $62 million
thereafter. We provide certain general and administrative support functions to Conrail, the fees for which are billed in accordance with several service-provider arrangements and approximate $6 million annually.
In 2020, we converted $254 million of accounts payable into long-term advances from Conrail included in “Other liabilities.” “Accounts payable” includes $173 million at December 31, 2022, and $112 million at December 31, 2021, due to Conrail for the operation of the Shared Assets Areas. “Other liabilities” includes $534 million at December 31, 2022 and 2021, respectively, for long-term advances from Conrail, maturing in 2050 that bear interest at an average rate of 1.31%.
Our equity in Conrail’s earnings, net of amortization, was $58 million for 2022, $56 million for 2021, and $58 million for 2020. These amounts partially offset the costs of operating the Shared Assets Areas and are included in “Purchased services and rents.” Equity in Conrail’s earnings is included in the “Other – net” line item within operating activities in the Consolidated Statements of Cash Flows.
Investment in TTX
We and seven other North American railroads collectively own TTX Company (TTX), a railcar pooling company that provides its owner-railroads with standardized fleets of intermodal, automotive, and general use railcars at stated rates. We have a 19.78% ownership interest in TTX.
Expenses incurred for use of TTX equipment are included in “Purchased services and rents.” This amounted to $256 million, $246 million, and $250 million, respectively, for the years ended December 31, 2022, 2021 and 2020. Our equity in TTX’s earnings partially offsets these costs and totaled $53 million for 2022 and 2021, respectively, and $48 million for 2020. Equity in TTX’s earnings is included in the “Other – net” line item within operating activities in the Consolidated Statements of Cash Flows.
Impairment of Investment
In 2020, we recorded an other-than-temporary impairment of $99 million related to the carrying value of an equity method investment. This non-cash impairment charge is recorded in “Purchased services and rents” on the Consolidated Statements of Income and had a $74 million impact on net income.
7. Properties
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Accumulated | | Net Book | | Depreciation |
December 31, 2022 | Cost | | Depreciation | | Value | | Rate (1) |
| ($ in millions) | | |
| | | | | | | |
Land | $ | 2,405 | | | $ | — | | | $ | 2,405 | | | — |
| | | | | | | |
Roadway: | | | | | | | |
Rail and other track material | 7,589 | | | (1,971) | | | 5,618 | | | 2.42 | % |
Ties | 5,981 | | | (1,696) | | | 4,285 | | | 3.49 | % |
Ballast | 3,126 | | | (873) | | | 2,253 | | | 2.84 | % |
Construction in process | 431 | | | — | | | 431 | | | — |
Other roadway | 14,270 | | | (3,948) | | | 10,322 | | | 2.69 | % |
Total roadway | 31,397 | | | (8,488) | | | 22,909 | | | |
| | | | | | | |
Equipment: | | | | | | | |
Locomotives | 5,878 | | | (2,060) | | | 3,818 | | | 3.66 | % |
Freight cars | 2,701 | | | (1,033) | | | 1,668 | | | 2.51 | % |
Computers and software | 926 | | | (476) | | | 450 | | | 9.10 | % |
Construction in process | 206 | | | — | | | 206 | | | — |
Other equipment | 1,145 | | | (463) | | | 682 | | | 4.51 | % |
Total equipment | 10,856 | | | (4,032) | | | 6,824 | | | |
| | | | | | | |
Other property | 90 | | | (72) | | | 18 | | | 2.26 | % |
| | | | | | | |
Total properties | $ | 44,748 | | | $ | (12,592) | | | $ | 32,156 | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Accumulated | | Net Book | | Depreciation |
December 31, 2021 | Cost | | Depreciation | | Value | | Rate (1) |
| ($ in millions) | | |
| | | | | | | |
Land | $ | 2,453 | | | $ | — | | | $ | 2,453 | | | — |
| | | | | | | |
Roadway: | | | | | | | |
Rail and other track material | 7,330 | | | (1,907) | | | 5,423 | | | 2.40 | % |
Ties | 5,779 | | | (1,642) | | | 4,137 | | | 3.44 | % |
Ballast | 3,041 | | | (818) | | | 2,223 | | | 2.79 | % |
Construction in process | 339 | | | — | | | 339 | | | — |
Other roadway | 14,111 | | | (3,733) | | | 10,378 | | | 2.69 | % |
Total roadway | 30,600 | | | (8,100) | | | 22,500 | | | |
| | | | | | | |
Equipment: | | | | | | | |
Locomotives | 5,695 | | | (1,994) | | | 3,701 | | | 3.87 | % |
Freight cars | 2,701 | | | (1,009) | | | 1,692 | | | 2.59 | % |
Computers and software | 893 | | | (438) | | | 455 | | | 10.34 | % |
Construction in process | 164 | | | — | | | 164 | | | — |
Other equipment | 1,088 | | | (420) | | | 668 | | | 4.63 | % |
Total equipment | 10,541 | | | (3,861) | | | 6,680 | | | |
| | | | | | | |
Other property | 90 | | | (70) | | | 20 | | | 2.25 | % |
| | | | | | | |
Total properties | $ | 43,684 | | | $ | (12,031) | | | $ | 31,653 | | | |
(1)Composite annual depreciation rate for the underlying assets, excluding the effects of the amortization of any deficiency (or excess) that resulted from our depreciation studies.
Loss on Asset Disposal
In 2020, we sold 703 locomotives deemed excess and no longer needed for railroad operations. We evaluated these locomotive retirements and concluded they were abnormal (see Note 1). Accordingly, we recorded a $385 million loss to adjust their carrying amount to their estimated fair value, which resulted in a $97 million tax benefit.
Capitalized Interest
Total interest cost incurred on debt was $708 million, $657 million, and $639 million during 2022, 2021 and 2020, respectively, of which $16 million, $11 million, and $14 million was capitalized during 2022, 2021 and 2020, respectively.
8. Current Liabilities
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| ($ in millions) |
Accounts payable: | | | |
Accounts and wages payable | $ | 712 | | | $ | 850 | |
Due to Conrail (Note 6) | 173 | | | 112 | |
Casualty and other claims (Note 17) | 170 | | | 166 | |
Vacation liability | 136 | | | 119 | |
Other | 102 | | | 104 | |
| | | |
Total | $ | 1,293 | | | $ | 1,351 | |
| | | |
Other current liabilities: | | | |
Interest payable | $ | 157 | | | $ | 150 | |
Current operating lease liability (Note 10) | 94 | | | 82 | |
Pension benefit obligations (Note 12) | 20 | | | 20 | |
Other | 70 | | | 60 | |
| | | |
Total | $ | 341 | | | $ | 312 | |
9. Debt
Debt maturities are presented below:
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| ($ in millions) |
Notes and debentures, with weighted-average interest rates as of December 31, 2022: | | | |
3.95% maturing to 2027 | $ | 2,770 | | | $ | 3,318 | |
3.66% maturing 2028 to 2032 | 2,595 | | | 1,995 | |
4.05% maturing 2037 to 2055 | 9,247 | | | 8,097 | |
5.22% maturing 2097 to 2121 | 1,384 | | | 1,384 | |
Securitization borrowings and finance leases | 116 | | | 22 | |
Discounts, premiums, and debt issuance costs | (930) | | | (976) | |
Total debt | 15,182 | | | 13,840 | |
| | | |
Less current maturities and short-term debt | (703) | | | (553) | |
| | | |
Long-term debt excluding current maturities and short-term debt | $ | 14,479 | | | $ | 13,287 | |
| | | | | | | | | | | |
Long-term debt maturities subsequent to 2023 are as follows: | | | |
2024 | | | $ | 403 | |
2025 | | | 554 | |
2026 | | | 602 | |
2027 | | | 621 | |
2028 and subsequent years | | | 12,299 | |
| | | |
Total | | | $ | 14,479 | |
In June 2022, we issued $750 million of 4.55% senior notes due 2053.
In February 2022, we issued $600 million of 3.00% senior notes due 2032 and $400 million of 3.70% senior notes due 2053.
In May 2022, we renewed our accounts receivable securitization program with a maximum borrowing capacity of $400 million. The term expires in May 2023. Under this facility NSR sells substantially all of its eligible third-party receivables to a subsidiary, which in turn may transfer beneficial interests in the receivables to various commercial paper vehicles. Amounts received under this facility are accounted for as borrowings. We had $100 million (at an average variable interest rate of 5.05%) outstanding under this program at December 31, 2022, which is included within “Short-term debt”, and no amounts outstanding at December 31, 2021. Our available borrowing capacity was $300 million and $400 million at December 31, 2022 and December 31, 2021, respectively. Our accounts receivable securitization program was supported by $883 million in receivables at December 31, 2022, which are included in “Accounts receivable – net”.
Credit Agreement and Debt Covenants
We also have in place and available an $800 million credit agreement expiring in March 2025, which provides for borrowings at prevailing rates and includes covenants. We had no amounts outstanding under this facility at either December 31, 2022 or December 31, 2021, and we are in compliance with all of its covenants.
Subsequent Event
On February 2, 2023, we issued $500 million of 4.45% senior notes due 2033.
10. Leases
We are committed under long-term lease agreements for equipment, lines of road, and other property. We combine lease and non-lease components for new and reassessed leases. Some of these agreements are variable lease agreements that include usage-based payments. These agreements contain payment provisions that depend on an index or rate, initially measured using the index or rate at the lease commencement date, and are therefore not included in our future minimum lease payments. Our long-term lease agreements do not contain any material restrictive covenants.
Our equipment leases have remaining terms of less than 1 year to 7 years and our lines of road and land leases have remaining terms of less than 1 year to 135 years. Some of these leases include options to extend the leases for up to 99 years and some include options to terminate the leases within 30 days. Because we are not reasonably certain to exercise these renewal options, the options are not considered in determining the lease term, and associated payments are excluded from future minimum lease payments.
Leases with an initial term of twelve months or less are not recorded on the balance sheet. We recognize lease expense for these leases on a straight-line basis over the lease term.
Operating lease amounts included on the Consolidated Balance Sheets are as follows:
| | | | | | | | | | | | | | |
| | December 31, |
| | 2022 | | 2021 |
| | ($ in millions) |
| Classification | | | |
Assets | | | | |
Right-of-use (ROU) assets | Other assets | $ | 407 | | | $ | 411 | |
| | | | |
Liabilities | | | | |
Current lease liabilities | Other current liabilities | $ | 94 | | | $ | 82 | |
Non-current lease liabilities | Other liabilities | 316 | | | 331 | |
| | | | |
Total lease liabilities | | $ | 410 | | | $ | 413 | |
The components of total lease expense, primarily included in “Purchased services and rents,” are as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
Operating lease expense | $ | 101 | | | $ | 106 | | | $ | 109 | |
Variable lease expense | 55 | | | 44 | | | 42 | |
Short-term lease expense | 18 | | | 9 | | | 9 | |
| | | | | |
Total lease expense | $ | 174 | | | $ | 159 | | | $ | 160 | |
In March 2019, we entered into a non-cancellable lease for an office building. In 2021, the construction of the office building was completed and the lease commenced. The initial lease term is five years with options to renew, purchase, or sell the office building at the end of the lease term. The lease contains a residual value guarantee of up to eighty-three percent of the total construction cost of $499 million.
Other information related to operating leases is as follows:
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| | | |
Weighted-average remaining lease term (years) on operating leases | 6.67 | | 7.49 |
| | | |
Weighted-average discount rates on operating leases | 3.16 | % | | 3.04 | % |
As the rates implicit in most of our leases are not readily determinable, we use a collateralized incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future payments. We use the portfolio approach and group leases into short-, medium-, and long-term categories, applying the corresponding incremental borrowing rates to these categories.
During 2022 and 2021, respectively, ROU assets obtained in exchange for new operating lease liabilities were $57 million at both periods. Cash paid for amounts included in the measurement of lease liabilities was $100 million and $103 million in 2022 and 2021, respectively, and is included in operating cash flows.
Future minimum lease payments under non-cancellable operating leases are as follows:
| | | | | |
| December 31, 2022 |
| ($ in millions) |
| |
2023 | $ | 103 | |
2024 | 95 | |
2025 | 87 | |
2026 | 69 | |
2027 | 27 | |
2028 and subsequent years | 81 | |
Total lease payments | 462 | |
Less: Interest | 52 | |
| |
Present value of lease liabilities | $ | 410 | |
| | | | | |
| December 31, 2021 |
| ($ in millions) |
| |
2022 | $ | 92 | |
2023 | 83 | |
2024 | 73 | |
2025 | 69 | |
2026 | 55 | |
2027 and subsequent years | 98 | |
Total lease payments | 470 | |
Less: Interest | 57 | |
| |
Present value of lease liabilities | $ | 413 | |
11. Other Liabilities
| | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 |
| ($ in millions) |
| | | |
Long-term advances from Conrail (Note 6) | $ | 534 | | | $ | 534 | |
Non-current operating lease liability (Note 10) | 316 | | | 331 | |
Net pension benefit obligations (Note 12) | 255 | | | 338 | |
Casualty and other claims (Note 17) | 218 | | | 170 | |
Net other postretirement benefit obligations (Note 12) | 204 | | | 244 | |
Deferred compensation | 91 | | | 109 | |
Other | 141 | | | 153 | |
| | | |
Total | $ | 1,759 | | | $ | 1,879 | |
12. Pensions and Other Postretirement Benefits
We have both funded and unfunded defined benefit pension plans covering eligible employees. We also provide specified health care benefits to eligible retired employees; these plans can be amended or terminated at our option. Under our self-insured retiree health care plan, for those participants who are not Medicare-eligible, certain health care expenses are covered for retired employees and their dependents, reduced by any deductibles, coinsurance, and, in some cases, coverage provided under other group insurance policies. Eligible retired participants and their spouses who are Medicare-eligible are not covered under the self-insured retiree health care plan, but instead are provided with an employer-funded health reimbursement account which can be used for reimbursement of health insurance premiums or eligible out-of-pocket medical expenses.
Pension and Other Postretirement Benefit Obligations and Plan Assets
| | | | | | | | | | | | | | | | | | | | | | | |
| Pension Benefits | | Other Postretirement Benefits |
| 2022 | | 2021 | | 2022 | | 2021 |
| ($ in millions) |
Change in benefit obligations: | | | | | | | |
Benefit obligation at beginning of year | $ | 2,777 | | | $ | 2,845 | | | $ | 417 | | | $ | 471 | |
Service cost | 40 | | | 43 | | | 6 | | | 6 | |
Interest cost | 67 | | | 55 | | | 9 | | | 7 | |
Actuarial gains | (677) | | | (13) | | | (70) | | | (29) | |
Plan amendments | (4) | | | (2) | | | — | | | — | |
Benefits paid | (152) | | | (151) | | | (36) | | | (38) | |
Benefit obligation at end of year | 2,051 | | | 2,777 | | | 326 | | | 417 | |
| | | | | | | |
Change in plan assets: | | | | | | | |
Fair value of plan assets at beginning of year | 2,861 | | | 2,675 | | | 173 | | | 165 | |
Actual return on plan assets | (470) | | | 317 | | | (28) | | | 29 | |
Employer contributions | 21 | | | 20 | | | 13 | | | 17 | |
Benefits paid | (152) | | | (151) | | | (36) | | | (38) | |
Fair value of plan assets at end of year | 2,260 | | | 2,861 | | | 122 | | | 173 | |
| | | | | | | |
Funded status at end of year | $ | 209 | | | $ | 84 | | | $ | (204) | | | $ | (244) | |
| | | | | | | |
Amounts recognized in the Consolidated Balance Sheets: | | | | | | | |
Other assets | $ | 484 | | | $ | 442 | | | $ | — | | | $ | — | |
Other current liabilities | (20) | | | (20) | | | — | | | — | |
Other liabilities | (255) | | | (338) | | | (204) | | | (244) | |
| | | | | | | |
Net amount recognized | $ | 209 | | | $ | 84 | | | $ | (204) | | | $ | (244) | |
| | | | | | | |
Amounts included in accumulated other comprehensive | | | | | | | |
loss (before tax): | | | | | | | |
Net (gain) loss | $ | 623 | | | $ | 666 | | | $ | (19) | | | $ | 10 | |
Prior service benefit | (6) | | | (2) | | | (177) | | | (202) | |
Our accumulated benefit obligation for our defined benefit pension plans is $1.9 billion and $2.6 billion at December 31, 2022 and 2021, respectively. Our unfunded pension plans, included above, which in all cases have no assets, had projected benefit obligations of $275 million and $358 million at December 31, 2022 and 2021, respectively, and had accumulated benefit obligations of $249 million and $332 million at December 31, 2022 and 2021, respectively.
Pension and Other Postretirement Benefit Cost Components
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
Pension benefits: | | | | | |
Service cost | $ | 40 | | | $ | 43 | | | $ | 40 | |
Interest cost | 67 | | | 55 | | | 74 | |
Expected return on plan assets | (213) | | | (193) | | | (190) | |
Amortization of net losses | 49 | | | 66 | | | 51 | |
Amortization of prior service cost | — | | | — | | | 1 | |
| | | | | |
Net benefit | $ | (57) | | | $ | (29) | | | $ | (24) | |
| | | | | |
Other postretirement benefits: | | | | | |
Service cost | $ | 6 | | | $ | 6 | | | $ | 6 | |
Interest cost | 9 | | | 7 | | | 12 | |
Expected return on plan assets | (13) | | | (12) | | | (14) | |
Amortization of net losses | — | | | 1 | | | — | |
Amortization of prior service benefit | (25) | | | (26) | | | (25) | |
| | | | | |
Net benefit | $ | (23) | | | $ | (24) | | | $ | (21) | |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income
| | | | | | | | | | | |
| 2022 |
| Pension Benefits | | Other Postretirement Benefits |
| ($ in millions) |
| | | |
Net (gains) losses arising during the year | $ | 6 | | | $ | (29) | |
| | | |
Prior service effect of plan amendment | (4) | | | — | |
Amortization of net losses | (49) | | | — | |
Amortization of prior service benefit | — | | | 25 | |
| | | |
Total recognized in other comprehensive income | $ | (47) | | | $ | (4) | |
| | | |
Total recognized in net periodic cost and other comprehensive income | $ | (104) | | | $ | (27) | |
Net losses arising during the year for pension benefits were due primarily to lower actual returns on plan assets offset by an increase in discount rates. Net gains arising during the year for other postretirement benefits were due primarily to an increase in discount rates, partially offset by lower actual returns on plan assets.
The estimated net losses and prior service credits for the pension plans that will be amortized from accumulated other comprehensive loss into net periodic cost over the next year are $4 million. The estimated net gains and prior service benefit for the other postretirement benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit over the next year is $26 million.
Pension and Other Postretirement Benefits Assumptions
Costs for pension and other postretirement benefits are determined based on actuarial valuations that reflect appropriate assumptions as of the measurement date, ordinarily the beginning of each year. The funded status of the plans is determined using appropriate assumptions as of each year end. A summary of the major assumptions follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Pension funded status: | | | | | |
Discount rate | 5.56 | % | | 2.97 | % | | 2.67 | % |
Future salary increases | 4.44 | % | | 4.44 | % | | 4.21 | % |
Other postretirement benefits funded status: | | | | | |
Discount rate | 5.45 | % | | 2.72 | % | | 2.27 | % |
Pension cost: | | | | | |
Discount rate - service cost | 3.25 | % | | 3.14 | % | | 3.71 | % |
Discount rate - interest cost | 2.45 | % | | 1.95 | % | | 2.92 | % |
Return on assets in plans | 8.00 | % | | 8.00 | % | | 8.25 | % |
Future salary increases | 4.44 | % | | 4.44 | % | | 4.21 | % |
Other postretirement benefits cost: | | | | | |
Discount rate - service cost | 3.01 | % | | 2.71 | % | | 3.41 | % |
Discount rate - interest cost | 2.13 | % | | 1.57 | % | | 2.69 | % |
Return on assets in plans | 7.75 | % | | 7.75 | % | | 8.00 | % |
Health care trend rate | 6.50 | % | | 6.00 | % | | 6.25 | % |
To determine the discount rates used to measure our benefit obligations, we utilize analyses in which the projected annual cash flows from the pension and other postretirement benefit plans were matched with yield curves based on an appropriate universe of high-quality corporate bonds. We use the results of the yield curve analyses to select the discount rates that match the payment streams of the benefits in these plans.
We use a spot rate approach to estimate the service cost and interest cost components of net periodic benefit cost for our pension and other postretirement benefit plans.
Health Care Cost Trend Assumptions
For measurement purposes at December 31, 2022, increases in the per capita cost of pre-Medicare covered health care benefits were assumed to be 7.0% for 2023. We assume the rate will ratably decrease to an ultimate rate of 5.0% for 2030 and remain at that level thereafter.
Assumed health care cost trend rates affect the amounts reported in the financial statements. To illustrate, a one-percentage point change in the assumed health care cost trend would have the following effects:
| | | | | | | | | | | |
| One-percentage Point |
| Increase | | Decrease |
| ($ in millions) |
Increase (decrease) in: | | | |
Total service and interest cost components | $ | 1 | | | $ | (1) | |
Postretirement benefit obligation | 6 | | | (5) | |
Asset Management
Thirteen investment firms manage our defined benefit pension plan’s assets under investment guidelines approved by our Benefits Investment Committee that is composed of members of our management. Investments are restricted to domestic and international equity securities, domestic and international fixed income securities, and unleveraged exchange-traded options and financial futures. Limitations restrict investment concentration and use of certain derivative investments. The target asset allocation for equity is 75% of the pension plan’s assets. Fixed income investments must consist predominantly of securities rated investment grade or higher. Equity investments must be in liquid securities listed on national exchanges. No investment is permitted in our securities (except through commingled pension trust funds).
Our pension plan’s weighted-average asset allocations, by asset category, were as follows:
| | | | | | | | | | | |
| Percentage of Plan Assets at December 31, |
| 2022 | | 2021 |
| | | |
Domestic equity securities | 53 | % | | 52 | % |
Debt securities | 26 | % | | 24 | % |
International equity securities | 20 | % | | 23 | % |
Cash and cash equivalents | 1 | % | | 1 | % |
| | | |
Total | 100 | % | | 100 | % |
The other postretirement benefit plan assets consist primarily of trust-owned variable life insurance policies with an asset allocation at December 31, 2022 of 64% in equity securities and 36% in debt securities compared with 65% in equity securities and 35% in debt securities at December 31, 2021. The target asset allocation for equity is between 50% and 75% of the plan’s assets.
The plans’ assumed future returns are based principally on the asset allocations and historical returns for the plans’ asset classes determined from both actual plan returns and, over longer time periods, expected market returns for those asset classes. For 2023, we assume an 8.00% return on pension plan assets.
Fair Value of Plan Assets
The following is a description of the valuation methodologies used for pension plan assets measured at fair value.
Common stock: Shares held by the plan at year end are valued at the official closing price as defined by the exchange or at the most recent trade price of the security at the close of the active market.
Common collective trusts: The readily determinable fair value is based on the published fair value per unit of the trusts. The common collective trusts hold equity securities, fixed income securities and cash and cash equivalents.
Fixed income securities: Valued based on quotes received from independent pricing services or at an estimated price at which a dealer would pay for the security at year end using observable market-based inputs.
Commingled funds: The readily determinable fair value is based on the published fair value per unit of the funds. The commingled funds hold equity securities.
Cash and cash equivalents: Short-term Treasury bills or notes are valued at an estimated price at which a dealer would pay for the security at year end using observable market-based inputs; money market funds are valued at the closing price reported on the active market on which the funds are traded.
The following table sets forth the pension plan’s assets by valuation technique level, within the fair value hierarchy. There were no level 3 valued assets at December 31, 2022 or 2021.
| | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Level 1 | | Level 2 | | Total |
| ($ in millions) |
| | | | | |
Common stock | $ | 1,011 | | | $ | — | | | $ | 1,011 | |
Common collective trusts: | | | | | |
International equity securities | — | | | 336 | | | 336 | |
Debt securities | — | | | 291 | | | 291 | |
Domestic equity securities | — | | | 160 | | | 160 | |
Fixed income securities: | | | | | |
Government and agencies securities | — | | | 158 | | | 158 | |
Corporate bonds | — | | | 100 | | | 100 | |
Mortgage and other asset-backed securities | — | | | 28 | | | 28 | |
Commingled funds | — | | | 121 | | | 121 | |
Cash and cash equivalents | 55 | | | — | | | 55 | |
| | | | | |
| | | | | |
Total investments | $ | 1,066 | | | $ | 1,194 | | | $ | 2,260 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2021 |
| Level 1 | | Level 2 | | Total |
| ($ in millions) |
| | | | | |
Common stock | $ | 1,383 | | | $ | — | | | $ | 1,383 | |
Common collective trusts: | | | | | |
International equity securities | — | | | 397 | | | 397 | |
Debt securities | — | | | 367 | | | 367 | |
Domestic equity securities | — | | | 189 | | | 189 | |
Fixed income securities: | | | | | |
Government and agencies securities | — | | | 170 | | | 170 | |
Corporate bonds | — | | | 120 | | | 120 | |
Mortgage and other asset-backed securities | — | | | 33 | | | 33 | |
| | | | | |
Commingled funds | — | | | 160 | | | 160 | |
Cash and cash equivalents | 42 | | | — | | | 42 | |
| | | | | |
| | | | | |
Total investments | $ | 1,425 | | | $ | 1,436 | | | $ | 2,861 | |
The following is a description of the valuation methodologies used for other postretirement benefit plan assets measured at fair value.
Trust-owned life insurance: Valued at our interest in trust-owned life insurance issued by a major insurance company. The underlying investments owned by the insurance company consist of a U.S. stock account and a U.S. bond account but may retain cash at times as well. The U.S. stock account and U.S. bond account are valued based on readily determinable fair values.
The other postretirement benefit plan assets consisted of trust-owned life insurance with fair values of $122 million and $173 million at December 31, 2022 and 2021, respectively, and are valued under level 2 of the fair value hierarchy. There were no level 1 or level 3 valued assets.
Contributions and Estimated Future Benefit Payments
In 2023, we expect to contribute approximately $20 million to our unfunded pension plans for payments to pensioners and approximately $33 million to our other postretirement benefit plans for retiree health and death benefits. We do not expect to contribute to our funded pension plan in 2023.
Benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:
| | | | | | | | | | | |
| Pension Benefits | | Other Postretirement Benefits |
| ($ in millions) |
| | | |
2023 | $ | 148 | | | $ | 33 | |
2024 | 148 | | | 32 | |
2025 | 147 | | | 31 | |
2026 | 147 | | | 30 | |
2027 | 147 | | | 29 | |
Years 2028 – 2032 | 736 | | | 135 | |
Other Postretirement Coverage
Under collective bargaining agreements, Norfolk Southern and certain subsidiaries participate in a multi-employer benefit plan, which provides certain postretirement health care and life insurance benefits to eligible craft employees. Premiums under this plan are expensed as incurred and totaled $13 million in 2022, $21 million in 2021, and $22 million in 2020.
Section 401(k) Plans
Norfolk Southern and certain subsidiaries provide Section 401(k) savings plans for employees. Under the plans, we match a portion of employee contributions, subject to applicable limitations. Our matching contributions, recorded as an expense, totaled $22 million in 2022, $23 million in 2021, and $21 million in 2020.
13. Stock-Based Compensation
Under the stockholder-approved LTIP, the Human Capital Management and Compensation Committee (Committee), which is made up of nonemployee members of the Board, or the Chief Executive Officer (when delegated authority by such Committee), may grant stock options, stock appreciation rights (SARs), restricted stock units (RSUs), restricted shares, performance share units (PSUs), and performance shares, up to a maximum of 104,125,000 shares of our Common Stock, of which 8,238,993 remain available for future grants as of December 31, 2022.
The number of shares remaining for issuance under the LTIP is reduced (i) by 1 for each award granted as a stock option or stock-settled SAR, or (ii) by 1.61 for an award made in the form other than a stock option or stock-settled SAR. Under the Board-approved Thoroughbred Stock Option Plan (TSOP), the Committee may grant stock options up to a maximum of 6,000,000 shares of Common Stock. We use newly issued shares to satisfy any exercises and awards under the LTIP and the TSOP.
The LTIP also permits the payment, on a current or a deferred basis and in cash or in stock, of dividend equivalents on shares of Common Stock covered by stock options, RSUs, or PSUs in an amount commensurate with regular quarterly dividends paid on Common Stock. With respect to stock options, if employment of the participant is terminated for any reason, including retirement, disability, or death, we have no further obligation to make any dividend equivalent payments. Regarding RSUs, we have no further obligation to make any dividend equivalent payments unless employment of the participant is terminated as a result of qualifying retirement or disability. Should an employee terminate employment, they are not required to forfeit dividend equivalent payments already received. Outstanding PSUs do not receive dividend equivalent payments.
The Committee granted stock options, RSUs and PSUs pursuant to the LTIP for the last three years as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Granted | | Weighted- Average Grant-Date Fair Value | | Granted | | Weighted- Average Grant-Date Fair Value | | Granted | | Weighted- Average Grant-Date Fair Value |
Stock options | 140,080 | | $ | 61.32 | | | 42,770 | | $ | 62.49 | | | 43,770 | | $ | 52.05 | |
RSUs | 180,306 | | 265.21 | | | 183,093 | | 240.09 | | | 178,190 | | 210.11 | |
PSUs | 58,945 | | 272.22 | | | 50,100 | | 240.72 | | | 78,830 | | 212.66 | |
Recipients of certain RSUs and PSUs pursuant to the LTIP who retire prior to October 1st will forfeit awards received in the current year. Receipt of certain LTIP awards is contingent on the recipient having executed a non-compete agreement with the company.
We account for our grants of stock options, RSUs, PSUs, and dividend equivalent payments in accordance with FASB ASC 718, “Compensation - Stock Compensation.” Accordingly, all awards result in charges to net income while dividend equivalent payments, which are all related to equity classified awards, are charged to retained income. Compensation cost for the awards is recognized on a straight-line basis over the requisite service period for the entire award. Related compensation costs and tax benefits during the years were:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
Stock-based compensation expense | $ | 53 | | | $ | 54 | | | $ | 28 | |
Total tax benefit | 27 | | | 34 | | | 44 | |
Stock Options
Option exercise prices will be at least the higher of (i) the average of the high and low prices at which Common Stock is traded on the grant date, or (ii) the closing price of Common Stock on the grant date. All options are subject to a vesting period of at least one year, and the term of the option will not exceed ten years. Holders of the options granted under the 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.
For all years, options granted under the LTIP and the TSOP may not be exercised prior to the fourth and third anniversaries of the date of grant, respectively, or if the optionee retires or dies before that anniversary date, may not be exercised before the later of one year after the grant date or the date of the optionee’s retirement or death.
The fair value of each option awarded was measured on the date of grant using the Black-Scholes valuation model. Expected volatility is based on implied volatility from traded options on, and historical volatility of, Common Stock. Historical data is used to estimate option exercises and employee terminations within the valuation model. Historical exercise data is used to estimate the average expected option term. The average risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. A dividend yield of zero was used for the LTIP options during the vesting period. For 2022, 2021, and 2020, a dividend yield of 1.85%, 1.64%, and 1.76%, respectively, was used for the vested period during the remaining expected option term for LTIP options.
The assumptions for the LTIP grants for the last three years are shown in the following table:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| | | | | |
| | | | | |
Average expected volatility | 27 | % | | 26 | % | | 22 | % |
Average risk-free interest rate | 1.80 | % | | 0.75 | % | | 1.47 | % |
Average expected option term | 6.5 years | | 7.5 years | | 7.5 years |
| | | | | |
A summary of changes in stock options is presented below:
| | | | | | | | | | | |
| Stock Options | | Weighted- Average Exercise Price |
| | | |
Outstanding at December 31, 2021 | 1,095,895 | | | $ | 106.58 | |
Granted | 140,080 | | | 287.31 | |
Exercised | (307,660) | | | 82.72 | |
Forfeited | (48,313) | | | 270.92 | |
| | | |
Outstanding at December 31, 2022 | 880,002 | | | 134.66 | |
The aggregate intrinsic value of options outstanding at December 31, 2022 was $103 million with a weighted-average remaining contractual term of 4.1 years. Of these options outstanding, 742,810 were exercisable and had an aggregate intrinsic value of $101 million with a weighted-average exercise price of $110.09 and a weighted-average remaining contractual term of 2.1 years.
The following table provides information related to options exercised for the last three years:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
Options exercised | 307,660 | | | 470,632 | | | 1,171,786 | |
Total intrinsic value | $ | 54 | | | $ | 83 | | | $ | 144 | |
Cash received upon exercise | 25 | | | 42 | | | 98 | |
Related tax benefits realized | 12 | | | 17 | | | 29 | |
At December 31, 2022, total unrecognized compensation related to options granted under the LTIP was $3 million, and is expected to be recognized over a weighted-average period of approximately 3.0 years.
Restricted Stock Units
RSUs granted primarily have a four-year ratable restriction period and will be settled through the issuance of shares of Common Stock. Certain RSU grants include cash dividend equivalent payments during the restriction period in an amount equal to regular quarterly dividends paid on Common Stock. The fair value of each RSU was measured on the date of grant as the average of the high and low prices at which Common Stock is traded on the grant date, adjusted for the impact of dividend equivalent payments as applicable.
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
RSUs vested | 249,138 | | | 260,307 | | | 204,665 | |
Common Stock issued net of tax withholding | 175,781 | | | 184,319 | | | 146,047 | |
Related tax benefits realized | $ | 5 | | | $ | 7 | | | $ | 4 | |
A summary of changes in RSUs is presented below:
| | | | | | | | | | | |
| RSUs | | Weighted- Average Grant-Date Fair Value |
| | | |
Nonvested at December 31, 2021 | 501,103 | | | $ | 193.23 | |
Granted | 180,306 | | | 265.21 | |
Vested | (249,138) | | | 168.66 | |
Forfeited | (44,890) | | | 244.99 | |
| | | |
Nonvested at December 31, 2022 | 387,381 | | | 236.53 | |
At December 31, 2022, total unrecognized compensation related to RSUs was $37 million, and is expected to be recognized over a weighted-average period of approximately 2.6 years.
Performance Share Units
PSUs provide for awards based on the achievement of certain predetermined corporate performance goals at the end of a three-year cycle and are settled through the issuance of shares of Common Stock. All PSUs will earn out based on the achievement of performance conditions and some will also earn out based on a market condition. The market condition fair value was measured on the date of grant using a Monte Carlo simulation model.
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| ($ in millions) |
| | | | | |
PSUs earned | 86,420 | | | 78,727 | | | 235,935 | |
Common Stock issued net of tax withholding | 54,651 | | | 49,967 | | | 156,477 | |
Related tax benefits realized | $ | 1 | | | $ | 1 | | | $ | 7 | |
A summary of changes in PSUs is presented below:
| | | | | | | | | | | |
| PSUs | | Weighted- Average Grant-Date Fair Value |
| | | |
Balance at December 31, 2021 | 202,930 | | | $ | 197.33 | |
Granted | 58,945 | | | 272.22 | |
Earned | (86,420) | | | 161.14 | |
Unearned | (260) | | | 161.14 | |
Forfeited | (32,758) | | | 254.83 | |
| | | |
Balance at December 31, 2022 | 142,437 | | | 236.70 | |
At December 31, 2022, total unrecognized compensation related to PSUs granted under the LTIP was $3 million, and is expected to be recognized over a weighted-average period of approximately 1.7 years.
Shares Available and Issued
Shares of Common Stock available for future grants and issued in connection with all features of the LTIP and the TSOP at December 31, were as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Available for future grants: | | | | | |
LTIP | 8,238,993 | | | 8,609,075 | | | 8,995,582 | |
TSOP | 436,402 | | | 435,867 | | | 435,699 | |
Issued: | | | | | |
LTIP | 503,090 | | | 632,279 | | | 1,270,208 | |
TSOP | 35,002 | | | 72,639 | | | 204,102 | |
14. Stockholders’ Equity
Common Stock
Common Stock is reported net of shares held by our consolidated subsidiaries (Treasury Shares). Treasury Shares at December 31, 2022 and 2021 amounted to 20,320,777, with a cost of $19 million at both dates.
Accumulated Other Comprehensive Loss
The components of “Other comprehensive income (loss)” reported in the Consolidated Statements of Comprehensive Income and changes in the cumulative balances of “Accumulated other comprehensive loss” reported in the Consolidated Balance Sheets consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | |
| Balance at Beginning of Year | | Net Income | | Reclassification Adjustments | | Balance at End of Year |
| ($ in millions) |
Year ended December 31, 2022 | | | | | | | |
| | | | | | | |
Pensions and other postretirement liabilities | $ | (356) | | | $ | 20 | | | $ | 17 | | | $ | (319) | |
Other comprehensive income of equity investees | (46) | | | 14 | | | — | | | (32) | |
| | | | | | | |
Accumulated other comprehensive loss | $ | (402) | | | $ | 34 | | | $ | 17 | | | $ | (351) | |
| | | | | | | |
Year ended December 31, 2021 | | | | | | | |
| | | | | | | |
Pensions and other postretirement liabilities | $ | (526) | | | $ | 139 | | | $ | 31 | | | $ | (356) | |
Other comprehensive income of equity investees | (68) | | | 22 | | | — | | | (46) | |
| | | | | | | |
Accumulated other comprehensive loss | $ | (594) | | | $ | 161 | | | $ | 31 | | | $ | (402) | |
Other Comprehensive Income (Loss)
“Other comprehensive income (loss)” reported in the Consolidated Statements of Comprehensive Income consisted of the following:
| | | | | | | | | | | | | | | | | |
| Pretax Amount | | Tax (Expense) Benefit | | Net-of-Tax Amount |
| ($ in millions) |
Year ended December 31, 2022 | | | | | |
Net gain arising during the year: | | | | | |
Pensions and other postretirement benefits | $ | 27 | | | $ | (7) | | | $ | 20 | |
Reclassification adjustments for costs included in net income | 24 | | | (7) | | | 17 | |
| | | | | |
Subtotal | 51 | | | (14) | | | 37 | |
| | | | | |
Other comprehensive income of equity investees | 17 | | | (3) | | | 14 | |
| | | | | |
Other comprehensive income | $ | 68 | | | $ | (17) | | | $ | 51 | |
| | | | | |
Year ended December 31, 2021 | | | | | |
Net gain arising during the year: | | | | | |
Pensions and other postretirement benefits | $ | 185 | | | $ | (46) | | | $ | 139 | |
Reclassification adjustments for costs included in net income | 41 | | | (10) | | | 31 | |
| | | | | |
Subtotal | 226 | | | (56) | | | 170 | |
| | | | | |
Other comprehensive income of equity investees | 24 | | | (2) | | | 22 | |
| | | | | |
Other comprehensive income | $ | 250 | | | $ | (58) | | | $ | 192 | |
| | | | | |
Year ended December 31, 2020 | | | | | |
Net loss arising during the year: | | | | | |
Pensions and other postretirement benefits | $ | (167) | | | $ | 42 | | | $ | (125) | |
Reclassification adjustments for costs included in net income | 27 | | | (7) | | | 20 | |
| | | | | |
Subtotal | (140) | | | 35 | | | (105) | |
| | | | | |
Other comprehensive income of equity investees | 2 | | | — | | | 2 | |
| | | | | |
Other comprehensive loss | $ | (138) | | | $ | 35 | | | $ | (103) | |
15. Stock Repurchase Programs
We repurchased and retired 12.6 million, 12.7 million, and 7.4 million shares of Common Stock under our stock repurchase programs in 2022, 2021, and 2020, respectively, at a cost of $3.1 billion, $3.4 billion, and $1.4 billion, respectively.
On March 29, 2022, our Board of Directors authorized a new program for the repurchase of up to $10.0 billion of
Common Stock beginning April 1, 2022. As of December 31, 2022, $7.5 billion remains authorized for repurchase. Our previous share repurchase program terminated on March 31, 2022.
16. Earnings Per Share
The following table sets forth the calculation of basic and diluted earnings per share:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | Diluted |
| 2022 | | 2021 | | 2020 | | 2022 | | 2021 | | 2020 |
| ($ in millions except per share amounts, shares in millions) |
| | | | | | | | | | | |
Net income | $ | 3,270 | | | $ | 3,005 | | | $ | 2,013 | | | $ | 3,270 | | | $ | 3,005 | | | $ | 2,013 | |
Dividend equivalent payments | (2) | | | (2) | | | (3) | | | (1) | | | — | | | (2) | |
| | | | | | | | | | | |
Income available to common stockholders | $ | 3,268 | | | $ | 3,003 | | | $ | 2,010 | | | $ | 3,269 | | | $ | 3,005 | | | $ | 2,011 | |
| | | | | | | | | | | |
Weighted-average shares outstanding | 234.8 | | | 246.9 | | | 255.1 | | | 234.8 | | | 246.9 | | | 255.1 | |
Dilutive effect of outstanding options | | | | | | | | | | | |
and share-settled awards | | | | | | | 0.8 | | | 1.2 | | | 1.5 | |
Adjusted weighted-average shares outstanding | | | | | | | 235.6 | | | 248.1 | | | 256.6 | |
| | | | | | | | | | | |
Earnings per share | $ | 13.92 | | | $ | 12.16 | | | $ | 7.88 | | | $ | 13.88 | | | $ | 12.11 | | | $ | 7.84 | |
In each year, dividend equivalent payments were made to certain holders of stock options and RSUs. For purposes of computing basic earnings per share, dividend equivalent payments made to holders of stock options and RSUs were deducted from net income to determine income available to common stockholders. For purposes of computing diluted earnings per share, we evaluate on a grant-by-grant basis those stock options and RSUs receiving dividend equivalent payments under the two-class and treasury stock methods to determine which method is more dilutive for each grant. For those grants for which the two-class method was more dilutive, net income was reduced by dividend equivalent payments to determine income available to common stockholders. The dilution calculations exclude options having exercise prices exceeding the average market price of Common Stock as follows: 0.1 million in the year ended December 31, 2022 and none in the years ended December 31, 2021 and 2020.
17. 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 and, if material, disclosed below. 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 become known. For lawsuits and other claims where a loss may be reasonably possible, but not probable, or is probable but not reasonably estimable, no accrual is established but the matter, if potentially material, is disclosed below. We routinely review relevant information with respect to our lawsuits and other claims and update our accruals, disclosures and estimates of reasonably possible loss based on such reviews.
In 2007, various antitrust class actions filed against us and other Class I railroads in various Federal district courts regarding fuel surcharges were consolidated in the District of Columbia by the Judicial Panel on Multidistrict Litigation. In 2012, the court certified the case as a class action. The defendant railroads appealed this certification, and the Court of Appeals for the District of Columbia vacated the District Court’s decision and remanded the case for further consideration. On October 10, 2017, the District Court denied class certification. The decision was upheld by the Court of Appeals on August 16, 2019. Since that decision, various individual cases have been filed in multiple jurisdictions and also consolidated in the District of Columbia. 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.
In 2018, a lawsuit was filed against one of our subsidiaries by the minority owner in a jointly-owned terminal railroad company in which our subsidiary has the majority ownership. The lawsuit alleged violations of various state laws and federal antitrust laws. On January 3, 2023, the court granted summary judgment to us on all of the compensatory claims but denied summary judgment for all equitable relief claims. On January 18, 2023, the court dismissed the federal equitable relief claims, leaving the state equitable relief claims as the sole remaining issue under consideration. We expect the rulings will be appealed. A trial on the state equitable relief claims has not been scheduled. We continue to vigorously defend the lawsuit and, although it is reasonably possible we could incur a loss in the case, we believe that we will prevail. However, given that litigation is inherently unpredictable and subject to uncertainties, there can be no assurances that the final outcome of the litigation (including any related appeal) will not be material. Until such appeal is final, we cannot reasonably estimate the potential loss or range of loss associated with this matter.
Casualty Claims
Casualty claims include employee personal injury and occupational claims as well as third-party claims, all exclusive of legal costs. To aid in valuing our personal injury liability and determining the amount to accrue with respect to such claims during the year, we utilize studies prepared by an independent consulting actuarial firm. Job-related personal injury and occupational claims are subject to FELA, which is applicable only to railroads. The variability inherent in FELA’s fault-based tort system could result in actual costs being different from the liability recorded. While the ultimate amount of claims incurred is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payments of claims and is supported by the most recent actuarial study. In all cases, we record a liability when the expected loss for the claim is both probable and reasonably estimable.
Employee personal injury claims – The largest component of claims expense is employee personal injury costs. The independent actuarial firm we engage provides quarterly studies to aid in valuing our employee personal injury liability and estimating personal injury expense. The actuarial firm studies our historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences. The actuarial firm uses the results of these analyses to estimate the ultimate amount of liability. We adjust the liability quarterly based upon our assessment and the results of the study. The accuracy of our estimate of the liability is subject to inherent limitation given the difficulty of predicting future events such as jury decisions, court interpretations, or legislative changes. As a result, actual claim settlements may vary from the estimated liability recorded.
Occupational claims – Occupational claims include injuries and illnesses alleged to be caused by exposures which occur over time as opposed to injuries or illnesses caused by a specific accident or event. Types of occupational claims commonly seen allege exposure to asbestos and other claimed toxic substances resulting in respiratory diseases or cancer. Many such claims are being asserted by former or retired employees, some of whom have not been employed in the rail industry for decades. The independent actuarial firm provides an estimate of the occupational claims liability based upon our history of claim filings, severity, payments, and other pertinent facts. The liability is dependent upon judgments we make as to the specific case reserves as well as judgments of the actuarial firm in the quarterly studies. Our estimate of ultimate loss includes a provision for those claims that have been incurred but not reported. This provision is derived by analyzing industry data and projecting our experience. We adjust the liability quarterly based upon our assessment and the results of the study. However, it is
possible that the recorded liability may not be adequate to cover the future payment of claims. Adjustments to the recorded liability are reflected in operating expenses in the periods in which such adjustments become known.
Third-party claims – We record a liability for third-party claims including those for highway crossing accidents, trespasser and other injuries, property damage, and lading damage. The actuarial firm assists us with the calculation of potential liability for third-party claims, except lading damage, based upon our experience including the number and timing of incidents, amount of payments, settlement rates, number of open claims, and legal defenses. We adjust the liability quarterly based upon our assessment and the results of the study. Given the inherent uncertainty in regard to the ultimate outcome of third-party claims, it is possible that the actual loss may differ from the estimated liability recorded.
Environmental Matters
We are subject to various jurisdictions’ environmental laws and regulations. We record a liability where such liability or loss is probable and reasonably estimable. Environmental specialists regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates.
Our Consolidated Balance Sheets include liabilities for environmental exposures of $66 million at December 31, 2022, and $49 million at December 31, 2021, of which $15 million is classified as a current liability at the end of both 2022 and 2021. At December 31, 2022, the liability represents our estimates of the probable cleanup, investigation, and remediation costs based on available information at 85 known locations and projects compared with 88 locations and projects at December 31, 2021. At December 31, 2022, twenty-two sites accounted for $55 million of the liability, and no individual site was considered to be material. We anticipate that most of this liability will be paid out over five years; however, some costs will be paid out over a longer period.
At eight locations, one or more of our subsidiaries in conjunction with a number of other parties have been identified as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 or comparable state statutes that impose joint and several liability for cleanup costs. We calculate our estimated liability for these sites based on facts and legal defenses applicable to each site and not solely on the basis of the potential for joint liability.
With respect to known environmental sites (whether identified by us or by the Environmental Protection Agency or comparable state authorities), estimates of our ultimate potential financial exposure for a given site or in the aggregate for all such sites can change over time because of the widely varying costs of currently available cleanup techniques, unpredictable contaminant recovery and reduction rates associated with available cleanup technologies, the likely development of new cleanup technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant’s share of any estimated loss (and that participant’s ability to bear it), and evolving statutory and regulatory standards governing liability.
The risk of incurring environmental liability for acts and omissions, past, present, and future, is inherent in the railroad business. Some of the commodities we transport, particularly those classified as hazardous materials, pose special risks that we work diligently to reduce. In addition, several of our subsidiaries own, or have owned, land used as operating property, or which is leased and operated by others, or held for sale. Because environmental problems that are latent or undisclosed may exist on these properties, there can be no assurance that we will not incur environmental liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and potentially other unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial position, results of operations, or liquidity in a particular year or quarter.
Based on our assessment of the facts and circumstances now known, we believe we have recorded the probable and reasonably estimable costs for dealing with those environmental matters of which we are aware. Further, we believe that it is unlikely that any known matters, either individually or in the aggregate, will have a material adverse effect on our financial position, results of operations, or liquidity.
Labor Agreements
Approximately 80% of our railroad employees are covered by collective bargaining agreements with various labor unions. Pursuant to the RLA, these agreements remain in effect until new agreements are reached, or until the bargaining procedures mandated by the RLA are completed. Moratorium provisions in the labor agreements govern when the railroads and unions may propose changes to the agreements. We largely bargain nationally in concert with other major railroads, represented by the National Carriers’ Conference Committee.
After management and the unions served their formal proposals in November 2019 for changes to the collective bargaining agreements, negotiations began in 2020 following the expiration of the last moratorium. On June 17, 2022, the National Mediation Board notified the parties that all practical methods of ending the dispute had been exhausted without effecting a settlement and that its mediation services had been terminated. Shortly thereafter, President Biden created PEB No. 250, effective July 18, 2022, to investigate the facts of the dispute and make recommendations. The PEB issued its recommendations on August 16, 2022, and the parties engaged in further negotiations. By December 2022, agreements based on the PEB’s recommendations had either been ratified or enacted through legislative action for all twelve unions. For 2022, “Compensation and benefits” includes $54 million and “Purchased services and rents” includes $2 million of additional expenses pertaining to wages earned prior to January 1, 2022.
While the parties are engaged in additional discussions to conclude the implementation of the recently finalized agreements, neither party can compel mandatory bargaining around any new proposals until November 1, 2024. That said, we understand the imperative to continue improving quality of life for our craft employees and are actively engaged in voluntary discussions (which carry no risk of a work stoppage) with all of our unions on this important issue.
Insurance
We purchase insurance covering legal liabilities for bodily injury and property damage to third parties. This insurance provides coverage above $75 million and below $800 million ($1.1 billion for specific perils) per occurrence and/or policy year. In addition, we purchase insurance covering damage to property owned by us or in our care, custody, or control. This insurance covers approximately 82% of potential losses above $75 million and below $275 million per occurrence and/or policy year.
Purchase Commitments
At December 31, 2022, we had outstanding purchase commitments totaling $1.7 billion through 2030 for locomotive modernizations, long-term technology support and development contracts, track material, and intermodal equipment.
Asset Purchase and Sale Agreement
In November 2022, we entered into an asset purchase and sale agreement with the Board of Trustees of the Cincinnati Southern Railway to purchase approximately 337 miles of railway line that extends from Cincinnati, Ohio to Chattanooga, Tennessee which we currently operate under a lease agreement. The total purchase price for the line and other associated real and personal property included in the transaction is approximately $1.6 billion. The agreement is conditioned upon (i) certain changes to Ohio state law applicable to the use of the related sale proceeds, (ii) approval by the voters of the City of Cincinnati, and (iii) the receipt of regulatory approval from the STB. The agreement includes various termination provisions including termination at any time prior to closing by the mutual written consent of the parties, termination at any time after December 31, 2024 by the mutual written consent of the parties, termination by us if the STB takes action that we deem unsatisfactory, and termination by either party if Cincinnati voter approval is not obtained on or before the later of June 30, 2025 and the calendar date on which the polls are open for the 2025 Cincinnati primary election.
Change-In-Control Arrangements
We have compensation agreements with certain officers and key employees that become operative only upon a change in control of Norfolk Southern, as defined in those agreements. The agreements provide generally for payments based on compensation at the time of a covered individual’s involuntary or other specified termination and for certain other benefits.
Indemnifications
In a number of instances, we have agreed to indemnify lenders for additional costs they may bear as a result of certain changes in laws or regulations applicable to their loans. Such changes may include impositions or modifications with respect to taxes, duties, reserves, liquidity, capital adequacy, special deposits, and similar requirements relating to extensions of credit by, deposits with, or the assets or liabilities of such lenders. The nature and timing of changes in laws or regulations applicable to our financings are inherently unpredictable, and therefore our exposure in connection with the foregoing indemnifications cannot be quantified. No liability has been recorded related to these indemnifications.