PAGE 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------- ----------
Commission file numbers 1-743; 1-3744; 1-4793; 1-5462
NORFOLK SOUTHERN RAILWAY COMPANY
- --------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 53-6002016
- ----------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
Three Commercial Place
Norfolk, Virginia 23510-2191
- ----------------------------------- ---------------------------------
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (757) 629-2682
----------------------
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. (X) Yes ( ) No
The number of shares outstanding of each of the registrant's classes of
Common Stock, as of the last practicable date:
Class Outstanding as of July 31, 1999
----- -------------------------------
Common Stock (par value $1.00) 16,668,997
PAGE 2
INDEX
-----
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR)
Page
----
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Statements of Income
Three Months and Six Months Ended
June 30, 1999 and 1998 3
Consolidated Balance Sheets
June 30, 1999, and December 31, 1998 4
Consolidated Statements of Cash Flows
Six Months Ended June 30, 1999 and 1998 5-6
Notes to Consolidated Financial Statements 7-11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-21
Part II. Other Information:
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 22
Item 4. Submission of Matters to a Vote of
Security Holders 22
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
Index to Exhibits 25
PAGE 3
PART I. FINANCIAL INFORMATION
-------------------------------
Item 1. Financial Statements.
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Income
($ in millions)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1999 1998 1999 1998
---- ---- ---- ----
Railway operating revenues:
Coal $ 298 $ 316 $ 580 $ 639
General merchandise 723 622 1,346 1,227
Intermodal 160 141 285 279
------- ------- ------- -------
TOTAL RAILWAY OPERATING
REVENUES $ 1,181 $ 1,079 $ 2,211 $ 2,145
------- ------- ------- -------
Railway operating expenses:
Compensation and benefits
(Note 3) 533 365 901 761
Materials, services, and rents 293 206 490 397
Conrail rents and services
(Note 3) 43 -- 43 --
Depreciation 115 108 228 214
Diesel fuel 48 45 85 93
Casualties and other claims 29 22 64 52
Other 98 39 156 83
------- ------- ------- -------
TOTAL RAILWAY OPERATING
EXPENSES 1,159 785 1,967 1,600
------- ------- ------- -------
Income from railway
operations 22 294 244 545
Other income - net 4 34 19 54
Interest expense on debt (9) (6) (16) (11)
------- ------- ------- -------
Income before income taxes 17 322 247 588
Provision for income taxes 4 116 88 214
------- ------- ------- -------
NET INCOME $ 13 $ 206 $ 159 $ 374
======= ======= ======= =======
See accompanying notes to consolidated financial statements.
PAGE 4
Item 1. Financial Statements. (continued)
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Balance Sheets
($ in millions)
(Unaudited)
June 30, December 31,
1999 1998
------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 91 $ --
Short-term investments 14 44
Accounts receivable, net of allowance
for doubtful accounts of $5 million and
$4 million, respectively 680 508
Materials and supplies 52 59
Deferred income taxes 124 110
Other current assets 152 130
------- -------
Total current assets 1,113 851
Due from NS - net (Note 3) -- 43
Investments 893 990
Properties less accumulated depreciation 10,283 9,985
Other assets 195 148
------- -------
TOTAL ASSETS $12,484 $12,017
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 764 $ 577
Income and other taxes 205 139
Due to NS - net (Note 3) 188 --
Other current liabilities 128 73
Current maturities of long-term debt 154 141
------- -------
Total current liabilities 1,439 930
Long-term debt (Note 4) 770 619
Other liabilities 1,017 909
Minority interests 2 2
Deferred income taxes 3,452 3,420
------- -------
TOTAL LIABILITIES 6,680 5,880
------- -------
Stockholders' equity:
Serial preferred stock 55 55
Common stock 167 167
Additional paid-in capital 548 548
Accumulated other comprehensive income
(Note 5) 391 414
Retained income 4,643 4,953
------- -------
TOTAL STOCKHOLDERS' EQUITY 5,804 6,137
------- -------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $12,484 $12,017
======= =======
See accompanying notes to consolidated financial statements.
PAGE 5
Item 1. Financial Statements. (continued)
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Cash Flows
($ in millions)
(Unaudited)
Six Months Ended
June 30,
----------------
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 159 $ 374
Reconciliation of net income to net cash
provided by operating activities:
Depreciation 229 214
Deferred income taxes (42) 21
Nonoperating gains and losses on property
and investments (10) (25)
Changes in assets and liabilities
affecting operations:
Accounts receivable (172) 19
Materials and supplies 7 (3)
Other current assets 21 25
Income tax liabilities 128 126
Other short-term liabilities 156 (22)
Other - net 137 (28)
------- -------
Net cash provided by operating activities 613 701
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (Note 4) (544) (429)
Property sales and other transactions 23 12
Investments, including short-term (73) (58)
Investment sales and other transactions 146 62
------- -------
Net cash used for investing activities (448) (413)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends (Note 3) (1) (1)
Advances and repayments to NS (258) (267)
Advances and repayments from NS 22 41
Proceeds from long-term borrowings (Note 4) 188 4
Debt repayments (25) (24)
------- -------
Net cash used for financing activities (74) (247)
------- -------
Net increase in cash and cash equivalents 91 41
CASH AND CASH EQUIVALENTS:*
At beginning of year -- 7
------- -------
At end of period $ 91 $ 48
======= =======
PAGE 6
Item 1. Financial Statements. (continued)
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Cash Flows (continued)
($ in millions)
(Unaudited)
Six Months Ended
June 30,
----------------
1999 1998
---- ----
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of amounts capitalized) $ 31 $ 37
Income taxes $ 2 $ 52
* Cash equivalents represent all highly liquid investments
purchased three months or less from maturity.
See accompanying notes to consolidated financial statements.
PAGE 7
Item 1. Financial Statements. (continued)
- ------ --------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Notes to Consolidated Financial Statements
1. In the opinion of Management, the accompanying unaudited interim
financial statements contain all adjustments (consisting of
normal recurring accruals) necessary to present fairly the
Company's financial position as of June 30, 1999, and results of
operations and cash flows for the six months ended June 30, 1999
and 1998.
Although Management believes that the disclosures presented are
adequate to make the information not misleading, these consolidated
financial statements should be read in conjunction with:
(a) the financial statements and notes included in the Company's
latest Annual Report on Form 10-K and in subsequent Quarterly
Report on Form 10-Q, and (b) any Current Reports on Form 8-K.
2. Commitments and Contingencies
There have been no significant changes since year-end 1998 in the
matters as discussed in NOTE 16, COMMITMENTS AND CONTINGENCIES,
appearing in the NS Rail Annual Report on Form 10-K for 1998,
Notes to Consolidated Financial Statements, beginning on page 66.
In July 1999, NS Rail announced that it had made a special
incentive program available to its 30,000 employees who are
represented by labor unions. The program, which runs through
early September, provides an incentive to covered employees who
remain available for service throughout certain defined periods.
Employees can earn a maximum incentive of $3,000, payable, to the
extent possible, in the form of contributions of NS Common Stock
to each employee's 401(k) account. The total cost of the program
will depend upon the extent of employee participation and will be
reflected in NS Rail's results of operations for the third quarter.
3. Related Parties
General
-------
NS is the parent holding company of NS Rail. The costs of
functions performed by NS are charged to NS Rail. In addition,
effective Nov. 1, 1998, NS charges NS Rail a revenue-based
licensing fee (which totaled $31 million for the first six months
of 1999) for use of certain intangible assets owned by NS. Rail
operations are coordinated at the holding company level by the
NS Vice Chairman and Chief Operating Officer.
Operations Over Conrail's Lines
-------------------------------
NS and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail),
whose primary subsidiary is Consolidated Rail Corporation (CRC),
the major railroad in the Northeast. From May 23, 1997, the date
NS and CSX completed their acquisition of Conrail stock, until
June 1, 1999, Conrail's operations continued substantially
PAGE 8
Item 1. Financial Statements. (continued)
- ------ --------------------
3. Related Parties (continued)
unchanged while NS and CSX awaited regulatory approvals and
thereafter devoted significant effort to prepare for the
integration of the respective Conrail routes and assets to be
leased to NS Rail and CSX Transportation, Inc. (CSXT).
On June 1, 1999 (the "Closing Date"), NS Rail and CSXT began
operating the Conrail routes and assets leased to them pursuant
to operating and lease agreements entered into in accordance with
the Transaction Agreement between NS and CSX.
The Operating Agreement between NS Rail and Pennsylvania Lines
LLC (PRR), a wholly owned subsidiary of CRC, governs
substantially all nonequipment assets to be used by NS Rail and
has an initial 25-year term, renewable at the option of NS Rail
for two 5-year terms. Payments under the Operating Agreement are
based on appraised values that are subject to adjustment every
six years to reflect changes in such values. NS Rail has also
leased or subleased for varying term lengths from PRR a number of
equipment assets at rentals based on appraised values. NS Rail's
payments to PRR under the Operating Agreement and lease
agreements currently amount to approximately $340 million
annually. In addition, all costs necessary to operate and
maintain the PRR assets will be borne by NS Rail. CSXT has
entered into comparable arrangements, for the operation and use
of other CRC assets, with another wholly owned CRC subsidiary.
NS Rail and CSXT also have entered into agreements with CRC
governing other Conrail properties that continue to be owned and
operated by Conrail (the "Shared Assets Areas"). NS Rail and
CSXT pay CRC a fee for joint and exclusive access to the Shared
Assets Areas. In addition, NS Rail and CSXT pay, based on usage,
the costs incurred by CRC to operate the Shared Assets Areas.
As a result of these transactions, effective June 1, 1999, route
miles operated by NS Rail and its employees increased by
approximately 50 percent. NS Rail and CSXT now provide
substantially all rail freight services on Conrail's route
system, perform or are responsible for performing most services
incident to customer freight contracts, and employ the majority
of Conrail's former work force. Consequently, NS Rail began to
receive all freight revenues and incur all operating expenses on
the Conrail lines it now operates.
During the month of June, congestion and other inefficiencies
resulting from difficulties in NS Rail's integration of the new
routes and operations adversely affected second-quarter revenues
and expenses. The higher expenses included service alteration
costs to meet the immediate needs of shippers, as well as higher
labor costs and equipment rents. A long-term failure by NS Rail
to integrate successfully the portion of Conrail that it is now
operating could have a substantial adverse impact on NS Rail's
financial position, results of operations, and liquidity.
PAGE 9
Item 1. Financial Statements. (continued)
- ------ --------------------
3. Related Parties (continued)
"Conrail rents and services," a new line on the income statements
beginning June 1, 1999, includes expenses for amounts due to
PRR and CRC for use of operating properties and equipment, operation
of the Shared Assets Areas, and continued operation of certain
facilities during a transition period.
"Other current assets" includes $39 million due from CRC for its
vacation liability related to the portion of its work force that
became NS Rail employees on the Closing Date. NS Rail increased
its vacation liability accordingly, and will pay these employees
as they take vacation.
"Accounts payable" includes $43 million due to PRR and CRC
related to expenses included in "Conrail rents and services," as
discussed above.
Until the Closing Date, NS Rail and CRC had transactions with
each other in the course of handling interline traffic. Most of
the amounts receivable or payable related to these transactions
have been satisfied.
NS Rail's second-quarter railway operating expenses included
$168 million ($103 million after taxes) for contractual
obligations, principally to former Conrail employees. Most of
these costs are expected to be paid in the two years following
the Closing Date, and $42 million of such are classified on
NS Rail's balance sheet as "Current liabilities." However,
certain contractual obligations by their terms will be paid out
over a longer period. These costs are based on estimates of
separation and other labor-related contractual obligations to
former Conrail employees resulting from the integration. Through
June 30, 1999, NS Rail has paid $10 million of these costs.
NS Rail expects to incur an estimated $18 million of costs for
additional relocations of former Conrail employees. As
definitive plans are determined and communicated, costs, if any,
for severing or relocating NS Rail employees and for disposing of
NS Rail facilities will also be charged to operating expense.
PAGE 10
Item 1. Financial Statements. (continued)
- ------ --------------------
3. Related Parties (continued)
Intercompany Accounts
---------------------
June 30, 1999 December 31, 1998
------------------ ------------------
Average Average
Interest Interest
Balance Rate Balance Rate
------- -------- ------- --------
($ in millions)
Due from NS:
Advances $ 142 4% $ 354 5%
Due to NS:
Notes and advances 330 6% 311 7%
------ ------
Due (to) from
NS - net $ (188) $ 43
====== ======
Interest is applied to certain advances at the average NS yield
on short-term investments and to the notes at specified rates.
Noncash Dividend
----------------
In March and June 1999, NS Rail declared and issued to NS two
noncash dividends totaling $467 million, which were settled by
reduction of NS Rail's interest-bearing advances due from NS.
Noncash dividends are excluded from the Consolidated Statements
of Cash Flows.
Intercompany Federal Income Tax Accounts
----------------------------------------
In accordance with the NS Tax Allocation Agreement, intercompany
federal income tax accounts are recorded between companies in
the NS consolidated group. At June 30, 1999, and Dec. 31, 1998,
NS Rail had long-term intercompany federal income tax payables
(which are included in "Deferred income taxes" in the
Consolidated Balance Sheets) of $703 million and $633 million,
respectively.
Cash Required for NS Debt
-------------------------
NS has approximately $7.0 billion of unsecured notes and
commercial paper debt outstanding, most of which was issued to
finance the cost of the Conrail transaction. A significant
portion of the funding for the interest and repayments on this
debt is expected to be provided by NS Rail.
PAGE 11
Item 1. Financial Statements. (continued)
- ------ --------------------
4. Long-Term Debt
Equipment Trust Certificates
----------------------------
NS Rail issued equipment trust certificates in March and June
1999 and received $188 million of net proceeds. The
certificates mature serially in the years 2000 through 2014,
inclusive, and carry a weighted-average interest rate of
6.6 percent. Proceeds were used to acquire locomotives and
freight cars, and at June 30, 1999, $21 million of the proceeds
were included in "Other assets" and will be used later in the
year to acquire additional equipment.
Capital Lease Obligations
-------------------------
During the first six months of 1998, NS Rail entered into
capital leases covering new locomotives. The related capital
lease obligations, totaling $127 million, were reflected in the
Consolidated Balance Sheet as debt and, because they were
noncash transactions, were excluded from the Consolidated
Statement of Cash Flows.
5. Comprehensive Income
NS Rail's total comprehensive income was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1999 1998 1999 1998
---- ---- ---- ----
($ in millions)
Net income $ 13 $ 206 $ 159 $ 374
Other comprehensive income 52 (108) (24) (12)
----- ----- ----- -----
Total comprehensive
income $ 65 $ 98 $ 135 $ 362
===== ===== ===== =====
For NS Rail, "Other comprehensive income" is the unrealized gains
and losses on certain investments in debt and equity securities,
principally NS Common Stock.
PAGE 12
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations.
-------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Management's Discussion and Analysis of Financial Condition
and Results of Operations
In the following sections, NS Rail provides data for corresponding
periods in 1998 and, in some cases, indicates the percent of variance
between the 1999 and 1998 data. However, NS Rail does caution that all
such data should be considered in light of the substantially different
operating contexts to which they relate.
COMMENCEMENT OF OPERATIONS OVER CONRAIL'S LINES
On June 1, 1999, NS Rail began operating a portion of Conrail's
properties (its new "Northern Region") under various agreements with
Pennsylvania Lines LLC (PRR), a wholly owned subsidiary of Consolidated
Rail Corporation (CRC) (see Note 3). As a result, route miles operated
by NS Rail and its employees increased by approximately 50 percent.
Second-quarter results reflect two months (April and May) of operating
the former NS Rail system and one month (June) of operating the new
NS Rail system, which includes the Northern Region.
Moreover, during the month of June, system congestion and other
inefficiencies resulted from difficulties in the integration of the new
routes. NS Rail has made progress in reducing congestion and continues
to work diligently to resolve the operational issues and clear the
backlog of cars causing the congestion. This effort has required
additional labor and equipment resources, and the need for such
additional resources is expected to continue until the congestion is
cleared. In addition, freight has been diverted from NS Rail, and, in
some cases, NS Rail has incurred service alteration costs to meet the
immediate needs of shippers. The resulting decrease in revenues and
increase in costs negatively affected NS Rail's second-quarter results,
and NS Rail's financial statements will continue to be so affected
until the operational issues have been resolved.
RESULTS OF OPERATIONS
Net Income
- ----------
Net income for the second quarter was $13 million, down $193 million,
or 94 percent, compared with the second quarter of 1998. For the
first six months, net income was $159 million, $215 million, or
57 percent, below last year. The declines were largely attributable
to lower income from railway operations. Second-quarter 1999 railway
operating expenses included $168 million ($103 million after taxes) of
costs for contractual obligations, principally to former Conrail
employees, as well as an estimated $60 million of costs attributable
to the system congestion.
PAGE 13
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Railway Operating Revenues
- --------------------------
Second-quarter railway operating revenues were $1,181 million in 1999
and were $1,079 million in 1998. For the first six months, railway
operating revenues were $2,211 million in 1999 and were $2,145 million
in 1998. As shown in the table below, the improvements were due
entirely to higher traffic volume, largely the result of the
commencement of operations in the Northern Region. Traffic diversions
related to June's operational difficulties resulted in an estimated
$40 million of lost revenues, principally in the general merchandise
commodity groups.
Second Quarter First Six Months
1999 vs. 1998 1999 vs. 1998
Increase (Decrease) Increase (Decrease)
------------------ ------------------
($ in millions)
Traffic volume (carloads) $ 116 $ 80
Revenue per unit (14) (14)
------ ------
$ 102 $ 66
====== ======
Revenues and carloads for the commodity groups were as follows:
Revenues
----------------------------------------
Second Quarter Six Months
1999 1998 1999 1998
---- ---- ---- ----
($ in millions)
Coal $ 298 $ 316 $ 580 $ 639
General merchandise:
Automotive 187 145 347 283
Chemicals 166 145 314 291
Paper/clay/forest 139 139 267 276
Metals/construction 126 98 220 189
Agr./consumer prod./govt. 105 95 198 188
------ ------ ------ ------
General merchandise 723 622 1,346 1,227
Intermodal 160 141 285 279
------ ------ ------ ------
Total $1,181 $1,079 $2,211 $2,145
====== ====== ====== ======
PAGE 14
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Carloads
----------------------------------------
Second Quarter Six Months
1999 1998 1999 1998
---- ---- ---- ----
(in thousands)
Coal 340 327 640 658
General merchandise:
Automotive 156 127 292 243
Chemicals 114 102 213 204
Paper/clay/forest 112 117 215 233
Metals/construction 126 97 217 185
Agr./consumer prod./govt. 96 86 180 175
----- ----- ----- -----
General merchandise 604 529 1,117 1,040
Intermodal 425 375 771 742
----- ----- ----- -----
Total 1,369 1,231 2,528 2,440
===== ===== ===== =====
Coal
- ----
Second-quarter coal revenues were $298 million, versus $316 million
last year, and were $580 million for the first six months, versus
$639 million last year. Lower export and domestic metallurgical coal
traffic volume more than offset the combined effects of the Northern
Region traffic and increased utility coal tonnage. In addition,
revenue yields continued to be affected by a change in the mix of
traffic: increased utility coal shipments (especially new shorter-
haul business) and decreased export and domestic metallurgical coal
shipments. Total tonnage handled was 35.0 million tons in the second
quarter, versus 33.7 million tons last year, and was 66.3 million tons
for the first six months, versus 67.7 million tons last year. Export
coal tonnage fell 37 percent for the quarter and 35 percent for the
first six months, as the effects of adverse world economic conditions
and a strong U.S. dollar continued. Domestic steel coal tonnage
declined 4 percent in the second quarter and 11 percent for the first
six months, largely reflecting increased imports of lower-priced steel
and plant closures in the second quarter of 1998. Utility coal
tonnage increased 17 percent in the quarter and 10 percent for the
first six months, principally due to the handling of traffic in the
Northern Region.
Coal revenues for the remainder of the year are expected to continue
to be adversely affected by weak demand for export coal. However,
with the addition of traffic in the Northern Region, total coal
revenues are expected to be higher than in the same period last year.
PAGE 15
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
General Merchandise
- -------------------
Second-quarter general merchandise revenues were $723 million, versus
$622 million last year, and were $1,346 million for the first six
months, versus $1,227 million last year. Traffic volume increased
14 percent for the quarter and 7 percent for the first six months,
principally due to the addition of traffic in the Northern Region and
to continued strength in automotive traffic. Average revenue per unit
increased 2 percent in both periods, due to a longer average length of
haul and changes in traffic mix.
General merchandise revenues for the remainder of the year are
expected to be up almost 50 percent, versus the same period last year,
largely as a result of traffic in the Northern Region.
Intermodal
- ----------
Second-quarter intermodal revenues were $160 million, versus
$141 million last year, and were $285 million for the first six
months, versus $279 million last year. Traffic volume increased
13 percent for the quarter and 4 percent for the first six months,
largely due to the addition of Northern Region traffic.
For the remainder of the year, intermodal revenues are expected to
increase by about two-thirds, versus the same period last year,
reflecting the traffic in the Northern Region.
Railway Operating Expenses
- --------------------------
Second-quarter railway operating expenses were $1,159 million, up
$374 million, or 48 percent, compared with last year. For the first
six months, railway operating expenses were $1,967 million, up
$367 million, or 23 percent. Both increases were due to: (1) the
commencement of operations in the Northern Region, (2) the contractual
obligations assumed that principally resulted from employing a
significant portion of Conrail's former work force, and (3) an
estimated $60 million of additional costs arising from the operational
difficulties and resulting congestion.
"Compensation and benefits" expense increased $168 million, or
46 percent, in the second quarter, and $140 million, or 18 percent,
for the first six months, compared with the same periods last year.
Both increases were attributable to: (1) contractual obligations incurred
in employing a substantial portion of Conrail's work force,
(2) the 50 percent increase in NS Rail's work force in June, upon
commencement of operations in the Northern Region, and (3) an estimated
$15 million of higher labor costs associated with the operational
difficulties and system congestion. The effects of these increases
were mitigated by reduced incentive compensation expenses.
PAGE 16
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
"Materials, services, and rents" increased $87 million, or 42 percent,
in the second quarter, and $93 million, or 23 percent, for the first
six months, compared with the same periods last year. The increases
principally resulted from: (1) additional costs due to the system
congestion, including an estimated $29 million for alternate
transportation to meet critical customer needs and an estimated
$8 million for equipment rents and (2) expenses related to the
Northern Region.
"Other" expenses increased $59 million, or 151 percent, in the second
quarter, and $73 million, or 88 percent, for the first six months,
compared with the same periods last year. The increases resulted
from: (1) a licensing fee for use of certain intangible assets owned
by NS that became effective Nov. 1, 1998 (see Note 3), (2) costs for
obligations in the Northern Region, (3) favorable property tax adjustments
last year for which there was no comparable adjustment in 1999, (4) costs
to relocate former Conrail employees, and (5) higher travel costs this
year associated with the integration of the Northern Region.
"Conrail rents and services," a new category of expense, amounted to
$43 million and represented costs incurred in June associated with the
operation of a portion of Conrail's routes and assets. This item
includes amounts due to PRR and CRC related to: (1) use of their
operating properties and equipment, (2) CRC's operation of the Shared
Assets Areas, and (3) CRC's operation of certain transition facilities.
"Casualties and other claims" increased $7 million, or 32 percent, in
the second quarter, and $12 million, or 23 percent, for the first six
months, compared with the same periods last year. The increases were
largely attributable to: (1) the commencement of operations in the
Northern Region and the resulting congestion, (2) settlement in the
first quarter related to an environmental site in Slidell, La., and
(3) damages to automobiles being transported in a train that derailed
in the first quarter.
"Diesel fuel" expense increased $3 million, or 7 percent, in the
second quarter, but decreased $8 million, or 9 percent, for the first
six months, compared with the same periods last year. The increase
for the quarter was due to higher consumption in June attributable to
operations in the Northern Region, which more than offset lower
consumption in April and May that resulted from lower traffic volume.
The decrease for the first six months was due to a 23 percent decline
in the average price per gallon in the first quarter that more than
offset the increased consumption in the second quarter.
The railway operating ratio was 98.1 percent in the second quarter,
versus 72.8 percent last year, and was 89.0 percent for the first six
months, versus 74.6 percent last year. The $168 million of
contractual obligations and commitments increased the railway
operating ratio by about 14 percentage points and 8 percentage points
for the quarter and first six months, respectively. The operating
difficulties and related system congestion and traffic diversions are
estimated to have increased the railway operating ratio by about
PAGE 17
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
7 percentage points and 3-1/2 percentage points for the quarter and first
six months, respectively. The remaining increases in the railway
operating ratio were principally attributable to the change in traffic
mix related to increased resource-intensive traffic, such as automotive
and intermodal, and decreased coal traffic.
The railway operating ratio is expected to continue to show the
adverse effects of the system congestion and related traffic
diversions until the operating difficulties are fully resolved.
Moreover, NS Rail's third-quarter railway operating expenses will
include amounts related to a special incentive program for its
agreement employees (see Note 2).
Other Income - Net
- ------------------
"Other income - net" was $30 million lower in the second quarter and
was $35 million lower for the first six months, compared with the same
periods last year. Both decreases were largely attributable to the
effect of favorable adjustments last year to interest accruals on possible
federal income tax liabilities resulting from the settlement of the
1993 and 1994 tax-year audits and to lower interest income. The six-month
comparison was also affected by lower gains from the sale of properties
and investments.
Provision for Income Taxes
- --------------------------
The effective income tax rate was 23.5 percent in the second quarter,
compared with 36.0 percent last year, and was 35.6 percent for the
first six months, compared with 36.4 percent last year. The lower
average rate in the second quarter of 1999 resulted from the
difference between the deferred and effective tax rates.
FINANCIAL CONDITION AND LIQUIDITY
June 30, December 31,
1999 1998
------- -----------
($ in millions)
Cash and short-term investments $ 105 $ 44
Debt-to-total capitalization 13.7% 11.0%
CASH PROVIDED BY OPERATING ACTIVITIES is NS Rail's principal source of
liquidity. The decrease in "Net cash provided by operating
activities" in the first six months of 1999, compared with the same
period last year, was principally due to lower income from railway
operations, mitigated by lower income tax payments. The large changes
in "Accounts receivable" and "Other short-term liabilities" in this
year's cash flow statement principally resulted from the June 1
commencement of operations in the Northern Region. The large change
in "Other - net" resulted from the accrual of the contractual obligations
discussed above.
PAGE 18
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
CASH USED FOR INVESTING ACTIVITIES increased $35 million for the first
six months of 1999, compared with the same period last year. Capital
expenditures were 2 percent higher in the current year; however,
"Property additions" increased 27 percent, reflecting a change in
financing methods: in 1998, locomotives were acquired under capital
leases, which were excluded from the Consolidated Statements of Cash
Flows because they were noncash transactions; in 1999, locomotives and
freight cars were financed through the sale of equipment trust
certificates (see Note 4).
CASH USED FOR FINANCING ACTIVITIES in 1999 included proceeds from the
sale of equipment trust certificates (see Note 4).
YEAR-2000 COMPLIANCE
General
- -------
In October 1995, NS Rail initiated a project to review and modify, as
necessary, its computer applications, hardware, and other equipment to
make them Year-2000 compliant. NS Rail has engaged outside consultants
and independent contractors to assist with its Year-2000 project. The
progress of the project is reviewed regularly by NS Rail's senior
management and by the Audit Committee of NS' Board of Directors. The
project is organized into three principal areas: mainframe systems,
nonmainframe systems, and enterprise systems (operations and embedded
processors), and for each such system involves: inventory, assessment,
remediation, testing, and implementation. NS Rail expects to have all
business-critical systems remediated, tested, and implemented in the
third quarter of 1999.
State of Readiness
- ------------------
The inventory and assessment phases have been completed. The
remediation phase is over 99 percent complete, and the testing and
implementation phases are about 65 percent complete. The remaining
items to be addressed are principally purchased software products and
system integration testing.
For mainframe systems, all noncompliant business-critical applications
have been remediated, unit tested, and placed back into production
(implemented). System integration testing is expected to be completed
in the third quarter of 1999.
For nonmainframe and enterprise systems, all business-critical
applications have been inventoried and assessed, and remediation is
over 99 percent complete. For both types of systems, testing and
implementation are expected to be completed in the third quarter.
NS Rail also has initiated formal communications with third parties
having a substantial relationship to its business (including other
railroads, significant suppliers, larger customers, and financial
institutions) to determine the extent to which NS Rail may be vulnerable
to any such third parties' failure to achieve Year-2000 compliance.
PAGE 19
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Thus far, NS Rail has no information that indicates a significant third
party may be unable to provide goods or services or to request
NS Rail's services because of Year-2000 compliance issues. NS Rail
will continue to monitor the progress of such third parties' Year-2000
compliance efforts and develop contingency plans as warranted.
Cost
- ----
NS Rail has allocated existing information technology resources and
has incurred incremental costs, mostly for contract programmers and
consultants, in connection with its Year-2000 compliance project.
Since the project began, Management estimates that up to 10 percent of
NS Rail's in-house programming resources have been used for Year-2000
compliance efforts. The effects of deferring other information
technology projects to accommodate the Year-2000 effort have been
minor. Incremental costs incurred through June 30, 1999, which were
expensed, are immaterial to NS Rail's results of operations. Total
incremental costs are expected to be approximately $25 million.
Contingency Plans
- -----------------
In all areas, the project includes extensive testing to ensure that
remediation successfully addresses Year-2000 compliance. NS Rail has
established a series of initiatives to focus on business-critical
systems to ensure continued operations in the event of a Year-2000 problem.
In addition, contingency plans are being developed where warranted.
Conrail
- -------
NS Rail is implementing its own information technology systems on the
portion of Conrail's routes and assets it is operating. While some
systems are operational, others -- particularly the transportation
systems -- will be integrated geographically during the remainder of
1999. Accordingly, some of Conrail's systems have been modified to be
compatible with NS Rail's systems during the interim period. Moreover,
in the Shared Assets Areas, some of Conrail's existing systems still
are being used, and, therefore, must be compatible with both NS Rail's
and CSX's systems. NS Rail is continuing to work with Conrail and CSX
to address compatibility issues.
NS Rail also is working with Conrail and CSX to ensure that certain
Conrail computer applications, hardware, and other equipment are
Year-2000 compliant. Conrail's core transportation system is being
made Year-2000 compliant, with a projected completion date for all
programming and testing of September 1999. Conrail's other information
technology systems are expected to be replaced by NS Rail and CSX
systems by Dec. 1, 1999. A delay in replacing these systems, which are
not Year-2000 compliant, could result in their failure. Conrail also
has under way a project to inventory, assess, and remediate all of its
business-critical enterprise systems that will continue to support its
post Closing Date operations. This Conrail project is scheduled for
completion in the third quarter of 1999.
PAGE 20
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
Risks
- -----
Failure to achieve Year-2000 compliance -- by NS Rail, other railroads,
its principal suppliers and customers, and certain financial
institutions with which it has relationships -- could negatively affect
NS Rail's ability to conduct business for an extended period.
Management believes that NS Rail will be successful in its Year-2000
compliance effort; however, there can be no assurance that all NS Rail
information technology systems and components will be fully Year-2000
compliant. In addition, other companies on which NS Rail systems and
operations rely may or may not be fully compliant on a timely basis,
and any such failure could have a material adverse effect on NS Rail's
financial position, results of operations, or liquidity.
NEW ACCOUNTING PRONOUNCEMENT
In June 1999, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 137, "Accounting
for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133." Because of this deferral,
NS Rail expects to adopt SFAS No. 133 effective Jan. 1, 2001.
LITIGATION
The Company and certain subsidiaries are defendants in numerous
lawsuits relating principally to railroad operations.
On Sept. 8, 1997, a state court jury in New Orleans returned a verdict
awarding $175 million in punitive damages against The Alabama Great
Southern Railroad Company (AGS), a subsidiary of Norfolk Southern
Railway Company. The verdict was returned in a class action suit
involving some 8,000 individuals who claim to have been damaged as the
result of an explosion and fire that occurred in New Orleans on
Sept. 9, 1987, when a chemical called butadiene leaked from a tankcar.
The jury verdict awarded a total of nearly $3.2 billion in punitive
damages against four other defendants in the same case: two rail
carriers, the owner of the car, and the shipper. Previously, the jury
had awarded nearly $2 million in compensatory damages to 20 of the
more than 8,000 individual plaintiffs.
On May 21, 1999, AGS and four of the nine defendants reached an agreement
to settle this litigation. The four remaining defendants are not parties
to the settlement agreement, and the litigation will continue against those
defendants. Because it involves a class action, the settlement is subject
to final approval by the trial court, and to possible appeals.
PAGE 21
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations. (continued)
-------------------------
While the final outcome of this matter and other lawsuits cannot be
predicted with certainty, it is the opinion of Management, based on
known facts and circumstances, that the amount of NS Rail's ultimate
liability is unlikely to have a material adverse effect on NS Rail's
financial position, results of operations, or liquidity.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements, within the
meaning of the Private Securities Reform Act of 1995, that are based on
current expectations, estimates, and projections. Such forward-looking
statements reflect Management's good-faith evaluation of information
currently available. However, because such statements are based upon,
and therefore can be influenced by, a number of external variables over
which Management has no, or incomplete, control, they are not, and
should not be read as being, guarantees of future performance or of
actual future results; nor will they necessarily prove to be accurate
indications of the times at or by which any such performance or result
will be achieved. Accordingly, actual outcomes and results may differ
materially from those expressed in such forward-looking statements.
This caveat has particular importance in the context of all such
statements that relate to Year-2000 compliance and to the Conrail
transaction, including the realization and the timing of benefits
expected to result from its consummation.
The forward-looking statements contained in this filing speak only as
of the date on which they are made, and the Company does not undertake
any obligation to update any forward-looking statement to reflect
events or circumstances after the date hereof. If the Company does
update one or more forward-looking statements, no inference should be
drawn that the Company will make additional updates with respect
thereto or with respect to other forward-looking statements.
PAGE 22
PART II - OTHER INFORMATION
---------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR)
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
- ------ ----------------------------------------------------------
There has been no material change to the disclosures made under
the heading "Market Risks and Hedging Activities" on page 38 of the
Company's 1998 Annual Report on Form 10-K.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------ ---------------------------------------------------
Registrant's annual meeting of stockholders was held on May 25,
1999, at which meeting two directors were elected to the class whose
term will expire in 2002.
The two nominees for directors, who were uncontested, were
elected by the following vote:
THREE-YEAR TERM
-----------------------------------------------------------------
FOR AUTHORITY WITHHELD
--- ------------------
Jon L. Manetta 17,533,132 votes 5,403 votes
Henry C. Wolf 17,533,132 votes 5,403 votes
Item 6. Exhibits and Reports on Form 8-K.
- ------ --------------------------------
(a) Exhibits:
10.1 Amendment No. 1, dated as of August 22, 1998, to the
Transaction Agreement, dated as of 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, that agreement's having been
filed electronically as Exhibit 10 to Registrant's
Current Report on Form 8-K, dated June 23, 1997.
10.2 Amendment No. 2, dated as of June 1, 1999, 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, that agreement's having been
filed electronically as Exhibit 10 to Registrant's
Current Report on Form 8-K, dated June 23, 1997.
10.3 Operating Agreement, dated as of June 1, 1999, by and
between Pennsylvania Lines LLC and Norfolk Southern
Railway Company.
PAGE 23
Item 6. Exhibits and Reports on Form 8-K. (continued)
- ------ --------------------------------
(a) Exhibits (continued):
10.4 Shared Assets Area Operating Agreement for North
Jersey, dated as of June 1, 1999, by and among
Consolidated Rail Corporation, CSX Transportation,
Inc., and Norfolk Southern Railway Company, with
exhibit thereto.
10.5 Shared Assets Area Operating Agreement for South
Jersey/Philadelphia, dated as of June 1, 1999, by and
among Consolidated Rail Corporation, CSX Transportation,
Inc., and Norfolk Southern Railway Company, with
exhibit thereto.
10.6 Shared Assets Area Operating Agreement for Detroit,
dated as of June 1, 1999, by and among Consolidated
Rail Corporation, CSX Transportation, Inc., and Norfolk
Southern Railway Company, with exhibit thereto.
10.7 Monongahela Usage Agreement, dated as of June 1, 1999,
by and among CSX Transportation, Inc., Norfolk Southern
Railway Company, Pennsylvania Lines LLC, and New York
Central Lines LLC, with exhibit thereto.
27 Financial Data Schedule
(b) Reports on Form 8-K:
A report on Form 8-K was filed on April 26, 1999, reporting
that on that date, NS would close the sale of a $400 million
offering of 6.20 percent Senior Notes due April 15, 2009.
PAGE 24
SIGNATURES
----------
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.
NORFOLK SOUTHERN RAILWAY COMPANY
-----------------------------------------
(Registrant)
Date: August 11, 1999 /s/ Dezora M. Martin
------------------- -----------------------------------------
Dezora M. Martin
Assistant Corporate Secretary (Signature)
Date: August 11, 1999 /s/ John P. Rathbone
------------------- -----------------------------------------
John P. Rathbone
Vice President and Controller
(Principal Accounting Officer) (Signature)
PAGE 25
INDEX TO EXHIBITS
-----------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR)
Electronic
Submission
Exhibit
Number Description
- ---------- ------------------------------------------------------
10.1 Amendment No. 1, dated as of August 22, 1998, to the
Transaction Agreement, dated as of June 10, 1997.
10.2 Amendment No. 2, dated as of June 1, 1999, to the
Transaction Agreement, dated June 10, 1997.
10.3 Operating Agreement, dated as of June 1, 1999.
10.4 Shared Assets Area Operating Agreement for North Jersey,
dated as of June 1, 1999.
10.5 Shared Assets Area Operating Agreement for South
Jersey/Philadelphia, dated as of June 1, 1999.
10.6 Shared Assets Area Operating Agreement for Detroit,
dated as of June 1, 1999.
10.7 Monongahela Usage Agreement, dated as of June 1, 1999.
27 Financial Data Schedule (This exhibit is required to be
submitted electronically pursuant to the rules and
regulations of the Securities and Exchange Commission
and shall not be deemed filed for purposes of Section 11
of the Securities Act of 1933 or Section 18 of the
Securities Exchange Act of 1934.)