Notes to Consolidated Financial Statements
(Unaudited)
In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly Norfolk Southern Corporation (Norfolk Southern) and subsidiaries’ (collectively, NS, we, us, and our) financial position at
June 30, 2017
, and
December 31, 2016
, our results of operations and comprehensive income for the
second quarter
s and
first six months
of
2017
and
2016
, and our cash flows for the
first six months
of
2017
and
2016
in conformity with U.S. generally accepted accounting principles (GAAP).
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in our latest Annual Report on Form 10-K.
1. Stock-Based Compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
|
First Six Months
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
($ in millions)
|
Stock-based compensation expense
|
|
$
|
5
|
|
|
$
|
8
|
|
|
$
|
32
|
|
|
$
|
35
|
|
Total tax benefit
|
|
4
|
|
|
5
|
|
|
34
|
|
|
19
|
|
During
2017
, a committee of nonemployee members of our Board of Directors (or the Chief Executive Officer when delegated authority by such committee) granted stock options, restricted stock units (RSUs) and performance share units (PSUs) pursuant to the Long-Term Incentive Plan (LTIP) and granted stock options pursuant to the Thoroughbred Stock Option Plan (TSOP), as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
|
First Six Months
|
|
|
|
|
Granted
|
|
Weighted-Average Grant-Date Fair Value
|
|
Granted
|
|
Weighted-Average Grant-Date Fair Value
|
Stock options:
|
|
|
|
|
|
|
|
|
|
LTIP
|
|
—
|
|
|
$
|
—
|
|
|
341,120
|
|
$
|
37.73
|
|
|
TSOP
|
|
—
|
|
|
—
|
|
|
144,440
|
|
31.33
|
|
|
|
Total
|
|
—
|
|
|
|
|
485,560
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock units
|
|
2,970
|
|
|
117.75
|
|
|
83,330
|
|
120.16
|
|
Performance share units
|
|
10,648
|
|
|
116.48
|
|
|
295,601
|
|
87.97
|
|
Stock Options
The options granted under the LTIP and the TSOP have a term that will not exceed
ten
years and 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. 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 Norfolk Southern common stock (Common Stock). Dividend equivalent payments are not made on the TSOP options.
The fair value of each option award was measured on the date of grant using a binomial lattice-based option 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 within the valuation model. The average
expected option life is derived from the output of the valuation model and represents the period of time that all options granted are expected to be outstanding, including the branches of the model that result in options expiring unexercised. The average risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. A dividend yield of
zero
was used for the LTIP options during the vesting period. A dividend yield of
2.04%
was used for all vested LTIP options and all TSOP options.
The assumptions for the
2017
LTIP and TSOP grants are shown in the following table:
|
|
|
Average expected volatility
|
26%
|
Average risk-free interest rate
|
2.51
%
|
Average expected option term LTIP
|
8.6 years
|
Average expected option term TSOP
|
8.3 years
|
Per-share grant price LTIP and TSOP
|
$120.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Quarter
|
|
First Six Months
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
($ in millions)
|
Stock options exercised
|
|
125,593
|
|
|
156,003
|
|
|
1,011,315
|
|
|
369,917
|
|
Cash received upon exercise
|
|
$
|
8
|
|
|
$
|
8
|
|
|
$
|
57
|
|
|
$
|
18
|
|
Related tax benefit realized
|
|
$
|
3
|
|
|
$
|
1
|
|
|
$
|
19
|
|
|
$
|
2
|
|
Restricted Stock Units
RSUs primarily have a five-year restriction period and will be settled through the issuance of shares of Common Stock. The RSU grants include cash dividend equivalent payments during the restriction period in an amount equal to the regular quarterly dividends paid on Common Stock. The total related tax benefits were less than
$1 million
for the second quarter of 2017 and
$1 million
for the second quarter of 2016. No RSUs vested or were paid out during the second quarters of 2017 or 2016.
|
|
|
|
|
|
|
|
|
|
|
|
First Six Months
|
|
|
2017
|
|
2016
|
|
|
($ in millions)
|
RSUs vested
|
|
137,200
|
|
|
175,500
|
Common Stock issued net of tax withholding
|
|
81,318
|
|
|
103,936
|
Related tax benefit realized
|
|
$
|
3
|
|
|
$
|
1
|
|
Performance Share Units
PSUs provide for awards based on the achievement of certain predetermined corporate performance goals at the end of a
three
-year cycle and are settled through the issuance of shares of Common Stock. All PSUs will earn out based on the achievement of performance conditions and some will also earn out based on a market condition. The market condition fair value was measured on the date of grant using a Monte Carlo simulation model. No PSUs were earned or paid out during the second quarters of 2017 or 2016.
|
|
|
|
|
|
|
|
|
|
|
|
First Six Months
|
|
|
2017
|
|
2016
|
|
|
($ in millions)
|
PSUs earned
|
|
171,080
|
|
|
406,038
|
Common Stock issued net of tax withholding
|
|
99,805
|
|
|
241,757
|
Related tax benefit realized
|
|
$
|
1
|
|
|
$
|
3
|
|
2. Earnings Per Share
The following table sets forth the calculation of basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
Diluted
|
|
Second Quarter
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
($ in millions, except per share amounts,
shares in millions)
|
|
|
|
|
|
|
|
|
Net income
|
$
|
497
|
|
|
$
|
405
|
|
|
$
|
497
|
|
|
$
|
405
|
|
Dividend equivalent payments
|
(1
|
)
|
|
(1
|
)
|
|
—
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
Income available to common stockholders
|
$
|
496
|
|
|
$
|
404
|
|
|
$
|
497
|
|
|
$
|
404
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding
|
289.0
|
|
|
294.7
|
|
|
289.0
|
|
|
294.7
|
|
Dilutive effect of outstanding options
|
|
|
|
|
|
|
|
|
|
|
|
and share-settled awards
|
|
|
|
|
|
|
2.2
|
|
|
1.9
|
|
|
|
|
|
|
|
|
|
Adjusted weighted-average shares outstanding
|
|
|
|
|
|
|
291.2
|
|
|
296.6
|
|
|
|
|
|
|
|
|
|
Earnings per share
|
$
|
1.72
|
|
|
$
|
1.37
|
|
|
$
|
1.71
|
|
|
$
|
1.36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
Diluted
|
|
First Six Months
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
($ in millions, except per share amounts,
shares in millions)
|
Net income
|
$
|
930
|
|
|
$
|
792
|
|
|
$
|
930
|
|
|
$
|
792
|
|
Dividend equivalent payments
|
(2
|
)
|
|
(2
|
)
|
|
(1
|
)
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
Income available to common stockholders
|
$
|
928
|
|
|
$
|
790
|
|
|
$
|
929
|
|
|
$
|
790
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding
|
289.6
|
|
|
296.0
|
|
|
289.6
|
|
|
296.0
|
|
Dilutive effect of outstanding options
|
|
|
|
|
|
|
|
|
|
|
|
and share-settled awards
|
|
|
|
|
|
|
2.4
|
|
|
1.7
|
|
|
|
|
|
|
|
|
|
Adjusted weighted-average shares outstanding
|
|
|
|
|
|
|
292.0
|
|
|
297.7
|
|
|
|
|
|
|
|
|
|
Earnings per share
|
$
|
3.20
|
|
|
$
|
2.67
|
|
|
$
|
3.18
|
|
|
$
|
2.65
|
|
During the
second quarter
s and first six months of
2017
and
2016
, dividend equivalent payments were made to holders of LTIP stock options and RSUs. For purposes of computing basic earnings per share, dividend equivalent payments made to holders of these stock options and RSUs were deducted from net income to determine income available to common stockholders. For purposes of computing diluted earnings per share, we evaluate on a grant-by-grant basis those stock options and RSUs receiving dividend equivalent payments under the two-class and treasury stock methods to determine which method is the more dilutive for each grant. For those grants for which the two-class method was more dilutive, net income was reduced by dividend equivalent payments to determine income available to common stockholders. The dilution calculations exclude options having exercise prices
exceeding the average market price of Common Stock as follows:
0.5 million
in each of the first and second quarters of 2017 and
1.5 million
in each of the first and second quarters of 2016.
3. Accumulated Other Comprehensive Loss
The changes in the cumulative balances of “Accumulated other comprehensive loss” reported in the Consolidated Balance Sheets consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at Beginning
of Year
|
|
Net
Loss
|
|
Reclassification
Adjustments
|
|
Balance
at End
of Period
|
|
($ in millions)
|
Six months ended June 30, 2017
|
|
|
|
|
|
|
|
Pensions and other postretirement
|
|
|
|
|
|
|
|
liabilities
|
$
|
(414
|
)
|
|
$
|
—
|
|
|
$
|
8
|
|
(1)
|
$
|
(406
|
)
|
Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
of equity investees
|
(73
|
)
|
|
(1
|
)
|
|
—
|
|
|
(74
|
)
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive loss
|
$
|
(487
|
)
|
|
$
|
(1
|
)
|
|
$
|
8
|
|
|
$
|
(480
|
)
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
Pensions and other postretirement
|
|
|
|
|
|
|
|
liabilities
|
$
|
(367
|
)
|
|
$
|
—
|
|
|
$
|
8
|
|
(1)
|
$
|
(359
|
)
|
Other comprehensive loss
|
|
|
|
|
|
|
|
of equity investees
|
(78
|
)
|
|
—
|
|
|
—
|
|
|
(78
|
)
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive loss
|
$
|
(445
|
)
|
|
$
|
—
|
|
|
$
|
8
|
|
|
$
|
(437
|
)
|
|
|
(1)
|
These items are included in the computation of net periodic pension and postretirement benefit costs. See Note 7, “Pensions and Other Postretirement Benefits,” for additional information.
|
4. Stock Repurchase Program
We repurchased and retired
3.4 million
and
5.0 million
shares of Common Stock under our stock repurchase program in the
first six months
of
2017
and
2016
, respectively, at a cost of
$402 million
and
$400 million
, respectively. Since the beginning of 2006, we have repurchased and retired
163.7 million
shares at a total cost of
$10.7 billion
.
5. Investments
Investment in Conrail
Through a limited liability company, we and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primary subsidiary is Consolidated Rail Corporation (CRC). We have a
58%
economic and
50%
voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests. Our investment in Conrail was
$1.2 billion
at both
June 30, 2017
, and
December 31, 2016
.
CRC owns and operates certain properties (the Shared Assets Areas) for the joint and exclusive benefit of Norfolk Southern Railway Company (NSR) and CSX Transportation, Inc. (CSXT). The costs of operating the Shared Assets Areas are borne by NSR and CSXT based on usage. In addition, NSR and CSXT pay CRC a fee for access to the Shared Assets Areas. “Purchased services and rents” and “Fuel” include amounts payable to CRC for the operation of the Shared Assets Areas totaling
$37 million
and
$36 million
for the
second quarter
s of
2017
and
2016
,
respectively, and
$72 million
and
$75 million
for the
first six months
of
2017
and
2016
, respectively. Our equity in the earnings of Conrail, net of amortization, included in “Purchased services and rents” was
$10 million
and
$11 million
for the
second quarter
s of
2017
and
2016
, respectively, and
$20 million
and
$22 million
for the
first six months
of
2017
and
2016
, respectively.
“Other liabilities” includes
$280 million
at both
June 30, 2017
,
and
December 31, 2016
, for long-term advances from Conrail, maturing
2044
, that bear interest at an average rate of
2.9%
.
Investment in TTX
NS and eight other North American railroads jointly own TTX Company (TTX). NS has a
19.65%
ownership interest in TTX, a railcar pooling company that provides its owner-railroads with standardized fleets of intermodal, automotive, and general use railcars at stated rates.
Amounts payable to TTX for use of equipment are included in “Purchased services and rents” and amounted to
$58 million
and
$56 million
of expense for the
second quarter
s of
2017
and
2016
, respectively, and
$115 million
and
$114 million
for the
first six months
of
2017
and
2016
, respectively. Our equity in the earnings of TTX, also included in “Purchased services and rents,” totaled
$10 million
and
$5 million
for the
second quarter
s of
2017
and
2016
, respectively, and
$18 million
and
$10 million
for the
first six months
of
2017
and
2016
, respectively.
6. Debt
During the second quarter of 2017, NS issued
$300 million
of
3.15%
senior notes due
2027
.
We have in place a
$350 million
receivables securitization facility which expires in June 2018. At June 30, 2017, the amount outstanding under the facility was
$100 million
and was included within “Long-term debt” due to our intent to refinance
$100 million
of these borrowings on a long-term basis, which is supported by our
$750 million
credit agreement.
7. Pensions and Other Postretirement Benefits
We have both funded and unfunded defined benefit pension plans covering principally salaried employees. We also provide specified health care and life insurance benefits to eligible retired employees; these plans can be amended or terminated at our option. Under our self-insured retiree health care plan, for those participants who are not Medicare-eligible, a defined percentage of health care expenses is covered for retired employees and their dependents, reduced by any deductibles, coinsurance, and, in some cases, coverage provided under other group insurance policies. Those participants who are Medicare-eligible are not covered under the self-insured retiree health care plan, but instead are provided with an employer-funded health reimbursement account which can be used for reimbursement of health insurance premiums or eligible out-of-pocket medical expenses.
Pension and postretirement benefit cost components for the
second quarter
and
first six months
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Postretirement
|
|
Pension Benefits
|
|
Benefits
|
|
Second Quarter
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
($ in millions)
|
|
|
|
|
|
|
|
|
Service cost
|
$
|
10
|
|
|
$
|
9
|
|
|
$
|
2
|
|
|
$
|
2
|
|
Interest cost
|
20
|
|
|
21
|
|
|
4
|
|
|
4
|
|
Expected return on plan assets
|
(43
|
)
|
|
(43
|
)
|
|
(4
|
)
|
|
(5
|
)
|
Amortization of net losses
|
13
|
|
|
12
|
|
|
—
|
|
|
—
|
|
Amortization of prior service benefit
|
—
|
|
|
—
|
|
|
(6
|
)
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
Net benefit
|
$
|
—
|
|
|
$
|
(1
|
)
|
|
$
|
(4
|
)
|
|
$
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Postretirement
|
|
Pension Benefits
|
|
Benefits
|
|
First Six Months
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
($ in millions)
|
Service cost
|
$
|
19
|
|
|
$
|
18
|
|
|
$
|
4
|
|
|
$
|
3
|
|
Interest cost
|
40
|
|
|
41
|
|
|
8
|
|
|
8
|
|
Expected return on plan assets
|
(86
|
)
|
|
(86
|
)
|
|
(8
|
)
|
|
(9
|
)
|
Amortization of net losses
|
26
|
|
|
25
|
|
|
—
|
|
|
—
|
|
Amortization of prior service benefit
|
—
|
|
|
—
|
|
|
(12
|
)
|
|
(12
|
)
|
|
|
|
|
|
|
|
|
Net benefit
|
$
|
(1
|
)
|
|
$
|
(2
|
)
|
|
$
|
(8
|
)
|
|
$
|
(10
|
)
|
8. Fair Values of Financial Instruments
The fair values of “Cash and cash equivalents,” “Accounts receivable,” “Accounts payable,” and “Short-term debt” approximate carrying values because of the short maturity of these financial instruments. The carrying value of corporate-owned life insurance is recorded at cash surrender value and, accordingly, approximates fair value. Other than these assets and liabilities that approximate fair value, there are
no
other assets or liabilities measured at fair value on a recurring basis at
June 30, 2017
, or
December 31, 2016
. The carrying amounts and estimated fair values
for the remaining financial instruments, excluding investments accounted for under the equity method, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
|
($ in millions)
|
|
|
|
|
|
|
|
|
Long-term investments
|
$
|
115
|
|
|
$
|
139
|
|
|
$
|
116
|
|
|
$
|
141
|
|
Long-term debt, including current maturities
|
(9,873
|
)
|
|
(11,675
|
)
|
|
(10,112
|
)
|
|
(11,626
|
)
|
Underlying net assets and future discounted cash flows were used to estimate the fair value of investments. The fair values of long-term debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, credit rating, and remaining maturity.
The following table sets forth the fair value of long-term investment and long-term debt balances disclosed above by valuation technique level, within the fair value hierarchy (there were no level 3 valued assets or liabilities).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Total
|
|
($ in millions)
|
|
|
|
|
|
|
June 30, 2017
|
|
|
|
|
|
Long-term investments
|
$
|
4
|
|
|
$
|
135
|
|
|
$
|
139
|
|
Long-term debt, including current maturities
|
(11,478
|
)
|
|
(197
|
)
|
|
(11,675
|
)
|
|
|
|
|
|
|
December 31, 2016
|
|
|
|
|
|
|
|
|
Long-term investments
|
$
|
4
|
|
|
$
|
137
|
|
|
$
|
141
|
|
Long-term debt, including current maturities
|
(11,427
|
)
|
|
(199
|
)
|
|
(11,626
|
)
|
9. Commitments and Contingencies
Lawsuits
We and/or certain subsidiaries are defendants in numerous lawsuits and other claims relating principally to railroad operations. When we conclude that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, it is accrued through a charge to earnings. While the ultimate amount of liability incurred in any of these lawsuits and claims is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payment of such liability and claims. However, the final outcome of any of these lawsuits and claims cannot be predicted with certainty, and unfavorable or unexpected outcomes could result in additional accruals that could be significant to results of operations in a particular year or quarter. Any adjustments to the recorded liability will be reflected in earnings in the periods in which such adjustments become known.
One of our chemical customers, Sunbelt Chlor Alkali Partnership (Sunbelt), filed a rate reasonableness complaint before the Surface Transportation Board (STB) alleging that our tariff rates for transportation of regulated movements are unreasonable. Since April 1, 2011, we have been billing and collecting amounts based on the challenged tariff rates. In 2014, the STB resolved this rate reasonableness complaint in our favor, and in June 2016, the STB resolved petitions for reconsideration. The matter remains decided in our favor; however, the findings are still subject to appeal. We believe the estimate of any reasonably possible loss will not have a material effect on our financial position, results of operations, or liquidity. With regard to rate cases, we record adjustments to revenues in the periods if and when such adjustments are probable and reasonably estimable.
On November 6, 2007, various antitrust class actions filed against us and other Class I railroads in various Federal district courts regarding fuel surcharges were consolidated in the District of Columbia by the Judicial Panel on Multidistrict Litigation. On June 21, 2012, the court certified the case as a class action. The defendant railroads appealed this certification, and the Court of Appeals for the District of Columbia vacated the District Court’s decision and remanded the case for further consideration. We believe the allegations in the complaints are without merit and intend to vigorously defend the cases. We do not believe the outcome of these proceedings will have a material effect on our financial position, results of operations, or liquidity.
Casualty Claims
Casualty claims include employee personal injury and occupational claims as well as third-party claims, all exclusive of legal costs. To aid in valuing our personal injury liability and determining the amount to accrue with respect to such claims during the year, we utilize studies prepared by an independent consulting actuarial firm. Job-related accidental injury and occupational claims are subject to the Federal Employers’ Liability Act (FELA), which is applicable only to railroads. FELA’s fault-based system produces results that are unpredictable and inconsistent as compared with a no-fault workers’ compensation system. The variability inherent in this system could result in actual costs being different from the liability recorded. While the ultimate amount of claims incurred is dependent on future developments, in our opinion, the recorded liability is adequate to cover the future payments of claims and is supported by the most recent actuarial study. In all cases, we record a liability when the expected loss for the claim is both probable and reasonably estimable.
Employee personal injury claims
– The largest component of casualties and other claims expense is employee personal injury costs. The independent actuarial firm engaged by us provides quarterly studies to aid in valuing our employee personal injury liability and estimating personal injury expense. The actuarial firm studies our historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences. The actuarial firm uses the results of these analyses to estimate the ultimate amount of liability. We adjust the liability quarterly based upon our assessment and the results of the study. Our estimate of the liability is subject to inherent limitation given the difficulty of predicting future events such as jury decisions, court interpretations, or legislative changes. As a result, actual claim settlements may vary from the estimated liability recorded.
Occupational claims
– Occupational claims (including asbestosis and other respiratory diseases, as well as conditions allegedly related to repetitive motion) are often not caused by a specific accident or event but rather allegedly result from a claimed exposure over time. Many such claims are being asserted by former or retired employees, some of whom have not been employed in the rail industry for decades. The independent actuarial firm provides an estimate of the occupational claims liability based upon our history of claim filings, severity, payments, and other pertinent facts. The liability is dependent upon judgments we make as to the specific case reserves as well as judgments of the actuarial firm in the quarterly studies. The actuarial firm’s estimate of ultimate loss includes a provision for those claims that have been incurred but not reported. This provision is derived by analyzing industry data and projecting our experience. We adjust the liability quarterly based upon our assessment and the results of the study. However, it is possible that the recorded liability may not be adequate to cover the future payment of claims. Adjustments to the recorded liability are reflected in operating expenses in the periods in which such adjustments become known.
Third-party claims
– We record a liability for third-party claims, including those for highway crossing accidents, trespasser and other injuries, automobile liability, property damage, and lading damage. The actuarial firm assists us with the calculation of potential liability for third-party claims, except lading damage, based upon our experience including the number and timing of incidents, amount of payments, settlement rates, number of open claims, and legal defenses. We adjust the liability quarterly based upon our assessment and the results of the study. Given the inherent uncertainty in regard to the ultimate outcome of third-party claims, it is possible that the actual loss may differ from the estimated liability recorded.
Environmental Matters
We are subject to various jurisdictions’ environmental laws and regulations. We record a liability where such liability or loss is probable and reasonably estimable. Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates.
Our Consolidated Balance Sheets include liabilities for environmental exposures of
$65 million
and
$67 million
at
June 30, 2017
, and
December 31, 2016
, respectively (of which
$15 million
are classified as current liabilities at both dates). At
June 30, 2017
, the liability represents our estimates of the probable cleanup, investigation, and remediation costs based on available information at
131
known locations and projects compared with
134
locations and projects at
December 31, 2016
. At
June 30, 2017
,
16
sites accounted for
$42 million
of the liability, and no individual site was considered to be material. We anticipate that much of this liability will be paid out over
five
years; however, some costs will be paid out over a longer period.
At
ten
locations, one or more of our subsidiaries in conjunction with a number of other parties have been identified as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 or comparable state statutes that impose joint and several liability for cleanup costs. We calculate our estimated liability for these sites based on facts and legal defenses applicable to each site and not solely on the basis of the potential for joint liability.
With respect to known environmental sites (whether identified by us or by the Environmental Protection Agency or comparable state authorities), estimates of our ultimate potential financial exposure for a given site or in the aggregate for all such sites can change over time because of the widely varying costs of currently available cleanup techniques, unpredictable contaminant recovery and reduction rates associated with available cleanup technologies, the likely development of new cleanup technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant’s share of any estimated loss (and that participant’s ability to bear it), and evolving statutory and regulatory standards governing liability.
The risk of incurring environmental liability, for acts and omissions, past, present, and future, is inherent in the railroad business. Some of the commodities we transport, particularly those classified as hazardous materials, pose special risks that we work diligently to reduce. In addition, several of our subsidiaries own, or have owned, land used as operating property, or which is leased and operated by others, or held for sale. Because environmental problems that are latent or undisclosed may exist on these properties, there can be no assurance that we will not incur environmental liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and potentially other unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on our financial position, results of operations, or liquidity in a particular year or quarter.
Based on our assessment of the facts and circumstances now known, we believe we have recorded the probable and reasonably estimable costs for dealing with those environmental matters of which we are aware. Further, we believe that it is unlikely that any known matters, either individually or in the aggregate, will have a material adverse effect on our financial position, results of operations, or liquidity.
Insurance
We obtain, on behalf of ourself and our subsidiaries, insurance for potential losses for third-party liability and first-party property damages. We are currently self-insured up to
$50 million
and above
$1.1 billion
(
$1.5 billion
for specific perils) per occurrence and/or policy year for bodily injury and property damage to third parties and up to
$25 million
and above
$200 million
per occurrence and/or policy year for property owned by us or in our care, custody, or control.
10. New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09,
“Revenue from Contracts with Customers.”
This update will replace most existing revenue recognition guidance in GAAP and require an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new standard will be effective for our annual and interim reporting periods beginning January 1, 2018. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We are still evaluating the effects of ASU 2014-09, but we do not currently expect that adoption of the standard will have a material effect on our consolidated financial statements. There will be no change to our pattern of revenue recognition related to transportation revenue, which will continue to be recognized proportionally as a shipment moves from origin to destination. Certain additional financial statement disclosure requirements are mandated by the new standard including disclosure of contract assets and contract liabilities as well as a disaggregated view of revenue, which we expect to be similar to our current disclosures within the “Railway Operating Revenues” section of Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We do not plan to adopt the standard early and we have not yet determined which transition method we will use.
In February 2016, the FASB issued ASU 2016-02,
“Leases.”
This update, effective for our annual and interim reporting periods beginning January 1, 2019, will replace existing lease guidance in GAAP and will require lessees to recognize lease assets and lease liabilities on the balance sheet for all leases greater than twelve months and disclose key information about leasing arrangements. When implemented, lessees and lessors will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. We are currently evaluating the effects ASU 2016-02 will have on our consolidated financial statements and related disclosures. We disclosed
$614 million
in operating lease obligations in our lease commitments footnote in our most recent Form 10-K and we will evaluate those contracts as well as other existing arrangements to determine if they qualify for lease accounting under the new standard. We do not plan to adopt the standard early.
In June 2016, the FASB issued ASU 2016-13,
“Credit Losses - Measurement of Credit Losses on Financial Instruments,”
which replaces the current incurred loss impairment method with a method that reflects expected credit losses. The new standard is effective as of January 1, 2020, and early adoption is permitted as of January 1, 2019. Because credit losses associated from our trade receivables have historically been insignificant, we do not expect this standard to have a material effect on our financial statements.
In March 2017, the FASB issued ASU No. 2017-07,
“Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.”
This update, effective for annual and interim reporting periods beginning January 1, 2018, will require segregation of these net benefit costs between operating and non-operating expenses. Currently, we report the net benefit costs associated with our defined benefit and postretirement plans in the “Compensation and benefits” line item of the Consolidated Statements of Income, as disclosed in Note 7, “Pensions and Other Postretirement Benefits.” When the ASU is implemented, only the service cost component of defined benefit pension cost and postretirement benefit cost will be reported within compensation costs, while all other components of net benefit cost will be presented within the “Other income
–
net” line item on the Consolidated Statements of Income. The standard requires retrospective application, and as such the adoption of this standard will result in offsetting increases in “Compensation and benefits” expense and “Other income
–
net” of the Consolidated Statements of Income for all periods of 2017 and 2016, with no impact on net income. We did not adopt the standard early.