FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended July 2, 1999 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number 1-3359 CSX TRANSPORTATION, INC. (Exact name of registrant as specified in its charter) Virginia 54-6000720 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 500 Water Street, Jacksonville, Florida 32202 (Address of principal executive offices) (Zip Code) (904) 359-3100 (Registrant's telephone number, including area code) No Change (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of July 2, 1999: 9,061,038 shares. REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H (1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT. - 1 - CSX TRANSPORTATION, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JULY 2, 1999 INDEX Page Number PART I. FINANCIAL INFORMATION Item 1: Financial Statements 1. Consolidated Statement of Earnings- Quarters and Six Months Ended July 2, 1999 and June 26, 1998 3 2. Consolidated Statement of Cash Flows- Six Months Ended July 2, 1999 and June 26, 1998 4 3. Consolidated Statement of Financial Position- At July 2, 1999 and December 25, 1998 5 Notes to Consolidated Financial Statements 6 Item 2: Management's Analysis and Results of Operations 12 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 18 Signature 18 - 2 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Consolidated Statement of Earnings (Millions of Dollars) (Unaudited) Quarters Ended Six Months Ended ------------------------ ------------------------ July 2, June 26, July 2, June 26, 1999 1998 1999 1998 ----------- ----------- ----------- ----------- OPERATING REVENUE Merchandise $ 958 $ 842 $ 1,864 $ 1,673 Coal 337 373 690 739 Other 39 38 77 96 ---------- ---------- ----------- ---------- Total 1,334 1,253 2,631 2,508 ---------- ---------- ----------- ---------- OPERATING EXPENSE Labor and Fringe Benefits 529 473 1,030 982 Materials, Supplies and Other 216 205 416 391 Conrail Operating Fee, Rent and Services 40 - 40 - Related Party Service Fees 144 70 245 150 Equipment Rent 105 93 214 181 Depreciation 115 112 238 224 Fuel 64 62 118 129 ---------- ---------- ----------- ---------- Total 1,213 1,015 2,301 2,057 ---------- ---------- ----------- ---------- OPERATING INCOME 121 238 330 451 Other Income (Expense) (28) (27) (83) (51) Interest Expense 20 16 38 32 ---------- ---------- ----------- ---------- EARNINGS BEFORE INCOME TAXES 73 195 209 368 Income Tax Expense 28 71 79 137 ---------- ---------- ----------- ---------- NET EARNINGS $ 45 $ 124 $ 130 $ 231 ========== ========== =========== ========== See accompanying Notes to Consolidated Financial Statements. - 3 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Consolidated Statement of Cash Flows (Millions of Dollars) (Unaudited) Six Months Ended ------------------------- July 2, June 26, 1999 1998 ----------- ------------ OPERATING ACTIVITIES Net Earnings $ 130 $ 231 Adjustments to Reconcile Net Earnings to Net Cash Provided Depreciation 238 223 Deferred Income Taxes 55 84 Productivity/Restructuring Charge Payments (6) (17) Other Operating Activities 7 (18) Changes in Operating Assets and Liabilities Accounts and Notes Receivable (244) 38 Materials and Supplies (19) (39) Other Current Assets 4 (35) Accounts Payable 9 83 Other Current Liabilities 109 (66) --------- ---------- Net Cash Provided by Operating Activities 283 484 --------- ---------- INVESTING ACTIVITIES Property Additions (480) (554) Other Investing Activities (20) (37) --------- ---------- Net Cash Used by Investing Activities (500) (591) --------- ---------- FINANCING ACTIVITIES Long-Term Debt Issued 195 166 Long-Term Debt Repaid (58) (46) Cash Dividends Paid (96) (74) Other Financing Activities (1) (1) --------- ---------- Net Cash Provided by Financing Activities 40 45 --------- ---------- Net Decrease in Cash and Cash Equivalents (177) (62) CASH AND CASH EQUIVALENTS Cash and Cash Equivalents at Beginning of Period 177 474 --------- ---------- Cash and Cash Equivalents at End of Period $ 0 $ 412 ========= ========== See accompanying Notes to Consolidated Financial Statements. - 4 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Consolidated Statement of Financial Position (Millions of Dollars) (Unaudited) July 2, December 25, 1999 1998 ------------ ----------- ASSETS Current Assets Cash and Cash Equivalents (principally investment in CSX Cash Management Plan - see Note 7) $ - $ 177 Accounts and Notes Receivable 430 170 Materials and Supplies 189 171 Deferred Income Taxes 131 111 Other Current Assets 162 102 ----------- ----------- Total Current Assets 912 731 Properties 15,693 15,215 Accumulated Depreciation (4,797) (4,559) ----------- ----------- Properties-Net 10,896 10,656 Affiliates and Other Companies 231 223 Other Long-Term Assets 418 287 ----------- ----------- Total Assets $ 12,457 $ 11,897 =========== =========== LIABILITIES Current Liabilities Accounts Payable $ 776 $ 751 Labor and Fringe Benefits Payable 258 278 Casualty, Environmental and Other Reserves 175 174 Current Maturities of Long-Term Debt 112 100 Due to Parent Company 118 25 Due to Affiliate 90 90 Other Current Liabilities 291 50 ----------- ----------- Total Current Liabilities 1,820 1,468 Casualty, Environmental and Other Reserves 505 521 Long-Term Debt 1,030 906 Deferred Income Taxes 2,851 2,776 Other Long-Term Liabilities 652 661 ----------- ----------- Total Liabilities 6,858 6,332 ----------- ----------- SHAREHOLDER'S EQUITY Common Stock, $20 Par Value: Authorized 10,000,000 Shares; Issued and Outstanding 9,061,038 Shares 181 181 Other Capital 1,294 1,294 Retained Earnings 4,124 4,090 ----------- ----------- Total Shareholder's Equity 5,599 5,565 ----------- ----------- Total Liabilities and Shareholder's Equity $ 12,457 $ 11,897 =========== =========== See accompanying Notes to Consolidated Financial Statements. - 5 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) (All Tables in Millions of Dollars) NOTE 1. BASIS OF PRESENTATION In the opinion of management, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position of CSX Transportation, Inc. (CSXT) and its majority-owned subsidiaries as of July 2, 1999 and December 25, 1998, the results of their operations and their cash flows for the quarters and six months ended July 2, 1999 and June 26, 1998, such adjustments being of a normal recurring nature. CSXT is a wholly-owned subsidiary of CSX Corporation (CSX). While management believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the financial statements and the notes included in CSXT's latest Form 10-K. Certain prior-year data have been reclassified to conform to the 1999 presentation. The company's fiscal year is composed of 52 or 53 weeks ending on the last Friday in December. Fiscal year 1999 consists of 53 weeks ending on December 31, 1999. Fiscal year 1998 consisted of 52 weeks ended December 25, 1998. The financial statements presented are for the 13-week quarters ended July 2, 1999 and June 26, 1998, the 27-week period ended July 2, 1999, the 26- week period ended June 26, 1998, and as of December 25, 1998. NOTE 2. ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board has issued Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133" which postpones the effective date of FASB Statement No. 133 until fiscal quarters of all fiscal years beginning after June 15, 2000. Statement No. 133 requires companies to record derivatives on the statement of financial position, measured at fair value. The statement also sets forth new accounting rules for gains or losses resulting from changes in the values of derivatives. While CSXT does not currently use derivative financial instruments, and its historical use of such instruments has not been material, the company plans to adopt this statement in the first quarter of 2001 to the extent it may apply at that time. The company would not expect the adoption of Statement No. 133 to have a material impact on its financial statements. NOTE 3. INTEGRATION OF CONRAIL On June 1, 1999, CSXT and Norfolk Southern Corporation's (Norfolk Southern) rail subsidiary formally began integrated operations over their respective portions of the Conrail Inc. (Conrail) rail systems. This step implements the operating plan envisioned by CSX and Norfolk Southern when they completed the joint acquisition of Conrail in May 1997 and later received regulatory approval permitting them to exercise joint control over Conrail in August 1998. The respective railroads operate designated portions of the Conrail system pursuant to various operating agreements which took effect on June 1. Under these agreements, which have terms of 25 years plus options to extend, the railroads pay operating fees to Conrail for the use of right-of-way and rent for the use of equipment. Conrail continues to provide rail service in certain shared geographic areas for the joint benefit of CSXT and Norfolk Southern for which it is compensated on the basis of - 6 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited), Continued (All Tables in Millions of Dollars) NOTE 3. INTEGRATION OF CONRAIL, Continued usage by the respective railroads. CSX and Norfolk Southern, through a joint acquisition entity, hold economic interests in Conrail of 42% and 58%, respectively, and voting interests of 50% each. Upon integration, substantially all of Conrail's customer freight contracts were assumed by CSX (either CSXT or a sister company, CSX Intermodal, Inc.) or by Norfolk Southern. As a result, beginning June 1, 1999, CSXT's operating revenue includes revenue from traffic previously moving on Conrail. Operating expenses reflect corresponding increases for costs incurred to handle the new traffic and operate the former Conrail lines. Effective June 1, 1999, CSXT's expenses also include a new expense category, "Conrail Operating Fee, Rent and Services", which reflects payments to Conrail for the use of right-of-way and equipment; as well as charges for transportation, switching, and terminal services provided by Conrail in three geographic areas operated for the joint benefit of CSX and Norfolk Southern. NOTE 4. ACCOUNTS RECEIVABLE CSXT has an ongoing agreement to sell without recourse, on a revolving basis each month, an undivided percentage ownership interest in all rail freight accounts receivable to CSX Trade Receivables Corporation, a wholly-owned subsidiary of CSX. Accounts receivable sold under this agreement totaled $605 million at July 2, 1999 and $642 million at December 25, 1998. In addition, CSXT has a revolving agreement with a financial institution to sell with recourse on a monthly basis an undivided percentage ownership interest in all miscellaneous accounts receivable. Accounts receivable sold under this agreement totaled $47 million at July 2, 1999 and December 25, 1998. The sales of receivables have been reflected as reductions of "Accounts and Notes Receivable" in the Consolidated Statement of Financial Position. The net losses associated with sales of receivables were $14 million for the quarter and $27 million for the six months ended July 2, 1999, and $15 million for the quarter and $30 million for the six months ended June 26, 1998. - 7 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited), Continued (All Tables in Millions of Dollars) NOTE 5. OTHER INCOME (EXPENSE) Quarters Ended Six Months Ended -------------------- -------------------- July 2, June 26, July 2, June 26, 1999 1998 1999 1998 -------- -------- -------- -------- Interest Income - CSX Cash Management Plan $ 1 $ - $ 2 $ - Interest Income - Other - 8 4 15 Income from Real Estate Operations(1) 12 9 14 14 Net Losses from Accounts Receivable Sold (14) (15) (27) (30) Conrail Transition Expenses (28) (31) (67) (50) Miscellaneous 1 2 (9) - --------- --------- --------- --------- Total $ (28) $ (27) $ (83) $ (51) ========= ========= ========= ========= (1) Gross revenue from real estate operations was $19 million for the quarter and $28 million for the six months ended July 2, 1999, and $17 million and $29 million for the quarter and six months ended June 26, 1998. NOTE 6. COMMITMENTS AND CONTINGENCIES New Orleans Tank Car Fire - ------------------------- In September 1997, a state court jury in New Orleans, Louisiana returned a $2.5 billion punitive damages award against CSXT. The award was made in a class action lawsuit against a group of nine companies based on personal injuries alleged to have arisen from a 1987 fire. The fire was caused by a leaking chemical tank car parked on CSXT tracks and resulted in the 36-hour evacuation of a New Orleans neighborhood. In the same case, the court awarded a group of 20 plaintiffs compensatory damages of approximately $2 million against the defendants, including CSXT, to which the jury assigned 15 percent of the responsibility for the incident. CSXT's liability under that compensatory damages award is not material, and adequate provision has been made for the award. In October 1997, the Louisiana Supreme Court set aside the punitive damages judgment, ruling the judgment should not have been entered until all liability issues were resolved. In February 1999, the Louisiana Supreme Court issued a further decision, authorizing and instructing the trial court to enter individual punitive damages judgments in favor of the 20 plaintiffs who had received awards of compensatory damages, in amounts representing an appropriate share of the jury's award. The trial court on April 8, 1999 entered judgment awarding approximately $2 million in compensatory damages and approximately $8.5 million in punitive damages to those 20 plaintiffs. Approximately $6.2 million of the punitive damages awarded were assessed against CSXT. CSXT then filed post-trial motions, for a new trial and for judgment notwithstanding the verdict, as to the April 8 judgment. CSXT believes that these recent judicial decisions will expedite the process of full appellate review of the 1997 trial. A trial for the claims of 20 additional plaintiffs for compensatory damages began on May 24, 1999. In early July, the jury in that trial rendered verdicts of approximately $330,000 in favor of eighteen of those twenty plaintiffs. Two plaintiffs received nothing; that is, the jury found that they - 8 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited), Continued (All Tables in Millions of Dollars) NOTE 6. COMMITMENTS AND CONTINGENCIES, Continued New Orleans Tank Car Fire, Continued - ------------------------------------ had not proved any damages. Management believes that this result, while still excessive, supports CSXT's contention that the $2.5 billion punitive damages award was unwarranted. CSXT continues to pursue an aggressive legal strategy. Management believes that any adverse outcome will not be material to CSX's or CSXT's overall results of operations or financial position, although it could be material to results of operations in a particular quarterly accounting period. Environmental Contingencies - --------------------------- CSXT is a party to various proceedings involving private parties and regulatory agencies related to environmental issues. CSXT has been identified as a potentially responsible party (PRP) at approximately 108 environmentally impaired sites that are or may be subject to remedial action under the Federal Superfund statute (Superfund) or similar state statutes. A number of these proceedings are based on allegations that CSXT, or its railroad predecessors, sent hazardous substances to the facilities in question for disposal. Such proceedings arising under Superfund or similar state statutes can involve numerous other waste generators and disposal companies and seek to allocate or recover costs associated with site investigation and cleanup, which could be substantial. CSXT is involved in a number of administrative and judicial proceedings and other clean-up efforts at 246 sites, including sites addressed under the Federal Superfund statute or similar state statutes, where it is participating in the study and/or clean-up of alleged environmental contamination. The assessment of the required response and remedial costs associated with most sites is extremely complex. Cost estimates are based on information available for each site, financial viability of other PRPs, where available, and existing technology, laws and regulations. CSXT's best estimates of the allocation method and percentage of liability when other PRPs are involved are based on assessments by consultants, agreements among PRPs, or determinations by the U.S. Environmental Protection Agency or other regulatory agencies. At least once each quarter, CSXT reviews its role, if any, with respect to each such location, giving consideration to the nature of CSXT's alleged connection to the location (i.e., generator, owner or operator), the extent of CSXT's alleged connection (i.e., volume of waste sent to the location and other relevant factors), the accuracy and strength of evidence connecting CSXT to the location, and the number, connection and financial position of other named and unnamed PRPs at the location. The ultimate liability for remediation can be difficult to determine with certainty because of the number and creditworthiness of PRPs involved. Through the assessment process, CSXT monitors the creditworthiness of such PRPs in determining ultimate liability. Based upon such reviews and updates of the sites with which it is involved, CSXT has recorded, and reviews at least quarterly for adequacy, reserves to cover estimated contingent future environmental costs with respect to such sites. The recorded liabilities for estimated future environmental costs at July 2, 1999 and December 25, 1998, were $69 million and $75 million, respectively. These recorded liabilities, which are undiscounted, include amounts representing CSXT's estimate of unasserted claims, which CSXT believes to be immaterial. The liability has been accrued for future costs for all sites where the company's obligation is probable and where such costs - 9 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited), Continued (All Tables in Millions of Dollars) NOTE 6. COMMITMENTS AND CONTINGENCIES, Continued Environmental Contingencies, Continued - -------------------------------------- can be reasonably estimated. The liability includes future costs for remediation and restoration of sites as well as any significant ongoing monitoring costs, but excludes any anticipated insurance recoveries. The majority of the July 2, 1999 environmental liability is expected to be paid out over the next five to seven years, funded by cash generated from operations. The company does not currently possess sufficient information to reasonably estimate the amounts of additional liabilities, if any, on some sites until completion of future environmental studies. In addition, latent conditions at any given location could result in exposure, the amount and materiality of which cannot presently be reliably estimated. Based upon information currently available, however, the company believes that its environmental reserves are adequate to accomplish remedial actions to comply with present laws and regulations, and that the ultimate liability for these matters will not materially affect its overall results of operations and financial condition. Other Legal Proceedings - ----------------------- A number of other legal actions are pending against CSXT in which claims are made in substantial amounts. While the ultimate results of lawsuits and claims involving CSXT cannot be predicted with certainty, management does not currently expect that resolution of these matters will have a material adverse effect on the consolidated financial position, results of operations and cash flows of the company. NOTE 7. RELATED PARTIES Cash and cash equivalents at December 25, 1998 includes $229 million, representing amounts due from CSX for CSXT's participation in the CSX cash management plan. At July 2, 1999, CSXT had a deficit balance in the plan of $92 million which is included in Due to Parent Company in the statement of financial position. Under this plan, excess cash is advanced to CSX for investment and CSX makes cash funds available to its subsidiaries as needed for use in their operations. CSX is committed to repay all amounts due on demand should circumstances require. The companies are charged for borrowings or compensated for investments based on returns earned by the plan portfolio. Related Party Service Fees expense consists of a management service fee charged by CSX, data processing related charges from CSX Technology, Inc. (CSX Technology); the reimbursement, under an operating agreement, from CSX Intermodal, Inc. (CSXI), for costs incurred by CSXT related to intermodal operations; charges from Customized Transportation, Inc. (CTI) for transportation, warehousing and managed transportation services provided to CSXT; charges from Total Distribution Services, Inc. (TDSI), for services provided at automobile ramps; and charges from Bulk Intermodal Distribution Services, Inc. (BIDS) for services provided at bulk commodity facilities. The management service fee charged by CSX represents compensation for certain corporate services provided to CSXT. These services include, but are not limited to, development of corporate policy and long-range strategic plans, allocation of capital, placement of debt, maintenance of employee benefit plans, internal audit and tax administration. The fee is calculated as a percentage of CSX's investment in CSXT which is identical to the method used to determine the management fee charged to all other major subsidiaries of CSX. Management believes this to be a reasonable method. The data processing related charges are - 10 - CSX TRANSPORTATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited), Continued (All Tables in Millions of Dollars) NOTE 7. RELATED PARTIES, Continued compensation to CSX Technology for the development, implementation and maintenance of computer systems, software and associated documentation for the day-to-day operations of CSXT. CSX Technology, CSXI, CTI, TDSI, and BIDS are wholly-owned subsidiaries of CSX. In March 1996, CSXT entered into a loan agreement with CSX Insurance Company (CSX Insurance), a wholly-owned subsidiary of CSX, whereby CSXT may borrow up to $100 million from CSX Insurance. The loan is payable in full on demand. At July 2, 1999 and December 25, 1998, $90 million was outstanding under the agreement. Interest on the loan is payable monthly at .25% over the LIBOR rate, and was 5.43% at July 2, 1999 and 5.91% at June 26, 1998. - 11 - ITEM 2. MANAGEMENT'S ANALYSIS AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS - --------------------- CSXT follows a 52/53-week fiscal calendar. Fiscal year 1999 consists of 53 weeks. The six month period ended July 2, 1999 consisted of 27 weeks and the six month period ended June 26, 1998 consisted of 26 weeks. Net earnings for the first half of 1999 were $130 million versus $231 million in the prior year period. The company reported operating income of $330 million, 27 percent below last year's period. Operating revenue of $2.63 billion was 5 percent higher than the 1998 period and operating expense rose 12 percent to $2.30 billion. The year over year increases in revenues and expenses are due largely to the integration of Conrail rail operations for one month in 1999, as well as the extra week in the 1999 period. Costs related to the preparation and start-up of the Conrail integration adversely affected the 1999 earnings. OPERATING INCOME (Millions of Dollars) ---------------------------------- Six Months Ended ------------------------ July 2, June 26, Percent 1999 1998 Change ---------- ---------- --------- Operating Revenue Merchandise $ 1,864 $ 1,673 11% Coal 690 739 (7) Other 77 96 (20) ---------- ---------- Total 2,631 2,508 5 Operating Expense 2,301 2,057 (12) ---------- ---------- Operating Income $ 330 $ 451 (27) ========== ========== Coal volume for the first half of the year declined 4 percent, to 76.4 million tons, reflecting reduced demand from overseas markets and from electric utilities. As a result, coal revenue fell 7 percent from the 1998 period. Total merchandise carloads were 9 percent higher and revenue was 11 percent higher than the prior year period, led by significant increases in automotive traffic and revenue that reflected the integration of Conrail business, continued strong demand for vehicles and parts, and the strike at major General Motors plants that adversely affected 1998 revenue. Metals revenue increased 12 percent due to former Conrail volumes and general strength in the iron ore market. Chemicals revenue was up 10% with the new traffic from the Conrail integration and overall growth in the plastics industry. CONRAIL INTEGRATION - ------------------- On June 1, 1999, CSXT and Norfolk Southern Corporation's (Norfolk Southern) rail subsidiary formally began integrated operations over their respective portions of the Conrail Inc. (Conrail) rail systems. This step implements the operating plan envisioned by CSX and Norfolk Southern when they completed the joint acquisition of Conrail in May 1997 and later received regulatory approval permitting them to exercise joint control over Conrail in August 1998. -12 - ITEM 2. MANAGEMENT'S ANALYSIS AND RESULTS OF OPERATIONS CONRAIL INTEGRATION, Continued - ------------------------------ The respective railroads operate designated portions of the Conrail system pursuant to various operating agreements which took effect on June 1. Under these agreements, which have terms of 25 years plus options to extend, the railroads pay operating fees to Conrail for the use of right-of-way and rent for the use of equipment. Conrail continues to provide rail service in certain shared geographic areas for the joint benefit of CSXT and Norfolk Southern for which it is compensated on the basis of usage by the respective railroads. CSX and Norfolk Southern, through a joint acquisition entity, hold economic interests in Conrail of 42% and 58%, respectively, and voting interests of 50% each. Upon integration, substantially all of Conrail's customer freight contracts were assumed by CSX (either CSXT or a sister company, CSX Intermodal, Inc.) or by Norfolk Southern. As a result, beginning June 1, 1999, CSXT's operating revenue includes revenue from traffic previously moving on Conrail. Operating expenses reflect corresponding increases for costs incurred to handle the new traffic and operate the former Conrail lines. Effective June 1, 1999, CSXT's expenses also include a new expense category, "Conrail Operating Fee, Rent and Services", which reflects payments to Conrail for the use of right-of-way and equipment; as well as charges for transportation, switching, and terminal services provided by Conrail in three geographic areas operated for the joint benefit of CSX and Norfolk Southern. OTHER MATTERS - ------------- Year 2000 Planning - ------------------ State of Year 2000 Readiness Technology systems and embedded computer chips that are not Year 2000 ready are unable to distinguish between the calendar year 1900 and the calendar year 2000. CSX recognizes that it must work to minimize the risks that its business operations will be adversely affected by transition to the upcoming calendar year 2000. Accordingly, in 1996, CSX and each of its transportation subsidiaries began a comprehensive plan to address the potential exposure. The plan fully encompasses all CSXT systems and operations. The company's Year 2000 plan includes the following phases: - - Awareness - General education about the Year 2000 problem. - - Inventory - Cataloging of all systems and business relationships that may be impacted by a Year 2000 date rollover. - - Assessment - Estimating the degree of severity of the Year 2000 problem for cataloged items. - - Remediation - Repair, replacement, or retirement of non-Year 2000 compliant systems. - - Validation - Testing to confirm the compliance of Year 2000 remediated systems. CSX's readiness efforts are focused, first and foremost, on the continued safe operation of its rail and other transportation systems. That includes employee safety, the safety of the general public, and the safety of the environments in which the company operates. Maintaining service continuity both to customers and with vendors before, during, and after the millennium change also is a priority. CSXT has material relationships with third parties whose failure to be Year 2000 ready could have adverse impacts on the company's business, operations or financial condition. Third parties CSXT considers to be in this category include significant suppliers, large customers and financial institutions. Accordingly, the company has met with or surveyed those parties to assess their Year 2000 readiness and, where applicable, is conducting interface tests with them upon completion of - 13 - ITEM 2. MANAGEMENT'S ANALYSIS AND RESULTS OF OPERATIONS, CONTINUED OTHER MATTERS, Continued Year 2000 Planning, Continued - ----------------------------- State of Year 2000 Readiness, Continued internal testing of remediated applications. Based on the results of those tests, and the information received, follow-up action or contingency plans will be made by the company as it deems appropriate. CSXT also is participating in interface tests with other Class I railroads to ensure that electronic data interchanges can be processed in a Year 2000 format. The industry effort has been coordinated by the Association of American Railroads since 1997 and is largely complete, with final work scheduled in the third quarter of 1999. Overall, substantial completion of key areas of CSXT's Year 2000 readiness plan is expected by the end of the third quarter of 1999. The company's readiness efforts are organized in five areas, which have the following status: Estimated Substantial Effort Completion Current Phase - --------------------------------------------------------------------------------------------- Core Information Systems Third Quarter 1999 Remediation and Validation Distributed Information Technology Third Quarter 1999 Remediation and Validation Electronic Commerce Third Quarter 1999 Remediation and Validation Non-information Technology (embedded systems) Third Quarter 1999 Remediation and Validation Trading Partners Fourth Quarter 1999 Validation During the second quarter of 1999, the integration of Conrail operations was formally implemented and Conrail's Year 2000 effort was incorporated into the Year 2000 efforts of CSX and Norfolk Southern. Year 2000 Costs CSXT has incurred total costs of $46 million to date related to Year 2000 readiness, which represents approximately 81% of the estimated expenditures for the entire plan. To provide a consistent, objective method for identifying costs of the Year 2000 plan, the company classifies expenditures as Year 2000 plan costs for reporting purposes only if they remedy only Year 2000 risks and would otherwise be unnecessary in the normal course of business. The cost of the Year 2000 plan is being expensed as incurred and funded by cash generated from operations. Projections of the remaining cost and completion dates for the Year 2000 plan are based on management's current estimates, which are derived utilizing assumptions of future events, including the continued availability of certain resources, and are inherently uncertain. No major projects have been delayed as a result of Year 2000 readiness efforts, and CSX is periodically assessing its Year 2000 progress with respect to CSXT systems with the assistance of outside consultants. Contingency Plans Contingency planning is an established and ongoing effort within CSX and CSXT to address many types of potential operating disruptions which may include Year 2000 issues. For example, detailed emergency operating plans already exist for unanticipated outages of electricity, - 14 - ITEM 2. MANAGEMENT'S ANALYSIS AND RESULTS OF OPERATIONS, CONTINUED OTHER MATTERS, Continued - ------------------------ Year 2000 Planning, Continued - ----------------------------- Contingency Plans, Continued telecommunications, and other essential services. The companies are not in a position to identify or to avoid all possible Year 2000 scenarios or to estimate their overall business impacts. However, the companies are currently assessing possible problems and making plans to mitigate the impacts. These plans may include identifying alternate suppliers, vendors, procedures and operational sites; generating equipment lists; conducting staff training; and developing communication plans. CSX defines three primary types of most reasonably likely worst-case scenarios, and anticipates that detailed contingency measures with respect to CSXT will include the following: - - Systemwide failures -- In the event of complete or nearly complete loss of key assets or services throughout the entire CSXT system, CSXT will conduct and maintain a safe and orderly shutdown of all operations that depend on those systems. - - Geographically isolated failures -- In the event of complete or nearly complete loss of key assets or services throughout a region, CSXT may employ manual fallback plans for non-transportation functions and may maintain a safe and orderly shutdown of affected transportation operations. - - Movable asset failures -- In the event of a Year 2000 failure of a transportation asset, such as a locomotive that does not have redundant systems for operation, CSXT may temporarily remove the asset from service and scale its operations accordingly. Risks CSX believes that its Year 2000 planning efforts are adequate to address all major risks with CSXT's systems and operations. There can be no assurance, however, that the company's systems or equipment, or those of third parties on which CSXT relies, will be Year 2000 ready in a timely manner or that the company's or third parties' contingency plans will mitigate the effects of the transition to the calendar Year 2000. The failure of the systems or equipment of CSXT or third parties (which the company believes is the most reasonably likely worst case scenario) could result in the reduction or suspension of the company's operations and could have a material adverse effect on the company's results of operations, liquidity and financial condition. - 15 - ITEM 2. MANAGEMENT'S ANALYSIS AND RESULTS OF OPERATIONS, CONTINUED OTHER MATTERS, Continued - ------------------------ Litigation In September 1997, a state court jury in New Orleans, Louisiana returned a $2.5 billion punitive damages award against CSXT. The award was made in a class action lawsuit against a group of nine companies based on personal injuries alleged to have arisen from a 1987 fire. The fire was caused by a leaking chemical tank car parked on CSXT tracks and resulted in the 36-hour evacuation of a New Orleans neighborhood. In the same case, the court awarded a group of 20 plaintiffs compensatory damages of approximately $2 million against the defendants, including CSXT, to which the jury assigned 15 percent of the responsibility for the incident. CSXT's liability under that compensatory damages award is not material, and adequate provision has been made for the award. In October 1997, the Louisiana Supreme Court set aside the punitive damages judgment, ruling the judgment should not have been entered until all liability issues were resolved. In February 1999, the Louisiana Supreme Court issued a further decision, authorizing and instructing the trial court to enter individual punitive damages judgments in favor of the 20 plaintiffs who had received awards of compensatory damages, in amounts representing an appropriate share of the jury's award. The trial court on April 8, 1999 entered judgment awarding approximately $2 million in compensatory damages and approximately $8.5 million in punitive damages to those 20 plaintiffs. Approximately $6.2 million of the punitive damages awarded were assessed against CSXT. CSXT then filed post-trial motions, for a new trial and for judgment notwithstanding the verdict, as to the April 8 judgment. CSXT believes that these recent judicial decisions will expedite the process of full appellate review of the 1997 trial. A trial for the claims of 20 additional plaintiffs for compensatory damages began on May 24, 1999. In early July, the jury in that trial rendered verdicts of approximately $330,000 in favor of eighteen of those twenty plaintiffs. Two plaintiffs received nothing; that is, the jury found that they had not proved any damages. Management believes that this result, while still excessive, supports CSXT's contention that the $2.5 billion punitive damages award was unwarranted. CSXT continues to pursue an aggressive legal strategy. Management believes that any adverse outcome will not be material to CSX's or CSXT's overall results of operations or financial position, although it could be material to results of operations in a particular quarterly accounting period. ------------------------------------- - 16 - ITEM 2. MANAGEMENT'S ANALYSIS AND RESULTS OF OPERATIONS, CONTINUED Estimates and forecasts in Management's Analysis and Results of Operations and in other sections of this Quarterly Report are based on many assumptions about complex economic and operating factors with respect to industry performance, general business and economic conditions and other matters that cannot be predicted accurately and that are subject to contingencies over which the company has no control. Such forward-looking statements are subject to certain uncertainties and other factors that may cause actual results to differ materially from the views, beliefs, and projections expressed in such statements. The words "believe", "expect", "anticipate", "project", and similar expressions signify forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statements made by or on behalf of the company. Any such statement speaks only as of the date the statement was made. The company undertakes no obligation to update or revise any forward-looking statement. Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others, the following possibilities: (i) cost savings expected from the integration of Conrail may not be fully realized or realized within the time frame anticipated, (ii) revenues following the integration of Conrail may be lower than expected, (iii) costs or difficulties related to the integration of Conrail may be greater than expected, (iv) general economic or business conditions, either nationally or internationally, an increase in fuel prices, a tightening of the labor market or changes in demands of organized labor resulting in higher wages, or increased benefits or other costs or disruption of operations may adversely affect the businesses of the company, (v) legislative or regulatory changes, including possible enactment of initiatives to re-regulate the rail industry, may adversely affect the businesses of the company, (vi) changes may occur in the securities markets, and (vii) disruptions of the operations of the company or any other governmental or private entity may occur as a result of issues related to the Year 2000. For additional factors, please refer to the company's annual report on Form 10-K for the fiscal year ended December 25, 1998. - 17 - PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 1. (27) Financial Data Schedule (b) Reports on Form 8-K 1. A report was filed on June 11, 1999, reporting Item 5, Other Events - announcement of the integrated operations of CSX Corporation and Norfolk Southern Corporation of their respective portions of the Conrail Inc. rail system; plus Item 7, Financial Statements and Exhibits - (1) Transaction Agreement dated June 10, 1997 by and among CSX Corporation, CSX Transportation, Inc., Norfolk Southern Corporation, Norfolk Southern Railway Company, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC and; (2) Operating Agreement dated June 1, 1999 by and between New York Central Lines LLC and CSX Transportation, Inc. and; (3) Amendments to the Transaction Agreement dated June 10, 1997 by and among CSX Corporation, CSX Transportation, Inc., Norfolk Southern Corporation, Norfolk Southern Railway Company, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC and; (4) Shared Assets Area Operating Agreements for North Jersey, South Jersey/Philadelphia, and Detroit dated June 1, 1999 by and among Consolidated Rail Corporation, CSX Transportation, Inc. and Norfolk Southern Railway Company and; (5) Monongahela Usage Agreement dated June 1, 1999 by and among CSX Transportation, Inc., Norfolk Southern Railway Company, Pennsylvania Lines LLC, and New York Central Lines LLC and; (7) a press release by CSX Corporation dated June 1, 1999. Signature --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CSX TRANSPORTATION, INC. (Registrant) By: /s/JAMES L. ROSS ----------------- James L. Ross (Principal Accounting Officer) Dated: August 6, 1999 - 18 -