NORFOLK SOUTHERN CORPORATION 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. OurNorfolk Southern Railway Company subsidiary operates approximately 19,500 route miles in 22 states and theDistrict of Columbia , serves every major container port in the easternUnited States , and provides efficient connections to other rail carriers. We are a major transporter of industrial products, including chemicals, agriculture, and metals and construction materials. In addition, we operate the most extensive intermodal network in the East and are a principal carrier of coal, automobiles, and automotive parts. Our second-quarter 2020 results were negatively impacted by the COVID-19 pandemic that caused significant global economic contraction. The pandemic influenced the demand for our services and, as a result, our volumes fell significantly across all of our major commodity groups. In response to lower customer demand, we focused on tailoring operating plans for the low-demand environment and reducing expenses, including further implementation of structural cost reductions associated with our strategic plan. Although the revenue reduction in the quarter exceeded the cost reductions we achieved, the initiatives implemented have further optimized our operating activities and network and have positioned us to benefit when volumes return in the future. The COVID-19 pandemic continues to generate significant uncertainty in the economy and our outlook for the remainder of 2020. The magnitude and duration of the pandemic, including its impact on our customers and general economic conditions, is still uncertain. We continue to monitor the impact of the pandemic on our employees' availability, which has not been adversely affected in a significant manner thus far in 2020. We remain committed to protecting our employees and providing excellent transportation service products for our customers. SUMMARIZED RESULTS OF OPERATIONS ($ in millions, except per share amounts) Second Quarter First Six Months 2020 2019 % change 2020 2019 % change Income from railway operations$ 610 $ 1,065 (43%)$ 1,178 $ 2,031 (42%) Net income$ 392 $ 722 (46%)$ 773 $ 1,399 (45%) Diluted earnings per share$ 1.53 $ 2.70 (43%)$ 3.00 $ 5.21 (42%) Railway operating ratio (percent) 70.7 63.6 11% 75.0 64.8 16% Income from railway operations decreased in both periods, leading to lower net income and diluted earnings per share. The reduction in income from railway operations resulted from decreased railway operating revenues that exceeded the operating expense declines, driving the increases in the railway operating ratio. Railway operating revenues declined as lower customer demand resulted in volume declines. Railway operating expenses decreased due to declines in fuel price and consumption, reduced employment levels, lower volumes and operational efficiency improvements. Additionally, our results for the first six months of 2020 were adversely impacted by a first-quarter loss on asset disposal of$385 million related to the loss on locomotives sold and a write-down of locomotives held-for-sale. For more information on the impact of the charge, see Note 3. 19 -------------------------------------------------------------------------------- The following table adjusts our 2020 GAAP financial results for the first six months to exclude the effects of this charge. We use these non-GAAP financial measures internally and believe this information provides useful supplemental information to investors to facilitate making period-to-period comparisons by excluding the 2020 charge. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant to be considered in isolation, or as a substitute for, the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similar measures presented by other companies. Non-GAAP
Reconciliation for First Six Months
Adjusted
2020 Loss on Asset 2020
Reported 2020 (GAAP) Disposal (non-GAAP)
($ in millions, except per share amounts)
Railway operating expenses $ 3,532 $ (385) $ 3,147
Income from railway operations $ 1,178 $ 385 $ 1,563
Net income $ 773 $ 288 $ 1,061
Diluted earnings per share $ 3.00 $ 1.11 $ 4.11
Railway operating ratio (percent) 75.0 (8.2) 66.8
In the table below, references to the first six months of 2020 results and
related comparisons use the adjusted, non-GAAP results from the reconciliation
in the table above.
First Six Months
Adjusted Adjusted 2020 (non-GAAP)
2020 vs.
(non-GAAP) 2019 2019
($ in millions, except per share amounts) % change
Railway operating expenses $ 3,147 $ 3,734 (16%)
Income from railway operations $ 1,563 $ 2,031 (23%)
Net income $ 1,061 $ 1,399 (24%)
Diluted earnings per share $ 4.11 $ 5.21 (21%)
Railway operating ratio (percent) 66.8 64.8 3%
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DETAILED RESULTS OF OPERATIONS
Railway Operating Revenues
The following tables present a comparison of revenues ($ in millions), volumes
(units in thousands), and average revenue per unit ($ per unit) by commodity
group.
Second Quarter First Six Months
Revenues 2020 2019 % change 2020 2019 % change
Merchandise:
Agriculture, forest and
consumer products $ 498 $ 577 (14%) $ 1,049 $ 1,135 (8%)
Chemicals 423 544 (22%) 943 1,051 (10%)
Metals and construction 293 384 (24%) 660 754 (12%)
Automotive 93 251 (63%) 327 502 (35%)
Merchandise 1,307 1,756 (26%) 2,979 3,442 (13%)
Intermodal 569 701 (19%) 1,224 1,420 (14%)
Coal 209 468 (55%) 507 903 (44%)
Total $ 2,085 $ 2,925 (29%) $ 4,710 $ 5,765 (18%)
Units
Merchandise:
Agriculture, forest and
consumer products 165.8 200.6 (17%) 347.3 391.3 (11%)
Chemicals 112.1 153.7 (27%) 254.4 298.7 (15%)
Metals and construction 136.1 182.1 (25%) 291.0 346.5 (16%)
Automotive 37.1 101.8 (64%) 127.5 199.9 (36%)
Merchandise 451.1 638.2 (29%) 1,020.2 1,236.4 (17%)
Intermodal 884.4 1,048.5 (16%) 1,839.5 2,119.5 (13%)
Coal 111.6 258.3 (57%) 275.1 494.6 (44%)
Total 1,447.1 1,945.0 (26%) 3,134.8 3,850.5 (19%)
Revenue per Unit
Merchandise:
Agriculture, forest and
consumer products $ 3,004 $ 2,875 4% $ 3,021 $ 2,900 4%
Chemicals 3,771 3,541 6% 3,705 3,519 5%
Metals and construction 2,154 2,104 2% 2,269 2,175 4%
Automotive 2,499 2,471 1% 2,566 2,513 2%
Merchandise 2,897 2,751 5% 2,920 2,784 5%
Intermodal 644 668 (4%) 665 670 (1%)
Coal 1,864 1,815 3% 1,841 1,826 1%
Total 1,440 1,504 (4%) 1,502 1,497 -%
At the beginning of 2020, we combined the agriculture products and forest and
consumer commodity groups. In addition, we also made changes in the
categorization of certain other commodity groups within Merchandise.
Specifically, certain commodities were shifted between agriculture, forest, and
consumer products; chemicals; and,
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metals and construction. These changes were made as a result of organizational
initiatives to better align with how we manage these commodities. Prior period
railway operating revenues, units, and revenue per unit have been reclassified
to conform to the current presentation.
Railway operating revenues decreased $840 million in the second quarter and $1.1
billion for the first six months compared with the same periods last year. The
table below reflects the components of the revenue change by major commodity
group ($ in millions).
Second Quarter First Six Months
Increase (Decrease) Increase (Decrease)
Merchandise Intermodal Coal Merchandise Intermodal Coal
Volume $ (515) $ (110) $ (266) $ (602) $ (188) $ (401)
Fuel surcharge revenue (24) (48) (3) (30) (58) (9)
Rate, mix and other 90 26 10 169 50 14
Total $ (449) $ (132) $ (259) $ (463) $ (196) $ (396)
Approximately 90% of our revenue base is covered by contracts that include
negotiated fuel surcharges. Revenues associated with these surcharges totaled
$69 million and $144 million in the second quarters of 2020 and 2019,
respectively, and $200 million and $297 million for the first six months of 2020
and 2019, respectively. The decrease in fuel surcharge revenues for the second
quarter and first six months are driven by lower fuel commodity prices and
volume declines.
Merchandise
Merchandise revenue decreased in both periods as lower volumes were partially offset by higher average revenue per unit driven by pricing gains. Overall, volumes fell in all merchandise commodity groups and across almost all markets within those commodity groups due to the impact of the COVID-19 pandemic. The pandemic caused industries to close and suspend production which negatively impacted customers' needs for receiving materials and shipping finished and semi-finished goods. Agriculture, forest and consumer products volume decreased in both periods across almost all markets due to the impact of COVID-19 on gasoline consumption, the food service industry, and building, industrial, commercial and consumer activities. Chemicals volume decreased in both periods for all markets due to the impact from COVID-19 and the continuing disruptions in the energy market. Oil and petroleum shipments were negatively impacted due to reductions in gasoline/jet fuel demand and consumer travel. The pandemic caused industries to close which negatively impacted our customers' needs for materials. Metals and construction volume fell in both periods, largely the result of weakened demand due to reductions in metal and domestic vehicle production. Low coal power generation in the second quarter weakened scrubber stone demand, which negatively affected aggregates volumes. The pandemic caused industries to close and suspend production which heavily impacted customers' needs for receiving materials and shipping finished and semi-finished goods.
Automotive volume declined in both periods due to unplanned automotive plant shutdowns, primarily associated with the COVID-19 pandemic.
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--------------------------------------------------------------------------------Intermodal
Intermodal revenue declined in both periods, the result of decreased volumes and lower revenue per unit, a result of lower fuel surcharge revenue.
Intermodal units (in thousands) by market were as follows:
Second Quarter First Six Months
2020 2019 % change 2020 2019 % change
Domestic 566.6 635.8 (11%) 1,164.9 1,292.1 (10%)
International 317.8 412.7 (23%) 674.6 827.4 (18%)
Total 884.4 1,048.5 (16%) 1,839.5 2,119.5 (13%)
Domestic and international volumes fell in both periods, the result of supply
chain disruption resulting from COVID-19 related shutdowns and lower consumer
demand. The first six months were additionally impacted by stronger
over-the-road competition.
Coal
Coal revenues decreased in both periods, primarily driven by significant volume
declines partially offset by higher revenue per unit, resulting from volume
shortfalls and favorable mix.
Coal tonnage (in thousands) by market was as follows:
Second Quarter First Six Months
2020 2019 % change 2020 2019 % change
Utility 5,700 17,129 (67%) 14,598 32,884 (56%)
Export 3,669 6,626 (45%) 9,738 13,014 (25%)
Domestic metallurgical 2,338 3,851 (39%) 4,614 6,782 (32%)
Industrial 747 1,181 (37%) 1,728 2,403 (28%)
Total 12,454 28,787 (57%) 30,678 55,083 (44%)
In both periods, low natural gas prices and reduced demand in global and
domestic manufacturing due to COVID-19 negatively impacted all four of our
distinct coal markets. Utility coal tonnage was challenged by low natural gas
prices, high stockpiles, and diminished industrial and commercial electricity
demand. Export coal tonnage declined in both periods as a result of COVID-19
related global disruptions and weak seaborne pricing. Domestic metallurgical
coal and coke tonnage fell in both periods due to reduced domestic steel demand
leading to idled customer facilities and lower production. Industrial coal
tonnage decreased in both periods as a result of customer sourcing changes and
continued pressure from natural gas conversions.
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--------------------------------------------------------------------------------Railway Operating Expenses
Railway operating expenses summarized by major classifications were as follows
($ in millions):
Second Quarter First Six Months
2020 2019 % change 2020 2019 % change
Compensation and benefits $ 586 $ 712 (18%) $ 1,208 $ 1,439 (16%)
Purchased services and rents 372 418 (11%) 775 842 (8%)
Fuel 84 254 (67%) 273 504 (46%)
Depreciation 282 284 (1%) 574 567 1%
Materials and other 151 192 (21%) 317 382 (17%)
Loss on asset disposal - - 385 -
Total $ 1,475 $ 1,860 (21%) $ 3,532 $ 3,734 (5%)
Compensation and benefits expense decreased in both periods as follows:
•employment levels (down$98 million for the quarter and$174 million for the first six months), •health and welfare benefits for agreement employees (down$21 million for the quarter and$39 million for the first six months), •overtime and recrews (down$20 million for the quarter and$37 million for the first six months), •stock-based and incentive compensation (down$16 million for the quarter and$33 million for the first six months), •lower capitalized labor (additional expense of$13 million for the quarter and$23 million for the first six months), •increased pay rates (up$14 million for the quarter and$30 million for the first six months), and •other (up$2 million for the quarter and down$1 million for the first six months).
Average rail headcount for the quarter was down by over 4,900 compared with the second quarter of 2019.
Purchased services and rents declined in both periods as follows ($ in millions):
Second Quarter First Six Months
2020 2019 % change 2020 2019 % change
Purchased services $ 302 $ 347 (13%) $ 623 $ 693 (10%)
Equipment rents 70 71 (1%) 152 149 2%
Total $ 372 $ 418 (11%) $ 775 $ 842 (8%)
The decline in purchased services in both periods was largely the result of
decreased intermodal-related costs and lower operational and transportation
expenses. Equipment rents remained relatively flat for the second quarter but
increased modestly for the first six months, primarily the result of lower TTX
equity earnings partially offset by decreased intermodal volume-related
expenses.
Fuel expense, which includes the cost of locomotive fuel as well as other fuel
used in railway operations, decreased due to lower locomotive fuel prices (down
53% in the second quarter and 31% in the first six months), and decreased
consumption (down 32% in the second quarter and 23% in the first six months).
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Materials and other expenses decreased in both periods as follows ($ in millions):
Second Quarter First Six Months
2020 2019 % change 2020 2019 % change
Materials $ 62 $ 82 (24%) $ 134 $ 169 (21%)
Claims 40 50 (20%) 82 99 (17%)
Other 49 60 (18%) 101 114 (11%)
Total $ 151 $ 192 (21%) $ 317 $ 382 (17%)
Materials costs decreased in both periods, due primarily to lower locomotive
maintenance requirements as a result of fewer locomotives in service. Claims
expenses declined in both periods, driven by lower costs related to
environmental remediation matters. Other expense decreased in both periods, due
to lower travel-related expenses. The decrease in the first six months was
partially offset by lower gains from sales of operating properties. Gains from
operating property sales amounted to $13 million and $21 million in the first
six months of 2020 and 2019, respectively.
Other income - net
Other income - net increased$27 million in the second quarter and$5 million for the first six months. The second quarter experienced higher investment returns on corporate-owned life insurance partially offset by expenses associated with the debt exchange. Both periods reflect the impact of a prior year impairment loss on our natural resource assets, lower pension expenses, and lower 2020 non-operating property sales. Coal royalties were also lower in both periods due to the sale of our natural resource assets in the first quarter of 2020. In 2019, coal royalties were$24 million for the full year.
Income taxes
The second-quarter effective tax rate was 22.1% compared with 22.7% for the same period last year. Both periods benefited from favorable tax benefits on stock-based compensation while the current quarter reflects increased tax benefits from higher returns on corporate-owned life insurance. The effective tax rates were 17.7% and 22.1% for the first six months of 2020 and 2019, respectively. Both periods reflect tax benefits on stock-based compensation, while the effective rate for the first six months includes a$19 million reduction of taxes upon the resolution of our 2012 amended federal return.
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities, our principal source of liquidity, was$1.8 billion for the first six months of 2020, compared with$2.0 billion for the same period of 2019. We had working capital of$415 million atJune 30, 2020 and negative working capital of$219 million atDecember 31, 2019 . Cash and cash equivalents totaled$1.1 billion atJune 30, 2020 . Cash used in investing activities was$540 million for the first six months of 2020, compared with$852 million for the same period last year. The decrease was primarily driven by lower property additions in 2020. Cash used in financing activities was$655 million for the first six months of 2020, compared with$1.2 billion in the same period last year, reflecting lower repayments of debt and repurchases of Common Stock, partially offset by lower proceeds from borrowing. We repurchased 3.9 million shares of Common Stock totaling$669 million in the first six months of 2020 compared to 5.7 million shares, totaling$1.1 billion in the same period last year. The timing and volume of future share repurchases will be guided by our assessment of market conditions, cash flow and other pertinent factors. Any near-term purchases under the program are expected to be made with internally-generated cash, cash on hand, or proceeds from borrowings. 25 --------------------------------------------------------------------------------
Our total-debt-to-total capitalization ratio was 46.1% at
In
InMay 2020 , we also issued$800 million of 3.155% senior notes due 2055 in exchange for$554 million of our previously-issued notes ($450 million at 5.1% due 2118,$42 million at 6% due 2111,$29 million at 7.9% due 2097,$26 million at 6% due 2105, and$7 million at 7.05% due 2037). As part of the debt exchange, a$4 million loss on extinguishment was recognized in "Other income - net." InMay 2020 , we renewed and amended our accounts receivable securitization program with maximum borrowing capacity of$400 million and a term expiring inMay 2021 . We had no amounts outstanding at bothJune 30, 2020 , andDecember 31, 2019 , and our available borrowing capacity was$308 million and$429 million , respectively. In addition, we have investments in general purpose corporate-owned life insurance policies and had the ability to borrow up to$725 million against these policies atJune 30, 2020 . InMarch 2020 , we renewed and amended our five-year credit agreement which expires inMarch 2025 and provides for borrowings at prevailing rates and includes covenants. We increased the program's borrowing capacity from$750 million to$800 million . We had no amounts outstanding under this facility at bothJune 30, 2020 , andDecember 31, 2019 , and we are in compliance with all of its covenants. We expect 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 expenditures on property additions and shareholder distributions, including share repurchases, provide additional flexibility to meet our ongoing obligations. Nonetheless, we are monitoring the ongoing impacts of the COVID-19 pandemic, which could lead to a further decline of cash inflows from operations. There have been no material changes to the information on future contractual obligations contained in our Form 10-K for the year endedDecember 31, 2019 , with the exception of additional senior notes (see Note 8).
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. These estimates and assumptions may require judgment about matters that are inherently uncertain, and future events are likely to occur that may require us to make changes to these estimates and assumptions. Accordingly, we regularly review these estimates and assumptions based on historical experience, changes in the business environment, and other factors we believe to be reasonable under the circumstances. There have been no significant changes to the application of the critical accounting policies contained in our Form 10-K atDecember 31, 2019 . 26 --------------------------------------------------------------------------------
OTHER MATTERS Labor Agreements Approximately 80% of our railroad employees are covered by collective bargaining agreements with various labor unions. Pursuant to the Railway Labor Act, these agreements remain in effect until new agreements are reached, or until the bargaining procedures mandated by the Railway Labor Act are completed. We largely bargain nationally in concert with other major railroads, represented by the National Carriers Conference Committee. Moratorium provisions in the labor agreements govern when the railroads and unions may propose changes to the agreements. The current round of bargaining commenced onNovember 1, 2019 with both management and the unions serving their formal proposals for changes to the collective bargaining agreements.
New Accounting Pronouncements
For a detailed discussion of new accounting pronouncements, see Note 12.
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 the risks and uncertainties related to the COVID-19 pandemic and those discussed under "Risk Factors" in our latest Form 10-K, as well as our subsequent filings with theSecurities and Exchange Commission , may cause actual results, performance, or achievements to differ materially from those expressed or implied by these forward-looking statements. The forward-looking statements herein are made only as of the date they were first issued, and unless otherwise required by applicable securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. 27
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