PAGE 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
------------------------
FORM 10-K405
(X)ANNUAL REPORT PURSUANT TO SECTION 13 OR l5(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997.
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 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 (I.R.S. Employer
incorporation or organization) Identification No.)
Three Commercial Place, Norfolk, Virginia 23510-2191
----------------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (757) 629-2682
----------------------
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS SO REGISTERED. EACH CLASS REGISTERED ON NEW YORK
STOCK EXCHANGE:
Norfolk and Western Railway Company 4.85% Subordinated Income
Debentures, due November 15, 2015; Guarantee of Norfolk Southern Railway
Company with respect to $1,754,900 principal amount of Norfolk and
Western Railway Company 4.85% Subordinated Income Debentures due
November 15, 2015; The Virginian Railway Company 6% Subordinated Income
Debentures, due August 1, 2008; Guarantee of Norfolk Southern Railway
Company with respect to $4,466,000 principal amount of The Virginian
Railway Company 6% Subordinated Income Debentures due August 1, 2008;
Norfolk Southern Railway Company $2.60 Cumulative Preferred Stock,
Series A (No Par Value, $50 Stated Value).
Securities registered pursuant to Section 12(g) of the Act: NONE
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 by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K405 or any amendment to this Form 10-K405. (X)
PAGE 2
The aggregate market value of the voting stock held by
nonaffiliates as of February 28, 1998: $41,639,231
The number of shares outstanding of each of the registrant's
classes of Common Stock, as of February 28, 1998: 16,668,997
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive proxy statement (to be
dated April 14, 1998), to be filed electronically pursuant to
Regulation 14A not later than 120 days after the end of the fiscal
year, are incorporated by reference in Part III.
PAGE 3
TABLE OF CONTENTS
Item Page
---- ----
Part I 1. Business 4
2. Properties 4
3. Legal Proceedings 16
4. Submission of Matters to a Vote of Security
Holders 16
Executive Officers of the Registrant 17
Part II 5. Market for Registrant's Common Stock and
Related Stockholder Matters 23
6. Selected Financial Data 24
7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 25
8. Financial Statements and Supplementary Data 40
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 67
Part III 10. Directors and Executive Officers of the
Registrant 67
11. Executive Compensation 67
12. Security Ownership of Certain Beneficial
Owners and Management 67
13. Certain Relationships and Related
Transactions 67
Part IV 14. Exhibits, Financial Statement Schedule, and
Reports on Form 8-K 68
Index to Consolidated Financial Statement
Schedule 68
Power of Attorney 71
Signatures 71
Exhibit Index 75
PAGE 4
PART I
Item 1. Business.
- ------ --------
and
Item 2. Properties.
- ------ ----------
GENERAL - Norfolk Southern Railway Company (Norfolk
Southern Railway) was incorporated in 1894 under the name Southern
Railway Company (Southern) in the Commonwealth of Virginia and,
together with its consolidated subsidiaries (collectively, NS Rail),
is primarily engaged in the transportation of freight by rail.
On June 1, l982, Southern and Norfolk and Western Railway
Company (Norfolk and Western) became subsidiaries of Norfolk Southern
Corporation (NS), a transportation holding company. Effective
December 31, 1990, NS transferred all the common stock of Norfolk and
Western to Southern, and Southern's name was changed to Norfolk
Southern Railway Company. Accordingly, all the common stock of
Norfolk and Western, which is its only voting security, is owned by
Norfolk Southern Railway, and all the common stock of Norfolk
Southern Railway (16,668,997 shares) is owned directly by NS. NS
common stock is publicly held and listed on the New York Stock
Exchange.
There remain issued and outstanding as of December 31,
1997, 1,197,027 shares of Norfolk Southern Railway's $2.60 Cumulative
Preferred Stock, Series A (Series A Stock), of which 1,096,907 shares
were held by other than subsidiaries. The Series A Stock is entitled
to one vote per share, is nonconvertible, and is traded on the New
York Stock Exchange. In June 1989, NS announced its intention to
purchase up to 250,000 shares of Norfolk Southern Railway's Series A
Stock during the subsequent two-year period. Subsequently, NS
extended the stock purchase program through 1996. As of Dec. 31,
1996, NS had purchased 176,608 shares of Series A Stock at a total
cost of $6.7 million. As of Dec. 31, 1997, NS held a total of
176,703 shares; consequently, as of the same date, NS held
94.8 percent of the voting stock of Norfolk Southern Railway.
JOINT ACQUISITION OF CONRAIL INC. BY NS - During 1997, NS
and CSX Corporation (CSX) completed the acquisition of Conrail Inc.
equity (see "Joint Acquisition of Conrail by NS" on page 34).
OPERATIONS - As of Dec. 31, 1997, NS Rail operated
approximately 14,400 miles of road in the states of Alabama, Florida,
Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland,
Michigan, Mississippi, Missouri, New York, North Carolina, Ohio,
Pennsylvania, South Carolina, Tennessee, Virginia and West Virginia,
and in the Province of Ontario, Canada. Of this total, 12,101 miles
are owned with the balance operated under lease or trackage rights;
most of this total is main line track. In addition, NS Rail operates
10,838 miles of passing, industrial, yard and side tracks.
PAGE 5
NS Rail has major leased lines between Cincinnati, Ohio, and
Chattanooga, Tennessee, and in the State of North Carolina.
The Cincinnati-Chattanooga lease, covering about 335 miles,
expires in 2026, and is subject to an option to extend the lease for
an additional 25 years, at terms to be agreed upon.
The North Carolina leases, covering approximately 330 miles,
expired by their terms at the end of 1994. Although a lease extension
agreement was approved by the boards of both NS and the North Carolina
Railroad Company (NCRR) and by the stockholders of NCRR, the
U.S. District Court in Raleigh ruled that there was no quorum at the
stockholders' meeting and enjoined the parties from performing under
the extension agreement. NCRR has suits pending against NS and
various subsidiaries in federal court in Raleigh to enforce rights
under the expired leases and at the STB to seek the establishment of
terms and conditions of NS Rail's continued use and the compensation
therefor. Also, certain NCRR stockholders earlier had filed four
separate, and still pending, derivative actions challenging the
adequacy of the rental terms in the extension agreement. NS Rail
presently is operating over the leased lines under the requirements of
federal law, and will continue to do so until the matter has been
resolved through agreement or a decision by the STB establishing
reasonable conditions or permitting discontinuance of such operations.
Whatever the ultimate resolution of the litigation, it is not expected
to have a material effect on NS Rail's consolidated financial
statements.
NS Rail's lines carry raw materials, intermediate products
and finished goods primarily in the Southeast and Midwest and to and
from the rest of the United States and parts of Canada. These lines
also transport overseas freight through several Atlantic and Gulf
Coast ports. Atlantic ports served by NS include: Norfolk, Virginia;
Morehead City, North Carolina; Charleston, South Carolina; Savannah
and Brunswick, Georgia; and Jacksonville, Florida. Gulf Coast ports
served include: Mobile, Alabama, and New Orleans, Louisiana.
NS Rail's lines reach most of the larger industrial and
trading centers of the Southeast and Midwest, with the exception of
those in central and southern Florida. Atlanta, Birmingham, New
Orleans, Memphis, St. Louis, Kansas City (Missouri), Chicago, Detroit,
Cincinnati, Buffalo, Norfolk, Charleston, Savannah and Jacksonville
are among the leading centers originating and terminating freight
traffic on the system. In addition, a haulage arrangement with the
Florida East Coast Railway allows NS Rail to provide single-line
service to and from south Florida, including the port cities of Miami,
West Palm Beach and Fort Lauderdale. The system's lines also reach
many individual industries, mines (in western Virginia, eastern
Kentucky and southern West Virginia) and businesses located in smaller
communities in its service area. The traffic corridors carrying the
heaviest volumes of freight include those from the Appalachian coal
fields of Virginia, West Virginia and Kentucky to Norfolk and
Sandusky, Ohio; Buffalo to Chicago and Kansas City; Chicago to
Jacksonville (via Cincinnati, Chattanooga and Atlanta); and
Washington, D.C./Hagerstown, Maryland, to New Orleans (via Atlanta and
Birmingham).
PAGE 6
Buffalo, Chicago, Hagerstown, Jacksonville, Kansas City,
Memphis, New Orleans and St. Louis are major gateways for
interterritorial system traffic.
Implementation of the Conrail transaction should expand
NS Rail's service area considerably, giving it access to most of the
major ports on the East Coast, to New York City and the Northeast,
and to the Midwest. Additional information is provided in
"Management's Discussion and Analysis," beginning on page 25, and in
Note 2 to the Consolidated Financial Statements.
NS Rail and other railroads have entered into service
interruption agreements, effective Dec. 30, 1994, providing
indemnities to parties affected by a strike over specified industry
issues. If NS Rail was so affected, it could receive daily
indemnities from non-affected parties; if parties other than NS Rail
were affected, it could be required to pay indemnities to those
parties. If NS Rail were required to pay the maximum amount of
indemnities required of it under these agreements -- an event
considered unlikely at this time -- such liability should not exceed
approximately $85 million.
RAILWAY OPERATING REVENUES - NS Rail's total railway
operating revenues were $4.2 billion in 1997. Revenue, shipments and
revenue yield by principal railway operating revenue sources for the
past five years are set forth in the following table:
Year Ended December 31,
Principal Sources of -------------------------------------------
Railway Operating
Revenues 1997 1996 1995 1994 1993
- -------------------- ---- ---- ---- ---- ----
(Revenues in millions, shipments in thousands, revenue yield in dollars
per shipments)
COAL
Revenues $1,301 $1,305 $1,268 $1,290 $1,239
% of total revenues 31% 32% 32% 33% 33%
Shipments 1,324 1,310 1,267 1,274 1,209
% of total shipments 28% 29% 29% 30% 30%
Revenue Yield $ 983 $ 996 $1,001 $1,013 $1,025
CHEMICALS
Revenues $ 585 $ 560 $ 541 $ 538 $ 501
% of total revenues 14% 14% 14% 14% 14%
Shipments 405 385 374 376 343
% of total shipments 8% 8% 8% 9% 8%
Revenue Yield $1,446 $1,456 $1,447 $1,433 $1,459
PAPER/CLAY/FOREST
Revenues $ 539 $ 513 $ 537 $ 522 $ 522
% of total revenues 13% 12% 13% 13% 14%
Shipments 457 438 459 464 466
% of total shipments 9% 10% 10% 11% 12%
Revenue Yield $1,178 $1,171 $1,170 $1,124 $1,120
PAGE 7
Year Ended December 31,
Principal Sources of -------------------------------------------
Railway Operating
Revenues 1997 1996 1995 1994 1993
- -------------------- ---- ---- ---- ---- ----
(Revenues in millions, shipments in thousands, revenue yield in dollars
per shipments)
AUTOMOTIVE
Revenues $ 492 $ 489 $ 449 $ 429 $ 426
% of total revenues 11% 12% 11% 11% 11%
Shipments 361 354 328 317 318
% of total shipments 8% 8% 7% 7% 8%
Revenue Yield $1,364 $1,379 $1,368 $1,352 $1,340
AGRI./GOVT./CONSUMER
Revenues $ 391 $ 393 $ 394 $ 380 $ 357
% of total revenues 9% 9% 10% 10% 10%
Shipments 366 376 391 383 359
% of total shipments 8% 8% 9% 9% 9%
Revenue Yield $1,065 $1,045 $1,007 $ 992 $ 994
METALS/CONSTRUCTION
Revenues $ 368 $ 354 $ 349 $ 330 $ 309
% of total revenues 9% 9% 8% 8% 8%
Shipments 374 359 367 366 338
% of total shipments 8% 8% 8% 8% 8%
Revenue Yield $ 985 $ 986 $ 951 $ 902 $ 915
INTERMODAL
(Trailers, Containers
and RoadRailers)
Revenues $ 547 $ 487 $ 474 $ 429 $ 374
% of total revenues 13% 12% 12% 11% 10%
Shipments 1,472 1,331 1,263 1,127 995
% of total shipments 31% 29% 29% 26% 25%
Revenue Yield $ 372 $ 366 $ 376 $ 380 $ 376
------ ------ ------ ------ ------
Total Railway Operating
Revenues $4,223 $4,101 $4,012 $3,918 $3,728
Total Railway Shipments 4,759 4,553 4,449 4,307 4,028
Railway Revenue Yield $ 887 $ 901 $ 902 $ 910 $ 926
Note: Revenues previously reported as "other railway revenues"
(principally switching and demurrage) have been allocated to
revenues reported for each commodity group.
Shipments include general merchandise and coal rail carloads and
intermodal rail and RoadRailer(RT) units.
PAGE 8
COAL TRAFFIC - Coal, coke and iron ore -- most of which is
bituminous coal -- is NS Rail's principal commodity group. They
originated 119 million tons of coal, coke and iron ore in 1997 and
handled a total of 134 million tons. Originated tonnage increased
2 percent from 117 million tons in 1996, and total tons handled
increased 3 percent from 130 million tons in 1996. Revenues from
coal, coke and iron ore account for about 31 percent of NS' total
railway operating revenues.
The following table shows total coal, coke and iron ore
tonnage originated on line, received from connections and handled for
the past five years:
Tons of Coal, Coke and Iron Ore (Millions)
---------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Originated 119 117 114 115 112
Received 15 13 11 11 6
---- ---- ---- ---- ----
Handled 134 130 125 126 118
Of the 119 million tons of coal, coke and iron ore
originated on NS Rail's lines in 1997, the approximate breakdown by
origin state was as follows:
Origin State Millions of Tons
------------ ----------------
West Virginia 43
Virginia 35
Kentucky 28
Alabama 5
Indiana 3
Illinois 2
Tennessee 2
Other 1
---
Total 119
===
Of this 119 million tons, approximately 28 million moved for
export, principally through NS Rail's pier facilities at Norfolk
(Lamberts Point), Virginia; 19 million moved to domestic and Canadian
steel industries; 64 million of steam coal moved to electric
utilities; and 8 million moved to other industrial and miscellaneous
users.
NS Rail moved 9 million tons of originated coal, coke and
iron ore to various docks on the Ohio River, and 5 million tons to
various Lake Erie ports. Other than coal for export, virtually all
coal handled by NS Rail was terminated in states situated east of the
Mississippi River.
Total coal handled through all system ports in 1997 was
45 million tons. Of this total, 71 percent, or 32 million tons
(including coastwise traffic), moved through Lamberts Point, a
7 percent increase, compared with the 30 million tons handled in 1996.
PAGE 9
The quantities of NS Rail export coal handled through
Lamberts Point for the past five years were as follows:
Export Coal through Lamberts Point
(Millions of tons)
----------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
28 26 25 24 25
See the discussion of coal traffic, by type of coal, in
Part II, Item 7, "Management's Discussion and Analysis," on page 25.
MERCHANDISE TRAFFIC - The merchandise traffic group consists
of Intermodal and five major commodity groupings: Paper, Clay, and
Forest Products; Chemicals; Automotive; Agriculture, Government, and
Consumer Products; and Metals and Construction. Total merchandise
revenues in 1997 were $2.92 billion, a 5 percent increase, compared
with 1996. Merchandise carloads handled in 1997 were 3.43 million,
compared with 3.24 million handled in 1996, an increase of 6 percent.
In 1997, 111 million tons of merchandise freight, or
approximately 67 percent of total merchandise tonnage handled by
NS Rail, originated on line. The balance of merchandise traffic was
received from connecting carriers, usually at interterritorial
gateways. The principal interchange points for NS Rail-received
traffic included Chicago, Memphis, New Orleans, Cincinnati, Kansas
City, Detroit, Hagerstown, St. Louis/East St. Louis and Louisville.
Revenues in five of the six market groups comprising
merchandise traffic improved in 1997. The largest gains were in
Intermodal, up $60 million; Paper, Clay and Forest Products, up
$26 million; and Chemicals, up $25 million.
See the discussion of merchandise rail traffic by commodity
group in Part II, Item 7, "Management's Discussion and Analysis," on
page 25.
OPERATING STATISTICS - The following table sets forth
certain statistics relating to NS Rail's operations for the past five
years:
Year Ended December 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
Revenue ton miles
(billions) 136 130 127 122 112
Freight train miles 49.7 49.4 48.5 46.0 43.3
traveled (millions)
Revenue per ton mile $0.0311 $0.0316 $0.0317 $0.0320 $0.0334
Revenue tons per train 2,732 2,625 2,611 2,655 2,577
Revenue ton miles
per man-hour worked 2,905 2,764 2,679 2,579 2,304
Percentage ratio of
railway operating
expenses to railway
operating revenues 71.3 71.6 73.5 73.2 75.3
PAGE 10
FREIGHT RATES - In 1997, NS Rail continued its reliance on
private contracts and exempt price quotes as the predominant pricing
mechanism. Thus, a major portion of NS Rail's freight business is
not economically regulated by the government. In general, market
forces have been substituted for government regulation and now are
the primary determinant of rail service prices.
In 1997, NS Rail was found by the STB to be "revenue
adequate" based on results for the year 1996. A railroad is "revenue
adequate" under the applicable law when its return on net investment
exceeds the rail industry's composite cost of capital.
The revenue adequacy measure is one of several factors
considered by the STB when it is called upon to rule on the
reasonableness of regulated rates.
PASSENGER OPERATIONS - Regularly scheduled passenger
operations on NS Rail's lines consist of Amtrak trains operating
between Alexandria and New Orleans, and between Charlotte and Selma,
North Carolina. Commuter trains are operated on the NS Rail line
between Manassas and Alexandria under contract with two
transportation commissions of the Commonwealth of Virginia. Both of
these services are under contracts providing for reimbursement of
related expenses incurred by NS Rail. NS Rail also leases the
Chicago to Manhattan, Illinois, line to the Commuter Rail Division of
the Regional Transportation Authority of Northeast Illinois.
Should the Conrail transaction become effective as
proposed, NS Rail will accommodate substantially increased Amtrak and
commuter passenger mileage and will conduct significant freight
operations over trackage owned by Amtrak or by commuter entities.
PAGE 11
RAILWAY PROPERTY:
EQUIPMENT - As of December 31, 1997, NS Rail owned or
leased the following units of equipment:
Number of Units
-------------------------------- Capacity
Owned* Leased Total of Equipment
--------- -------- -------- ------------
Type of Equipment
- -----------------
Locomotives: (Horsepower)
Multiple purpose 2,027 0 2,027 6,472,600
Switching 112 0 112 163,950
Auxiliary units 61 0 61 0
--------- ------- -------- ------------
Total locomotives 2,200 0 2,200 6,636,550
========= ======= ======== ============
Freight Cars: (Tons)
Hopper 22,639 331 22,970 2,425,379
Box 18,789 666 19,455 1,520,443
Covered Hopper 12,400 1,890 14,290 1,550,683
Gondola 26,140 0 26,140 2,797,632
Flat 3,967 825 4,792 346,931
Caboose 207 0 207 0
Other 808 0 808 64,970
--------- ------- -------- ------------
Total freight cars 84,950 3,712 88,662 8,706,038
========= ======= ======== ============
Other:
Work equipment 6,745 3 6,748
Vehicles 3,649 0 3,649
Highway trailers
and containers 2,043 2,785 4,828
Miscellaneous 1,498 1,799 3,297
--------- ------- --------
Total other 13,935 4,587 18,522
========= ======= ========
* Includes equipment leased to outside parties and equipment
subject to equipment trusts, condition sale agreements and
capitalized leases.
PAGE 12
The following table indicates the number and year of
purchase for locomotives and freight cars owned at Dec. 31, 1997:
Year Built
-----------------------------------------------------------
1987- 1981- 1980 &
1997 1996 1995 1994 1993 1992 1986 Before Total
---- ---- ---- ---- ---- ---- ---- ------ -----
Locomotives:
Number of
units 120 120 125 25 31 292 420 1,067 2,200
Percent of
fleet 5 5 6 1 1 13 19 50 100
Freight cars:
Number of
units 499 787 1,034 779 931 5,492 6,632 68,796 84,950
Percent of
fleet 1 1 1 1 1 6 8 81 100
The average age of the freight car fleet at Dec. 31, 1997,
was 23.1 years. During 1997, 2,250 freight cars were retired. As of
Dec. 31, 1997, the average age of the locomotive fleet was 15.3 years.
During 1997, 78 locomotives, the average age of which was 23.3 years,
were retired. Since 1988, more than 25,100 coal cars have been
rebodied. As a result, the remaining serviceability of the freight
car fleet is greater than may be inferred from the high percentage of
freight cars built in earlier years.
Ongoing freight car and locomotive maintenance programs are
intended to ensure the highest standards of safety, reliability,
customer satisfaction and equipment marketability. In past years,
the freight car bad order ratio reflected the storage of certain
types of cars which were not in high demand. The ratio has declined
more recently as a result of a disposition program for underutilized,
unserviceable and over-age revenue cars. In this connection, an
orderly disposition of 17,000 freight cars, begun in October 1994,
was completed in 1997. The locomotive bad order ratio rose in 1997,
particularly in the early months of the year as older units required
additional servicing and some new units were out-of-service related
to warranty work. By year-end, the locomotive bad order ratio had
returned to a more historic level.
Annual Average Bad Order Ratio
---------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Freight Cars (excluding cabooses):
NS Rail 4.6% 4.8% 5.8% 6.7% 7.3%
Locomotives:
NS Rail 5.0% 4.5% 4.7% 4.7% 4.3%
PAGE 13
TRACKAGE - All NS Rail trackage is standard gauge, and the
rail in approximately 95 percent of the main line trackage (including
first, second, third and branch main tracks, all excluding trackage
rights) ranges from 100 to 140 pounds per yard. Of the 22,427 miles
of track maintained as of Dec. 31, 1997, 15,878 were laid with welded
rail.
The density of traffic on running tracks (main line trackage
plus passing tracks) during 1997 was as follows:
Gross tons of
freight carried
per track mile Track miles Percent
(Millions) of running tracks* of total
--------------- ----------------- --------
0-4 4,470 28
5-19 4,708 29
20 and over 6,893 43
------ ---
16,071 100
* Excludes trackage rights.
The following table summarizes certain information about
track roadway additions and replacements during the past five years:
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Track miles of rail installed 451 401 403 480 574
Miles of track surfaced 4,703 4,686 4,668 4,760 5,048
New crossties installed
(millions) 2.2 1.9 2.0 1.7 1.6
MICROWAVE SYSTEM - The NS Rail microwave system, consisting
of 7,610 radio path miles, 417 active stations and 4 passive repeater
stations, provides communications between most operating locations.
The microwave system is used principally for voice communications,
VHF radio control circuits, data and facsimile transmissions, traffic
control operations, AEI data transmissions and relay of intelligence
from defective equipment detectors.
TRAFFIC CONTROL - Of a total of 12,784 road miles operated
by NS Rail, excluding trackage rights over foreign lines, 5,400 road
miles are governed by centralized traffic control systems (of which
560 miles are controlled by data radio from 43 microwave site
locations) and 2,500 road miles are equipped for automatic block
system operation.
COMPUTERS - Data processing facilities connect the yards,
terminals, transportation offices, rolling stock repair points, sales
offices and other key system locations to the central computer complex
in Atlanta, Ga. Operating and traffic data are compiled and stored to
provide customers with information on their shipments throughout the
system. Data processing facilities are capable of providing current
information on the location of every train and each car on line, as
well as related waybill and other train and car movement data.
Additionally, these facilities afford substantial capacity for,
PAGE 14
and are utilized to assist management in the performance of, a wide
variety of functions and services, including payroll, car and revenue
accounting, billing, material management activities and controls, and
special studies.
NS Rail has underway a project to review, and modify as
necessary, computer and other systems for Year-2000 compliance. As of
December 1997, most of NS Rail's mainframe computer programs have been
reviewed. This mainframe project is expected to be completed by the
end of 1998. Failure to achieve Year-2000 compliance -- by NS Rail,
other railroads, its suppliers, and its customers -- could negatively
affect NS Rail's ability to conduct business for an extended period.
Management believes that NS Rail's project will be completed on time
and that the chance of failure is remote.
OTHER - NS Rail has extensive facilities for support of
railroad operations, including freight depots, car construction shops,
maintenance shops, office buildings, and signals and communications
facilities.
ENCUMBRANCES - Certain railroad equipment is subject to the
prior lien of equipment financing obligations amounting to
approximately $598 million as of Dec. 31, 1997, and $594 million at
Dec. 31, 1996. In addition, a portion of NS' properties is subject to
liens securing, as of Dec. 31, 1997, and 1996, approximately
$1 million and $51 million of mortgage debt, respectively.
CAPITAL EXPENDITURES - Capital expenditures for road,
equipment and other property for the past five years were as follows:
Capital Expenditures
----------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(In millions of dollars)
Railway property
Road $580 $428 $379 $383 $411
Equipment 304 326 333 235 218
Other property -- -- 1 22 --
---- ---- ---- ---- ----
Total $884 $754 $713 $640 $629
==== ==== ==== ==== ====
Capital spending and maintenance programs are and have been
designed to assure the ability to provide safe, efficient and reliable
transportation services. For 1998, NS Rail has budgeted approximately
$900 million of capital spending, of which $149 million are initial
outlays for facilities and equipment related to the Conrail
transaction. Capital spending is expected to be affected
significantly by Conrail-related expenditures, which are anticipated
to add approximately $500 million (net of predicted savings) over the
next three years.
ENVIRONMENTAL MATTERS - Compliance with federal, state and
local laws and regulations relating to the protection of the
environment is a principal NS Rail goal. To date, such compliance
has not affected materially NS Rail's capital additions, earnings,
liquidity or competitive position.
PAGE 15
See the discussion of "Environmental Matters" on page 37 in
Part II, Item 7, "Management's Discussion and Analysis," beginning on
page 25 and in Note 16 to the Consolidated Financial Statements on
page 64.
EMPLOYEES - NS Rail employed an average of 23,323 employees in
1997, compared with an average of 23,361 in 1996 (including Norfolk
Southern Corporation's employees whose primary duties relate to rail
operations). The approximate average cost per employee during 1997 was
$47,828 in wages and $18,418 in employee benefits. Approximately
81 percent of these employees are represented by various labor
organizations.
As of the end of 1997, NS Rail had negotiated labor agreements
with all of its unions. The accords with the 13 union organizations,
which include compensation settlements in line with other major
industries, will not be due for change until after January 1, 2000.
GOVERNMENT REGULATION - In addition to environmental,
safety, securities and other regulations generally applicable to all
businesses, NS Rail is subject to regulation by the STB, which
succeeded the ICC on January 1, 1996. The STB has jurisdiction over
some rates, routes, conditions of service, and the extension or
abandonment of rail lines. The STB also has jurisdiction over the
consolidation, merger or acquisition of control of and by rail common
carriers. The Department of Transportation regulates certain track
and mechanical equipment standards.
The relaxation of economic regulation of railroads, begun
over a decade ago by the ICC under the Staggers Rail Act of 1980, has
continued under the STB and additional rail business could be exempted
from regulation in the future. Significant exemptions are TOFC/COFC
(i.e., "piggyback") business, rail boxcar traffic, lumber,
manufactured steel, automobiles and certain bulk commodities such as
sand, gravel, pulpwood and wood chips for paper manufacturing.
Transportation contracts on regulated shipments, which no longer
require regulatory approval, effectively remove those shipments from
regulation as well. Over 80 percent of NS Rail's freight revenues
come from either exempt traffic or traffic moving under transportation
contracts.
Efforts will be made in 1998 to re-subject the rail industry
to unwarranted federal economic regulation. The Staggers Rail Act of
1980, which substantially reduced such regulation, encouraged and
enabled rail carriers to innovate and to compete for business, thereby
contributing to the economic health of the nation and to the
revitalization of the industry. Accordingly, NS Rail and other rail
carriers vigorously will oppose these counterproductive efforts to re-
impose or to authorize re-imposing such economic regulation.
COMPETITION - There is continuing strong competition among
rail, water and highway carriers. Price is usually only one factor
of importance as shippers and receivers choose a transport mode and
specific hauling company. Inventory carrying costs, service
reliability, ease of handling, and the desire to avoid loss and
damage during transit are increasingly important considerations,
PAGE 16
especially for higher valued finished goods, machinery and consumer
products. Even for raw materials, semi-finished goods and work-in-
process, users are increasingly sensitive to transport arrangements
which minimize problems at successive production stages.
NS Rail's primary rail competitor is the CSX system; both
operate throughout much of the same territory, and implementation of
the Conrail transaction should extend the area in which they compete.
Other railroads also operate in parts of the territory. NS Rail also
competes with motor carriers, water carriers and with shippers who
have the additional option of handling their own goods in private
carriage.
Certain cooperative strategies between railroads and between
railroads and motor carriers enable carriers to compete more
effectively in specific markets.
Item 3. Legal Proceedings.
- ------ -----------------
None.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------ ---------------------------------------------------
There were no matters submitted to a vote of security
holders during the fourth quarter of 1997.
PAGE 17
Executive Officers of the Registrant.
- ------------------------------------
Norfolk Southern Railway's officers are elected annually by
the Board of Directors at its first meeting held after the annual
meeting of stockholders, and they hold office until their successors
are elected. There are no family relationships among the officers,
nor any arrangement or understanding between any officer and any
other person pursuant to which the officer was selected. The
following table sets forth certain information, as of March 1, 1998,
relating to these officers:
Business Experience during
Name, Age, Present Position past 5 Years
- --------------------------- ------------------------------------
David R. Goode, 57, Present position since September
President and Chief 1992. Also, Chairman, President
Executive Officer and Chief Executive Officer of
Norfolk Southern Corporation
since September 1992.
Paul N. Austin, 54, Present position since June 1994.
Vice President-Personnel Also, Vice President-Personnel of
Norfolk Southern Corporation
since June 1994. Served as
Assistant Vice President-
Personnel of Norfolk Southern
Corporation from February 1993 to
June 1994, and prior thereto was
Director-Compensation.
James C. Bishop, Jr., 61, Present position since March 1996.
Vice President-Law Also, Executive Vice President-
Law of Norfolk Southern
Corporation since March 1996,
and prior thereto was Vice
President-Law.
R. Alan Brogan, 57, Present position since December
Vice President- 1992. Also, Executive Vice
Transportation Logistics President-Transportation
Logistics of Norfolk Southern
Corporation since December 1992.
David A. Cox, 61, Present position since December
Vice President-Properties 1995. Also, Vice President-
Properties of Norfolk Southern
Corporation since December 1995,
and prior thereto was Assistant
Vice President-Industrial
Development.
PAGE 18
Business Experience during
Name, Age, Present Position past 5 Years
- --------------------------- ------------------------------------
Thomas L. Finkbiner, 45, Present position since August 1993.
Vice President-Intermodal Also, Vice President-Intermodal
of Norfolk Southern Corporation
since August 1993. Served as
Senior Assistant Vice President-
International and Intermodal of
Norfolk Southern Corporation from
April to August 1993, and prior
thereto was Assistant Vice
President-International and
Intermodal.
Nancy S. Fleischman, 50, Present position since August 1997.
Vice President Also, Vice President of Norfolk
Southern Corporation since August
1997. Served as Assistant Vice
President-Strategic Planning of
Norfolk Southern Corporation from
November 1993 to August 1997, and
prior thereto was Senior General
Attorney.
Robert C. Fort, 53, Present position since December
Vice President- 1996. Also, Vice President-
Public Relations Public Relations of Norfolk
Southern Corporation since
December 1996, and prior thereto
was Assistant Vice President-
Public Relations.
John W. Fox, Jr., 50, Present position since October
Vice President- 1995. Also, Vice President-Coal
Coal Marketing Marketing of Norfolk Southern
Corporation since October 1995.
Served as Assistant Vice
President-Coal Marketing of
Norfolk Southern Corporation from
August 1993 to October 1995, and
prior thereto was General Manager-
Eastern Region.
Thomas J. Golian, 64, Present position since October
Vice President 1995. Also, Vice President of
Norfolk Southern Corporation
since October 1995. Served as
Executive Assistant to the
Chairman, President and CEO of
Norfolk Southern Corporation from
April 1993 to October 1995, and
prior thereto was Special
Assistant to the President.
PAGE 19
Business Experience during
Name, Age, Present Position past 5 Years
- --------------------------- ------------------------------------
James A. Hixon, 44, Present position since June 1993.
Vice President-Taxation Also, Vice President-Taxation of
Norfolk Southern Corporation
since June 1993, and prior
thereto was Assistant Vice
President-Tax Counsel.
Jon L. Manetta, 59, Present position since December
Vice President- 1995. Also, Vice President-
Transportation & Transportation & Mechanical of
Mechanical Norfolk Southern Corporation
since December 1995. Served as
Vice President-Transportation of
Norfolk Southern Railway and
Norfolk Southern Corporation
from June 1994 to December 1995,
Assistant Vice President-
Transportation from October 1993
to June 1994, Assistant Vice
President-Strategic Planning
from January to October 1993,
and prior thereto was Director-
Joint Facilities and Budget.
Harold C. Mauney, Jr., 59, Present position since August 1,
Vice President- 1997. Also, Vice President-
Public Affairs Public Affairs of Norfolk
Southern Corporation since
August 1, 1997. Served as Vice
President-Operations Planning
and Budget of Norfolk Southern
Railway Company and Norfolk
Southern Corporation from
December 1996 to August 1997,
and prior thereto was Vice
President-Quality Management.
Donald W. Mayberry, 54, Present position since December
Vice President- 1995. Also, Vice President-
Research and Tests Research and Tests of Norfolk
Southern Corporation since
December 1995, and prior thereto
was Vice President-Mechanical.
James W. McClellan, 58, Present position since October
Vice President- 1993. Also, Vice President-
Strategic Planning Strategic Planning of Norfolk
Southern Corporation since
October 1993, and prior thereto
was Assistant Vice President-
Corporate Planning.
PAGE 20
Business Experience during
Name, Age, Present Position past 5 Years
- --------------------------- ------------------------------------
Kathryn B. McQuade, 41, Present position since December
Vice President- 1992. Also, Vice President-
Internal Audit Internal Audit of Norfolk
Southern Corporation since
December 1992.
Charles W. Moorman, 46, Present position since October
Vice President- 1993. Also, Vice President-
Information Technology Information Technology of
Norfolk Southern Corporation
since October 1993, and prior
thereto was Vice President-
Employee Relations.
Phillip R. Ogden, 57, Present position since December
Vice President-Engineering 1992. Also, Vice President-
Engineering of Norfolk Southern
Corporation since December 1992.
L. I. Prillaman, 54, Present position since October
Vice President and 1995. Also, Executive Vice
Chief Traffic Officer President-Marketing of Norfolk
Southern Corporation since
October 1995, and prior thereto
was Vice President-Properties.
John P. Rathbone, 46, Present position since December
Vice President and 1992. Also, Vice President and
Controller Controller of Norfolk Southern
Corporation since December 1992.
William J. Romig, 53, Present position since December
Vice President 1992. Also, Vice President and
Treasurer of Norfolk Southern
Corporation since December 1992.
John M. Samuels, 54, Present position since January 16,
Vice President-Operations 1998. Also, Vice President-
Planning and Budget Operations Planning and Budget
of Norfolk Southern Corporation
since January 16, 1998.
Previously served as Vice
President-Operating Assets of
Conrail from January 1996 to
January 1998, Vice President-
Mechanical of Conrail from
November 1994 to January 1996,
and prior thereto was Vice
President-Engineering of
Conrail.
PAGE 21
Business Experience during
Name, Age, Present Position past 5 Years
- --------------------------- ------------------------------------
Donald W. Seale, 45, Present position since August 1993.
Vice President- Also, Vice President-Merchandise
Merchandise Marketing Marketing of Norfolk Southern
Corporation since August 1993,
and prior thereto was Assistant
Vice President-Sales and Service.
Robert S. Spenski, 63, Present position since June 1994.
Vice President- Also, Vice President-Labor
Labor Relations Relations of Norfolk Southern
Corporation since June 1994, and
prior thereto was Senior
Assistant Vice President-Labor
Relations.
Rashe W. Stephens, Jr., 56, Present position since December
Vice President- 1996. Also, Vice President-
Quality Management Quality Management of Norfolk
Southern Corporation since
December 1996. Served as
Assistant Vice President-Public
Affairs of Norfolk Southern
Corporation from February 1993 to
December 1996, and prior thereto
was Director-EEO and Manpower
Planning.
Stephen C. Tobias, 53, Present position since October
Vice President 1993. Also, Executive Vice
President-Operations of Norfolk
Southern Corporation since July
1994. Served as Senior Vice
President-Operations of Norfolk
Southern Corporation from October
1993 to July 1994, and prior
thereto was Vice President-
Strategic Planning.
Henry C. Wolf, 55, Present position since June 1993.
Vice President-Finance Also, Executive Vice President-
Finance of Norfolk Southern
Corporation since June 1993, and
prior thereto was Vice President-
Taxation.
William C. Wooldridge, 54, Present position since February 1,
Vice President 1997. Also, Vice President-Law
of Norfolk Southern Corporation
since March 1996, and prior
thereto was General Counsel-
Corporate.
PAGE 22
Business Experience during
Name, Age, Present Position past 5 Years
- --------------------------- ------------------------------------
Sandra T. Pierce, 43, Present position since June 1995.
Corporate Secretary Also, Assistant Corporate
Secretary of Norfolk Southern
Corporation since June 1995.
Served as Assistant Corporate
Secretary-Planning of Norfolk
Southern Corporation from
October 1993 to June 1995, and
prior thereto was Assistant to
Corporate Secretary.
Ronald E. Sink, 55, Present position since September
Treasurer 1987.
PAGE 23
PART II
Item 5. Market for the Registrant's Common Stock and Related
- ------ ----------------------------------------------------
Stockholder Matters.
-------------------
COMMON STOCK
- ------------
Since June 1, 1982, NS has owned all the common stock of Norfolk
Southern Railway Company. The common stock is not publicly traded.
PREFERRED STOCK INFORMATION
- ---------------------------
There are 10,000,000 shares of no par value serial preferred stock
authorized. This stock may be issued in series from time to time at the
discretion of the Board of Directors with any series having such voting
and other powers, designations, dividends and other preferences as deemed
appropriate at the time of issuance.
The $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of
which 1,197,027 shares were issued and 1,096,907 shares were held other
than by subsidiaries as of Dec. 31, 1997, has no par value but has a
$50 per share stated value. As indicated in the title, the stock pays a
dividend of $2.60 per share annually, payable quarterly on March 15,
June 15, Sept. 15 and Dec. 15. Dividends on this stock are cumulative and
in preference to dividends on all other classes of stock. Except for any
shares held by Norfolk Southern Railway Company subsidiaries and/or in a
fiduciary capacity, each share is entitled to one vote per share on all
matters, voting as a single class with holders of other stock. Should
dividends become delinquent for six quarters, this class of stock, voting
as a class, may elect two directors so long as any default in dividend
payments continues. The stock is redeemable at the option of Norfolk
Southern Railway Company at $50 per share plus accrued dividends. On
liquidation, the stock is entitled to $50 per share plus accrued
dividends before any amounts are paid on any other class of stock.
In June 1989, NS announced its intention to purchase up to 250,000
shares of the outstanding Series A Stock during the subsequent two-year
period. Subsequently, NS extended the stock purchase program through
1996. As of Dec. 31, 1996, NS had purchased 176,608 shares of Series A
Stock at a total cost of $6.7 million; as of Dec. 31, 1997, NS held a
total of 176,703 shares.
PAGE 24
Item 6. Selected Financial Data.
- ------ -----------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Five-Year Financial Review
1997 1996 1995 1994 1993<F1>
------- ------- ------- ------- -------
($ in millions)
RESULTS OF OPERATIONS:
Railway operating revenues $ 4,223 $ 4,101 $ 4,012 $ 3,918 $ 3,728
Railway operating expenses 3,010 2,936 2,949 2,869 2,806
------- ------- ------- ------- -------
Income from
railway operations 1,213 1,165 1,063 1,049 922
Other income (expense) - net (49) 39 44 46 57
Interest expense on debt (30) (34) (33) (28) (32)
------- ------- ------- ------- -------
Income before
income taxes 1,134 1,170 1,074 1,067 947
Provision for income taxes 380 401 372 385 413
------- ------- ------- ------- -------
Income before
accounting changes 754 769 702 682 534
Cumulative effect of
accounting changes -- -- -- -- 248
------- ------- ------- ------- -------
Net income $ 754 $ 769 $ 702 $ 682 $ 782
======= ======= ======= ======= =======
FINANCIAL POSITION:
Total assets $11,827 $11,053 $10,752 $10,289 $ 9,760
Total long-term debt,
including current
maturities $ 606 $ 598 $ 574 $ 540 $ 605
Stockholders' equity $ 6,392 $ 5,772 $ 5,645 $ 5,441 $ 5,185
OTHER:
Capital expenditures $ 884 $ 754 $ 713 $ 640 $ 629
Number of stockholders
at year-end 2,519 2,763 3,025 3,281 3,517
Average number
of employees <F2> 23,323 23,361 24,488 24,710 25,531
<FN>
<F1> 1993 results include a $61 million increase in the provision for
income taxes reflecting a 1% increase in the federal income tax
rate. The cumulative effect of accounting changes increased 1993
earnings by $248 million. The change in accounting for income taxes
increased net income by $470 million, with a corresponding reduction
in deferred taxes. The changes in accounting for postretirement and
postemployment benefits decreased net income by $222 million.
<F2> The employee count includes NS' employees whose primary duties
relate to rail operations.
PAGE 25
Item 7. 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
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements (beginning on page 41) and Notes
(beginning on page 46) and the Five-Year Financial Review on page 24.
SUMMARIZED RESULTS OF OPERATIONS
1997 Compared with 1996
- -----------------------
Net income in 1997 was $754 million, a decrease of 2%. The decline
was primarily due to a first-quarter charge of $77 million ($50 million
after taxes) for costs related to a credit agreement that provided
financing for the proposed acquisition of all Conrail stock (see Note 2,
on page 47). Excluding the effect of the charge for credit facility
costs, net income was up 5% over 1996's record results. The improvement
was largely attributable to a 4% increase in income from railway
operations.
1996 Compared with 1995
- -----------------------
Net income in 1996 was $769 million, an increase of 10%. However,
1995's results included a $34 million early retirement charge that
reduced net income by $20 million. Excluding the effects of that charge,
1996 net income was up 6%. The improvement was due to increased income
from railway operations, reflecting a 2% increase in operating revenues
and a less than 1% increase in operating expenses (excluding the early
retirement charge).
RAILWAY OPERATING REVENUES AND EXPENSES
(Shown as a Graph in the Annual Report to Stockholders)
($ in millions)
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Revenues $4,223 $4,101 $4,012 $3,918 $3,728
Expenses 3,010 2,936 2,949 2,869 2,806
PAGE 26
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
DETAILED RESULTS OF OPERATIONS
Railway Operating Revenues
- --------------------------
Railway operating revenues were $4.2 billion in 1997, compared with
$4.1 billion in 1996, and $4.0 billion in 1995. The following table
presents a three-year comparison of revenues by market group.
RAILWAY OPERATING REVENUES BY MARKET GROUP
($ in millions)
1997 1996 1995
-------- -------- --------
Coal $ 1,301 $ 1,305 $ 1,268
Chemicals 585 560 541
Paper/clay/forest 539 513 537
Automotive 492 489 449
Agriculture/government/consumer 391 393 394
Metals/construction 368 354 349
Intermodal 547 487 474
------- ------- -------
Total $ 4,223 $ 4,101 $ 4,012
======= ======= =======
In 1997, revenues increased or remained steady for all market
groups. In 1996, revenues increased in all market groups except in the
paper, clay, and forest products group, and the agriculture, government,
and consumer products group. As shown in the following table, volume
gains produced all of the revenue improvement in 1997 and most of the
improvement in 1996.
RAILWAY OPERATING REVENUE VARIANCE ANALYSIS
Increases (Decreases)
($ in millions)
1997 vs. 1996 1996 vs. 1995
------------- -------------
Volume $ 130 $ 73
Revenue per unit (8) 16
----- -----
Total $ 122 $ 89
===== =====
Coal tonnage increased 3% in 1997, primarily due to increased export
and utility tonnage; however, revenues decreased slightly as a result of
a shorter length of haul. Coal revenues represented 31% of total railway
operating revenues in 1997, and 89% of coal shipments originated on NS
Rail's lines. In 1996, coal tonnage increased 4%, and revenues increased
3%, principally due to increased utility and export tonnage.
PAGE 27
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
TOTAL COAL, COKE, AND IRON ORE TONNAGE
(In millions of tons)
1997 1996 1995
---- ---- ----
Utility 76 75 70
Export 29 27 26
Steel 21 20 22
Other 8 8 7
--- --- ---
Total 134 130 125
=== === ===
Utility coal traffic increased 2% in 1997, despite the unusually
cool weather in late spring and early summer that moderated demand for
domestic steam coal. Several utility customers in the NS Rail service
region shifted more generation to coal-fired plants, as some nuclear
power plants experienced downtime. New business resulting from innovative
marketing efforts also contributed to the increase.
In 1996, utility coal traffic volume increased 6%, primarily due to
nuclear generator downtime and market share gains in the Southeast.
The near-term outlook for utility coal remains positive, as coal-
fired generation continues to be the cheapest marginal source of
electricity. Normalized U.S. electricity demand continues to increase at
a rate greater than generation capacity is being added. Increased
electricity price competition expected from utility deregulation could
cause utilities to seek to reduce costs and increase plant utilization.
These factors, coupled with excess capacity at low-cost, coal-fired
generation plants, could provide an opportunity for coal volume growth.
However, competitive pressures on utilities to reduce costs also could
transfer price pressure to generation source fuels, including NS Rail-
delivered coal.
Moreover, a significant number of the mines served by NS Rail
produce coals that satisfy both the Phase I and Phase II requirements of
the Clean Air Act Amendments. Adoption of tighter restrictions on the
emission of nitrous oxides, as proposed by the Environmental Protection
Agency, however, could impose added cost burdens on some coal-fired
plants. Furthermore, if implemented, the greenhouse gas emission targets
proposed for the United States at the Global Climate Summit in Kyoto,
Japan, in December 1997 also could increase the cost of coal-fired
generation and adversely affect coal traffic.
The portion of Conrail's properties that NS Rail proposes to operate
serves 27 coal-fired utility plants and mines with an abundant supply of
low-cost, high-quality steam coal.
Export coal tonnage increased 6% in 1997, reaching the highest level
since 1992. Higher metallurgical coal demand and increased sales from NS
Rail-served producers caused growth in shipments to Japan. Increased
metallurgical coal exports to Holland and Romania and increased shipments
to Brazil early in the year also contributed to the improvement.
Export coal tonnage increased 5% in 1996, as NS Rail benefited from
increases in steam coal exports to Italy and metallurgical shipments to
Germany, a result of reduced subsidies to German coal producers that
enhanced the competitiveness of U.S. coal. Increased exports of U.S. coal
to Brazil also contributed to the improvement.
Metallurgical coal exports are expected to remain stable through
2000. The high-quality coking coals from mines on NS Rail should keep its
export metallurgical coal competitive. However, the current relative
strength of the U.S. dollar vs. the currencies of several other major
coal-producing nations has put U.S. coal at a price disadvantage. A
gradual decline in export metallurgical coal tonnage is projected over
PAGE 28
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
the long term, as new steel-making technologies take market share from
traditional coke-based producers. Export demand for steam coal is
expected to increase over the long term, and NS Rail is working to
increase its participation in this market.
Conrail and its coal-producing customers are well established in the
export steam coal market, which, assuming approval of the Conrail
transaction, should help NS Rail achieve greater levels of participation.
Furthermore, current NS Rail and Conrail coal exporters should benefit
from being able to ship their coal single-line through Baltimore, Md.,
and Norfolk, Va.
Steel coal domestic traffic increased 4% in 1997, due to growth in
coke and iron ore shipments. Metallurgical coal traffic declined,
primarily due to prolonged aggressive producer pricing of higher volatile
metallurgical coals not located on NS Rail's lines. In 1996, traffic
decreased 7%, a result of the aggressive high-volatile coal pricing.
With the reduction in U.S. blast-furnace capacity, coke production
in the United States continues to decline. Advanced technologies that
allow production of steel using little or no coke could cause this market
to decline slowly over the long term. However, NS Rail is working to
participate in the movement of non-coking coal used by technologies such
as pulverized coal injection and coal-based, direct-reduced iron, in
order to mitigate the potential decline in traditional metallurgical
shipments.
The Conrail transaction, if approved, should increase NS Rail's
participation in shipments of raw materials for the steel industry by
means of new single-line routes with access to most domestic integrated
steel plants and merchant coke plants.
Other coal traffic, primarily steam coal shipped to manufacturing
plants, decreased 3% in 1997, principally due to the unusually cool late
spring and early summer weather and to allocation of equipment to other
markets. Other coal traffic increased 14% in 1996, mostly reflecting
gains from other modes of transportation. This market is expected to
remain stable in coming years.
MERCHANDISE traffic volume and revenues each increased 3% in 1997,
as all market groups, except the agriculture, government, and consumer
products group, posted gains. In 1996, merchandise volume decreased
slightly, as gains in automotive, intermodal, and chemicals traffic were
more than offset by declines in the remaining market groups. However,
higher average revenues in 1996 resulted in a 2% revenue improvement.
CHEMICALS traffic increased 5%, and revenues increased 4% in 1997.
Plastics, chlor-alkali, and nonhazardous waste markets strengthened
during 1997. Petroleum and industrial chemicals volume also increased. In
1996, chemicals traffic volume grew 3%, and revenues increased 4%, as
fertilizer and plastics markets strengthened. In addition, the harsh
winter resulted in increased movements of liquid petroleum gas, and
industrial chemicals remained strong throughout the year.
The chemicals market group should continue to show moderate growth
through 1998, based on industrial expansion projects and expected
increases in national chemical production.
If approved, the Conrail transaction should give NS Rail a
competitive route from the southwest to northern New Jersey, where
Conrail currently originates or terminates annually about 40,000 carloads
of chemicals.
PAPER, CLAY, AND FOREST PRODUCTS traffic rose 4%, and revenues
increased 5% in 1997. Shipments of wood chips led the growth, as three
major on-line wood-chip plants began full production. Lumber traffic also
increased as Southern yellow pine from NS Rail's service territory
continued to replace timber from Pacific Northwest sources. Kaolin clay
traffic increased, and shipments of paper products were up slightly in a
mature industry where strong competition continues between rail and truck
transportation. In 1996, paper, clay, and forest products revenues and
traffic each declined 5%, due to the overall downturn in the paper and
forest products industry.
PAGE 29
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
The paper, clay, and forest products market group is expected to
experience modest growth in 1998, bolstered by increased printing paper
production in the Southeast and increased wood-chip volume when two
additional plants come on line.
The Conrail transaction, if approved, will give NS Rail access to 35
additional paper mills and 39 additional lumber reload centers.
AUTOMOTIVE traffic increased 2%, and revenues rose 1% in 1997, both
reaching the highest levels in this group's history. Auto parts drove the
growth as volume increased 12%. Vehicle traffic decreased 3%, due to
industrywide railcar shortages, service disruptions in the West,
unexpected downtime at certain plants and modest sales for some of the
models transported by NS. In 1996, automotive traffic rose 8%, and
revenues increased 9%. Auto parts traffic increased 21% and vehicle
traffic increased 3%, largely a result of new just-in-time rail centers
and all NS Rail-served assembly plants being on line.
The automotive group is expected to experience growth in 1998. When
fully operational, the Ford mixing centers are expected to increase NS
Rail's vehicle business with Ford. Full production at the Mercedes-Benz
plant in Vance, Ala., and Toyota's new minivan line at Georgetown, Ky.,
also should support growth. Parts traffic is expected to continue to
grow, supported by increased volumes on NS Rail's just-in-time network,
specifically less-than-truckload traffic moving from Detroit to Mexico.
If approved, the Conrail transaction will provide NS Rail access to
13 additional assembly plants with an annual production of more than 2.6
million vehicles, and NS Rail's network of automobile distribution
facilities will increase from 22 to 39.
AGRICULTURE, GOVERNMENT, AND CONSUMER PRODUCTS traffic decreased 3%,
and revenues decreased 1% in 1997. Most of the decline resulted from
decreases in the bulk agriculture commodities. Weak export markets,
declines in corn shipments to processors, and an unfavorable soybean
market resulting from higher prices led to traffic declines that began
early in the year. In 1996, agriculture, government, and consumer
products traffic declined 4%, and revenues were flat. Despite strong
demand for feed grains in the Southeast, grain traffic was affected
adversely by poor crops and strong export demand that left NS Rail
receivers competing for limited supplies. Slight average revenue growth
occurred, resulting primarily from longer hauls, as receivers obtained
grain supplies from the West.
The agriculture, government, and consumer products group is expected
to experience moderate growth in 1998 due to improved soybean and corn
crops. NS Rail also should benefit from the on-line location of one new
feed mill and three new wheat mills during the year.
The Conrail transaction, if approved, is expected to increase NS
Rail-accessed grain elevator capacity by about 10%.
METALS AND CONSTRUCTION traffic and revenues each increased 4% in
1997. Construction traffic on NS Rail experienced strong gains in 1997,
primarily due to increased highway building activity in the Southeast.
Metals traffic increased due to gains in domestic sheet steel movements
resulting from record steel production and increased pipe shipments. In
1996, metals and construction traffic declined 2%, but revenues were up
1%. Construction carloads fell behind in early 1996 due to inclement
weather and were flat the rest of the year; however, higher average
revenues more than offset the volume decline. In the metals market, NS
Rail's shipments remained strong due to a healthy domestic steel market,
which has added capacity, as efficiency at integrated mills and new steel
processing facilities has improved.
Moderate growth is expected in 1998, supported by several new metals
projects coming on line, and continued growth in construction traffic.
If approved, the Conrail transaction will give NS Rail access to 11
additional steel mills.
PAGE 30
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
INTERMODAL traffic volume increased 11%, and revenues increased 12%
in 1997, each exceeding the records set in 1996. Capacity expansions on
major terminals and trains, combined with a healthy domestic and
international economy, enabled NS Rail to achieve the third year of
double-digit growth in four years. Volume increases were balanced,
allowing NS Rail to outperform the market in all traffic segments.
Container traffic volume increased 12%, supported by strength in new
steamship business under contract.
In 1996, driven by increased domestic container and Triple Crown
Services Company (TCSC) volume, intermodal traffic volume increased 5%,
and revenues increased 3%, each reaching a record level. EMP, the
container equipment-sharing arrangement with Union Pacific and Conrail,
contributed significantly to the domestic growth. International container
volume declined only slightly, despite an industry slowdown that began in
the spring and lasted until the fall. NS Rail's overall market share
improved slightly due to new international business and the continued
domestic container and TCSC growth.
NS Rail's intermodal volume is expected to remain strong, although
growth in 1998 is not expected to equal the double-digit performance of
1997. New train services between Greensboro and Chicago, and St. Louis
and Atlanta are expected to attract less-than-truckload and other premium
service customers. Rate actions to improve balance and margin are
expected to be implemented throughout the year and to contribute to
traffic moderation.
The Conrail transaction, if approved, should result in significant
growth in intermodal revenues, as NS Rail will benefit from direct access
to most major East Coast ports.
Railway Operating Expenses
- --------------------------
Railway operating expenses increased 3% in 1997, despite a 5%
increase in traffic volume. In 1996, railway operating expenses decreased
slightly; however, 1995's expenses included a $34 million charge for an
early retirement program (see Note 12 on page 57). Excluding that charge,
railway operating expenses increased 1% on a 2% increase in traffic
volume.
As a result, the railway operating ratio, which measures the
percentage of railway revenues consumed by expenses, was a record 71.3 in
1997, compared with 71.6 in 1996, and 73.5 (72.7 excluding the early
retirement charge) in 1995. NS Rail's railway operating ratio continues
to be the best among the major railroads in the United States.
Even before the Conrail transaction is approved, NS Rail expects to
incur expenses related to integration efforts, and, as a result, the
railway operating ratio is anticipated to be higher in 1998.
RAILWAY OPERATING RATIO
(Shown as a Graph in the Annual Report to Stockholders)
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
71.3% 71.6% 73.5% 73.2% 75.3%
PAGE 31
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
The following table shows the changes in railway operating expenses
summarized by major classifications.
Railway Operating Expenses
Increases (Decreases)
($ in millions)
1997 vs. 1996 1996 vs.1995
------------- -------------
Compensation and benefits $ 5 $(80) *
Materials, services and rents 61 6
Depreciation 13 20
Diesel fuel (6) 43
Casualties and other claims -- 2
Other 1 (4)
---- ----
Total $ 74 $(13)
==== ====
*Reflects the $34 million early retirement charge in 1995.
COMPENSATION AND BENEFITS, which represents about half of total
railway operating expenses, increased slightly in 1997, but decreased 5%
(3% excluding the effect of the early retirement charge) in 1996.
In 1997, higher wages resulting from contract wage increases and
additional train and engine employees were offset by lower fringe benefit
and incentive compensation costs. The decline in fringe benefit costs was
largely due to favorable investment experience on pension plan assets.
Productivity improvements and train efficiencies offset the effects of
the higher traffic volume to a large extent.
The 1996 decrease (excluding the effect of the 1995 early retirement
charge) was principally attributable to: (1) reduced employment resulting
from the 1995 early retirement program and productivity improvements due
to ongoing reductions in train-crew sizes and train efficiencies and (2)
reduced costs for fringe benefits, principally medical costs for salaried
employees. These decreases were somewhat offset by increases attributable
to higher volume and increased wage rates resulting from new labor
agreements.
MATERIALS, SERVICES, AND RENTS includes items used for the
maintenance of the railroads' lines, structures, and equipment; the costs
of services purchased from outside contractors, including the net costs
of operating joint (or leased) facilities with other railroads; and the
net cost of equipment rentals. This category of expenses increased 10% in
1997 and 1% in 1996.
The 1997 increase resulted principally from higher volume-related
intermodal expenses, as well as higher equipment rent costs, partially a
result of a change in the mix of received vs. forwarded traffic. Higher
locomotive repair expenses and costs for contract programmers to make
computer processes Year-2000 compliant (discussed below) also contributed
to the increase. The 1996 increase also resulted from higher volume-
related intermodal expenses, as well as higher equipment rent costs that
more than offset lower locomotive and car-repair costs.
Equipment rents, which represent the cost to NS Rail of using
equipment (mostly freight cars) owned by other railroads or private
owners, less the rent paid to NS Rail for the use of its equipment, were
up 11% in 1997 and 10% in 1996. The 1997 increase was due to a 5%
increase in overall traffic and a shift in traffic mix. Carloadings in
other railroads' and privately owned freight cars were up 7%, due to
growth in traffic received from other railroads. Trailer and container
loadings, moving mostly on privately owned flatcars, were up 11%. These
increased costs were mitigated somewhat by higher receipts from short-
term leases of locomotives to various railroads. The 1996 increase
PAGE 32
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
resulted from higher container traffic, lower receipts from short-term
leases of locomotives, and more freight car leases necessary to meet
customer requirements. These increased costs were somewhat offset by
lower net costs for multilevel equipment.
Locomotive repair costs increased in 1997, a result of higher
traffic levels and an increase in the average number of locomotives in
service throughout the year.
In October 1995, NS Rail initiated a project to review, and modify
as necessary, computer and other systems for Year-2000 compliance. As of
December 1997, most of NS Rail's mainframe computer programs had been
reviewed. This mainframe project is expected to be completed by the end
of 1998. NS Rail has redeployed existing information technology resources
and has incurred incremental costs, mostly for contract programmers.
Incremental costs through 1997, which were expensed, were less than
$10 million, and the total incremental costs of the entire project are
expected to be less than $25 million. Failure to achieve Year-2000
compliance -- by NS Rail, other railroads, its suppliers, and its
customers -- could negatively affect NS Rail's ability to conduct
business for an extended period. Management believes that NS Rail's
project will be completed on time and that the chance of failure is
remote.
DEPRECIATION expense (see Note 1, "Properties," on page 47 for NS
Rail's depreciation policy) was up 3% in 1997 and 5% in 1996. Increases
in both years were due to property additions, reflecting recent
substantial levels of capital spending.
DIESEL FUEL costs declined 3% in 1997, but increased 23% in 1996.
The 1997 decrease was due to a 5% drop in the average price per gallon,
somewhat offset by a 3% rise in consumption. The 1996 increase was due to
a 20% rise in the average price per gallon, as prices reached levels
unseen since the Persian Gulf Crisis in 1991, and to a 3% increase in
consumption.
CASUALTIES AND OTHER CLAIMS (including estimates of costs related to
personal injury, property damage, and environmental matters) were
unchanged in 1997, but increased 2% in 1996. In 1997, a reduction in
personal injury expenses was offset by higher freight damage costs. In
1996, higher accruals for environmental remediation costs more than
offset reduced accruals for personal injury liabilities and the effects
of a nonrecurring liability insurance premium refund.
The largest component of casualties and other claims expense is
personal injury costs. NS Rail experienced another reduction in the
number of reportable injuries in 1997, with a consequent reduction in the
cost of personal injury claims. NS Rail continues to work actively to
reduce all accidents and to control the associated costs.
The rail industry remains uniquely susceptible to litigation
involving job-related accidental injury and occupational claims because
of an outmoded law, the Federal Employers' Liability Act (FELA),
originally passed in 1908 and applicable only to railroads. This law,
which covers employee claims for job-related injuries, promotes an
adversarial claim settlement environment and produces results that are
unpredictable and inconsistent, at a far greater cost to the rail
industry than the no-fault workers' compensation system to which non-rail
competitors are universally subject. The railroads have been unsuccessful
so far in efforts to persuade Congress to replace FELA with a no-fault
workers' compensation system.
NS Rail maintains substantial amounts of commercial insurance for
potential third-party liability and property damage losses. However, it
also retains reasonable levels of risk through self-insurance.
OTHER expenses increased 1% in 1997, but decreased 3% in 1996.
Income Taxes
- ------------
Income tax expense in 1997 was $380 million for an effective rate of
34%, compared with an effective rate of 34% in 1996 and 35% in 1995.
The effective rates in all three years were below the statutory
federal and state rates as a result of investments in corporate-owned
life insurance and in coal-seam gas properties and favorable adjustments
PAGE 33
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
upon filing the prior year tax returns. In addition, 1997 benefited from
favorable adjustments of accrued liabilities for state income taxes. 1996
benefited from favorable adjustments resulting from settlement of federal
income tax years 1990-1992.
Accounting Change and New Accounting Pronouncements
- ---------------------------------------------------
As discussed in Note 1 under "Required Accounting Change" on page
47, NS Rail adopted AICPA Statement of Position 96-1, "Environmental
Remediation Liabilities" (SOP 96-1), effective January 1, 1997. The
adoption of SOP 96-1 did not have a material effect on NS Rail's
financial statements.
During 1997, Statements of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," and No. 131, "Disclosures About
Segments of an Enterprise and Related Information," were issued. Neither
statement is expected to have a material effect on NS Rail's financial
statements.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Cash provided by operating activities, NS Rail's principal source of
liquidity, increased $211 million, or 17%, in 1997, but decreased $45
million, or 4%, in 1996. Since consolidation in 1982, cash provided by
operating activities has been sufficient to fund dividend requirements,
debt repayments, and a significant portion of capital spending. The 1997
increase was principally due to lower income tax payments and improved
income from railway operations. The 1996 decrease was largely
attributable to lump-sum wage payments associated with labor contract
settlements and higher income tax payments related to the settlement of
federal income tax years 1990-1992.
Cash used for investing activities increased 44% in 1997 and
decreased 7% in 1996. Property additions account for most of the spending
in this category.
The following tables show capital spending, track, and equipment
statistics for the past five years.
CAPITAL EXPENDITURES
--------------------
(Also shown as a Graph in the Annual Report to Stockholders)
($ in millions)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Road $580 $428 $379 $383 $411
Equipment 304 326 333 235 218
Other property -- -- 1 22 --
---- ---- ---- ---- ----
Total $884 $754 $713 $640 $629
==== ==== ==== ==== ====
Capital expenditures increased 17% in 1997 and 6% in 1996. The
increase in 1997 was due to higher roadway additions that included
construction costs for four motor vehicle distribution facilities
scheduled to be completed early in 1998.
PAGE 34
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
TRACK STRUCTURE STATISTICS (CAPITAL AND MAINTENANCE)
----------------------------------------------------
1997 1996 1995 1994 1993
----- ----- ----- ----- -----
Track miles of
rail installed 451 401 403 480 574
Miles of track
surfaced 4,703 4,686 4,668 4,760 5,048
New crossties
installed
(millions) 2.2 1.9 2.0 1.7 1.6
AVERAGE AGE OF RAILWAY EQUIPMENT
--------------------------------
(Years) 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Freight cars 23.0 22.3 22.0 21.9 21.3
Locomotives 15.3 15.4 15.7 15.8 15.1
Retired
locomotives 23.3 24.4 22.6 23.6 24.7
Since 1988, NS Rail has rebodied about 25,000 coal cars and plans to
continue that program. This work, performed at NS Rail's Roanoke Car
Shop, converts hopper cars into high-capacity steel gondolas or hoppers.
As a result, the remaining service life of the freight car fleet is
greater than may be inferred from the increasing average age shown in the
corresponding table.
NS Rail began an orderly disposition of approximately 17,000 freight
cars in October 1994. This was completed in 1997, with total proceeds of
$104 million included in "Property sales and other transactions" in the
1997, 1996, and 1995 Consolidated Statements of Cash Flows. In 1995 and
1996, this line item also reflected greater proceeds from land sales.
For 1998, NS Rail has budgeted approximately $900 million of capital
expenditures, of which $149 million are initial outlays for facilities
and equipment related to the Conrail transaction. Capital spending is
expected to be affected significantly by Conrail-related expenditures,
which are expected to incrementally add approximately $500 million over
the next three years.
Cash used for financing activities increased 48% in 1997, but
decreased 17% in 1996. The 1997 increase was due to significant advances
made to NS (see Note 2 on page 47).
JOINT ACQUISITION OF CONRAIL BY NS
On May 23, 1997, NS and CSX completed the acquisition of Conrail
stock that was tendered in response to the NS/CSX tender offer (see Note
2 on page 47). On June 2, 1997, a merger subsidiary jointly controlled by
NS and CSX was merged into Conrail. Pursuant to the merger, all
previously issued Conrail stock either was canceled or converted into the
right to receive $115 per share in cash. NS' total cost for its portion
of the acquisition, including NS' fees, was $5.8 billion. On June 23,
1997, NS and NS Rail (collectively, NSC) and CSX filed a joint
application with the Surface Transportation Board (STB) for control and
division of the use and operations of Conrail's assets and for authority
to implement the transaction. The application addresses projected traffic
PAGE 35
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
flows, proposed operations, and related matters; outlines the capital
investments NSC and CSX each plan to make in new connections and
facilities and to increase capacity on critical routes; and details
operating savings and other public benefits resulting from the
transaction. The application also contains certain historical and pro
forma financial information required by the STB. The joint application is
a public document, available for review in its entirety at the office of
the STB, located at 1925 K Street, NW, Washington, D.C. 20423-0001.
In May 1997, the STB issued a scheduling order providing for
issuance of a final decision no later than June 8, 1998, to become
effective 30 days thereafter. On Nov. 3, 1997, the STB extended the
period for issuing its final decision by 45 days, to July 23, 1998, to
become effective 30 days thereafter. This extension was in conjunction
with a new requirement that NSC and CSX comply with the STB's order to
submit detailed safety integration plans, and it is likely to delay
realization of the expected transaction benefits.
No assurance can be given with respect to the receipt of STB
approval or as to modifications or conditions that may be imposed in
connection therewith, or their impact, if any, on the expected
transaction benefits. The STB has the authority to modify contract terms
and impose additional conditions, including divestitures, grants of
trackage rights, modification of other proposed aspects of operations,
and requirements that could affect the timing of implementation and
realization of benefits.
Until NSC and CSX are permitted by the STB to assume control over
Conrail (the "Control Date"), Conrail will continue to be managed by its
current Board of Directors and Management. Following the Closing Date,
which will occur as soon as practicable after the Control Date, various
agreements between NSC and CSX provide, among other things, for each of
the parties: (1) separately to operate pursuant to lease agreements
portions of the routes and assets now owned and operated by Conrail, and
(2) jointly to operate other Conrail properties. The closing is
contingent upon, among other things, attainment of necessary labor
implementing agreements and is expected to occur as soon as practicable
after satisfaction of those contingencies and consistent with ensuring
safe and efficient operations.
NS Rail is in the process of negotiating necessary implementing
agreements with representatives of the affected employees. The United
Transportation Union, the nation's largest rail union, and the
Brotherhood of Locomotive Engineers have advised the STB that they have
withdrawn their opposition and have agreed to support the transaction.
Employees represented by these two unions make up 44% of the NS Rail work
force covered by labor agreements.
The NSC/CSX agreements also provide for the allocation of
responsibility for certain known and contingent Conrail liabilities.
Until the STB renders a final decision on the control application filed
by NSC and CSX, NSC will not have complete access to Conrail's related
books, records, and physical assets, and will not know precisely which
Conrail properties it will have responsibility for or control over
pursuant to its agreements with CSX. As a consequence, it is not possible
at this time for NS Rail to state or to assess with precision the amount
of its share of Conrail assets and liabilities.
As a result of the intensive efforts under way to plan for the
operation of NSC's portion of Conrail's assets, the timing of certain
integration expenses has accelerated; moreover, because of uncertainties
concerning both the conditions that the STB may impose and the timing of
other matters, the anticipated transaction synergies may be realized
later than originally believed.
Certain of the foregoing are forward-looking statements, and
attention is called to the related cautionary language at the end of
Management's Discussion and Analysis.
PAGE 36
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
OTHER MATTERS
Market Risks and Hedging Activities
- -----------------------------------
NS Rail does not engage in the trading of derivatives. NS Rail
manages its overall exposure to fluctuations in interest rates by issuing
both fixed- and floating-rate debt instruments and by entering into
interest-rate hedging transactions to achieve a targeted mix within its
debt portfolio. Of NS Rail's total debt outstanding (see Note 8 on page
55), all is fixed-rate debt, except for $244 million of capital leases.
The capital leases, which carry an average fixed rate of 7.4%, were
converted to variable rate obligations using interest rate swap
agreements. On Dec. 31, 1997, the average pay rate was 6.1% and the
average receive rate was 7.4% under these agreements. During 1997, the
effect of the swaps was to reduce interest expense by $3 million. A
portion of the lease obligations is payable in Japanese yen. NS Rail
hedged the associated exchange rate risk at the inception of each lease
with a yen deposit in Japan sufficient to fund the yen-denominated
obligation. As a result, NS Rail is exposed to financial market risk
relative to Japan. Counterparties to the interest rate swaps and Japanese
banks holding yen deposits are major financial institutions believed by
Management to be creditworthy.
A 1% increase in interest rates would increase NS Rail's total
annual interest expense related to all its variable debt by approximately
$2 million. Management considers it unlikely that interest rate
fluctuations applicable to these instruments will result in a material
adverse effect on NS Rail's financial position, results of operations, or
liquidity.
Lawsuits
- --------
Norfolk Southern Railway 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 NS Rail. 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 individuals.
Shortly after the trial, the Supreme Court of Louisiana ruled that under
the Louisiana Class Action Statute, the trial court cannot enter a
judgment for punitive damages until all compensatory damages have been
determined. In view of the number of individual plaintiffs claiming
compensatory damages, this process could take years.
Management will continue to monitor the progress of this litigation.
If the jury verdict is not vacated or modified in an acceptable manner,
appropriate appeals will be pursued. Management believes that the jury
verdicts are both grossly excessive and without factual or legal
justification.
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.
PAGE 37
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
Environmental Matters
- ---------------------
NS Rail is subject to various jurisdictions' environmental laws and
regulations. It is NS Rail's policy to record a liability where such
liability or loss is probable and can be reasonably estimated. Claims, if
any, against third parties for recovery of clean-up costs incurred by NS
Rail are reflected as receivables in the balance sheet and are not netted
against the associated NS Rail liability. Environmental engineers
regularly participate in ongoing evaluations of all identified sites and
in determining any necessary adjustments to initial liability estimates.
NS Rail also has established an Environmental Policy Council, composed of
senior managers, to oversee and interpret its environmental policy.
Operating expenses for environmental matters totaled approximately
$21 million in 1997, and capital expenditures totaled approximately $6
million. Both are expected to be at similar levels in 1998. As of Dec.
31, 1997, NS Rail's balance sheet included a reserve for environmental
exposures in the amount of $56 million (of which $12 million is accounted
for as a current liability), which is NS Rail's estimate of the probable
costs based on available information at 111 identified locations. On that
date, 11 sites accounted for $25 million of the reserve, and no
individual site was considered to be material. NS Rail anticipates that
much of this liability will be paid out over five years; however, some
costs will be paid out over a longer period.
At many of the 111 locations, certain NS Rail subsidiaries, usually
in conjunction with a number of other parties, have been identified as
potentially responsible parties by the Environmental Protection Agency
(EPA) or similar state authorities under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980, or comparable state
statutes, which often impose joint and several liability for clean-up
costs.
At one such site, the EPA alleged in 1995 that AGS, a subsidiary of
NS Rail, is responsible -- along with four other parties believed to be
financially solvent and with two of which the EPA and state authorities
have reached settlements -- for past and future clean-up and monitoring
costs at the Bayou Bonfouca NPL Superfund site located in Slidell, La.
The EPA indicates that it has expended or expects to expend a total of
approximately $130 million at the site. NS Rail continues to contest
liability on a variety of grounds, and trial now is scheduled to begin on
Feb. 22, 1999. The EPA bases its claim of NS Rail's liability on (a) the
alleged activities in the 1880s of a company not at the time owned or
controlled by an NS Rail subsidiary but acquired in 1916, and (b) certain
servitudes possessed by that subsidiary only for a rail right-of-way.
With respect to known environmental sites (whether identified by NS
Rail or by the EPA or comparable state authorities), estimates of NS
Rail's ultimate potential financial exposure for a given site or in the
aggregate for all such sites are necessarily imprecise because of the
widely varying costs of currently available clean-up techniques, the
likely development of new clean-up technologies, the difficulty of
determining in advance the nature and full extent of contamination and
each potential participant's share of any estimated loss (and that
participant's ability to bear it), and evolving statutory and regulatory
standards governing liability.
The risk of incurring environmental liability -- for acts and
omissions, past, present, and future -- is inherent in the railroad
business. Some of the commodities in NS Rail's traffic mix, particularly
those classified as hazardous materials, can pose special risks that NS
Rail and its subsidiaries work diligently to minimize. In addition,
several NS Rail subsidiaries own, or have owned in the past, land used as
operating property, or which is leased or may have been leased and
operated by others, or held for sale. Because environmental problems may
exist on these properties that are latent or undisclosed, there can be no
assurance that NS Rail will not incur environmentally related liabilities
or costs with respect to one or more of them, the amount and materiality
of which cannot be estimated reliably at this time. Moreover, lawsuits
PAGE 38
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
and claims involving these and other now-unidentified environmental sites
and matters are likely to arise from time to time. The resulting
liabilities could have a significant effect on financial condition,
results of operations, or liquidity in a particular year or quarter.
However, based on its assessments of the facts and circumstances now
known, Management believes that it has recorded the probable costs for
those environmental matters of which the Corporation is aware. Further,
Management believes that it is unlikely that any identified matters,
either individually or in the aggregate, will have a material adverse
effect on NS Rail's financial position, results of operations, or
liquidity.
Inflation
- ---------
Generally accepted accounting principles require the use of
historical cost in preparing financial statements. This approach
disregards the effects of inflation on the replacement cost of property.
NS Rail, a capital-intensive company, has approximately $14 billion
invested in such assets. The replacement cost of these assets, as well as
the related depreciation expense, would be substantially greater than the
amounts reported on the basis of historical cost.
Trends
- ------
- - Federal Economic Regulation -- Efforts will be made in 1998 to re-
subject the rail industry to unwarranted federal economic regulation.
The Staggers Rail Act of 1980, which substantially reduced such
regulation, encouraged and enabled rail carriers to innovate and to
compete for business, thereby contributing to the economic health of
the nation and to the revitalization of the industry. Accordingly, NS
Rail and other rail carriers vigorously will oppose these
counterproductive efforts to re-impose or to authorize re-imposing such
economic regulation.
- - Reduction of "Greenhouse" Gases -- In December 1997, international
environmental officials meeting in Kyoto, Japan, agreed to reduce
substantially the emission of so-called "greenhouse" gases by 2010.
Agreement on such reductions was reached on the basis of questionable
scientific evidence and in spite of the fact that the burden of the
reduction regimen will be borne disproportionally by developed nations
such as the United States. NS Rail, the rail industry, and a wide
variety of other affected constituencies in the United States expect to
assure that, prior to a Senate vote on the proposed treaty, the public
and governmental authorities have available to them additional
scientific information and data concerning other effects that are
likely to result from implementation.
- - Utility Deregulation -- Deregulation of the electrical utility industry
is expected to increase competition among electric power generators;
deregulation over time would permit wholesalers and possibly retailers
of electric power to sell or purchase increasing quantities of power to
or from far-distant parties. The effects of deregulation on NS Rail and
on its patrons cannot be predicted with certainty; however, NS Rail
serves a number of efficient power producers and is working diligently
to assure that its customers remain competitive in this evolving
environment.
PAGE 39
Item 7. Management's Discussion and Analysis of Financial
- ------ -------------------------------------------------
Condition and Results of Operations.
-----------------------------------
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other sections of this Annual Report contain
forward-looking statements 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 the realization and the
timing of benefits expected to result from consummation of the Conrail
transaction.
PAGE 40
Item 8. Financial Statements and Supplementary Data.
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Quarterly Financial Data (Unaudited)
---------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
($ in millions, except per share amounts)
1997
----
Railway operating revenues $1,046 $1,067 $1,048 $1,062
Income from railway operations 281 321 297 314
Net income 128 200 206 220
Dividends per serial
preferred share $ 0.65 $ 0.65 $ 0.65 $ 0.65
1996
----
Railway operating revenues $1,017 $1,038 $1,020 $1,026
Income from railway operations 262 300 300 303
Net income 163 191 209 206
Dividends per serial
preferred share $ 0.65 $ 0.65 $ 0.65 $ 0.65
Index to Financial Statements: Page
----------------------------- ----
Consolidated Statements of Income
Years ended December 31, 1997, 1996 and 1995 41
Consolidated Balance Sheets
As of December 31, 1997 and 1996 42
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996 and 1995 44
Consolidated Statements of Changes in
Stockholders' Equity
Years ended December 31, 1997, 1996 and 1995 45
Notes to Consolidated Financial Statements 46
Independent Auditors' Report 66
The Index to Consolidated Financial Statement Schedule appears
in Item 14 on page 68.
PAGE 41
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Income
Years ended December 31,
1997 1996 1995
------ ------ ------
($ in millions)
Railway operating revenues $4,223 $4,101 $4,012
Railway operating expenses:
Compensation and benefits (Note 12) 1,405 1,400 1,480
Materials, services, and rents 690 629 623
Depreciation 416 403 383
Diesel fuel 227 233 190
Casualties and other claims 123 123 121
Other 149 148 152
------ ------ ------
Railway operating expenses 3,010 2,936 2,949
------ ------ ------
Income from railway operations 1,213 1,165 1,063
Charge for credit facility costs (Note 2) (77) -- --
Other income - net (Note 3) 28 39 44
Interest expense on debt (Note 6) (30) (34) (33)
------ ------ ------
Income before income taxes 1,134 1,170 1,074
Provision for income taxes (Note 4) 380 401 372
------ ------ ------
Net income $ 754 $ 769 $ 702
====== ====== ======
See accompanying notes to consolidated financial statements.
PAGE 42
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Balance Sheets
As of December 31,
1997 1996
-------- --------
($ in millions)
Assets
Current assets:
Cash and cash equivalents $ 7 $ 172
Short-term investments (Note 14) 120 143
Accounts receivable net of allowance for
doubtful accounts of $3 million and
$4 million, respectively 539 546
Materials and supplies 58 61
Deferred income taxes (Note 4) 100 95
Other current assets 117 120
------- -------
Total current assets 941 1,137
Due from NS - net (Note 2) 447 --
Investments (Notes 5 and 14) 930 871
Properties less accumulated depreciation (Note 6) 9,447 9,015
Other assets 62 30
------- -------
Total assets $11,827 $11,053
======= =======
Liabilities and stockholders' equity
Current liabilities:
Short-term debt (Note 8) $ 27 $ 27
Accounts payable (Note 7) 586 550
Income and other taxes 149 158
Due to NS - net (Note 2) -- 65
Other current liabilities (Note 7) 98 109
Current maturities of long-term debt (Note 8) 59 54
------- -------
Total current liabilities 919 963
Long-term debt (Note 8) 547 544
Other liabilities (Note 10) 846 886
Minority interests 2 2
Deferred income taxes (Note 4) 3,121 2,886
------- -------
Total liabilities 5,435 5,281
------- -------
(continued)
PAGE 43
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Balance Sheets (continued)
As of December 31,
1997 1996
-------- --------
($ in millions)
Stockholders' equity:
Serial preferred stock (Note 11) 55 55
Common stock (Note 11) 167 167
Additional paid-in capital 525 525
Unrealized gain on marketable securities (Note 14) 414 398
Retained income 5,231 4,627
------- -------
Total stockholders' equity 6,392 5,772
------- -------
Total liabilities and stockholders' equity $11,827 $11,053
======= =======
See accompanying notes to consolidated financial statements.
PAGE 44
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Cash Flows
Years ended December 31,
1997 1996 1995
------ ------ ------
($ in millions)
Cash flows from operating activities:
Net income $ 754 $ 769 $ 702
Reconciliation of net income to net cash
provided by operating activities:
Depreciation 417 404 384
Deferred income taxes 70 89 43
Charge for credit facility costs 77 -- --
Nonoperating gains on property sales (9) (26) (9)
Changes in assets and liabilities
affecting operations:
Accounts receivable (23) (4) 11
Materials and supplies 3 (1) (1)
Other current assets (8) (13) (2)
Current liabilities other than debt 28 (43) 104
Other - net 108 31 19
------ ------ ------
Net cash provided by
operating activities 1,417 1,206 1,251
Cash flows from investing activities:
Property additions (838) (646) (609)
Property sales and other transactions 54 96 81
Investments, including short-term (175) (192) (246)
Investment sales and other transactions 165 190 178
------ ------ ------
Net cash used for
investing activities (794) (552) (596)
Cash flows from financing activities:
Dividends (Note 2) (3) (289) (292)
Credit facility costs paid (Note 2) (72) (5) --
Advances to NS (Note 2) (760) (302) (373)
Advances and repayments from NS (Note 2) 101 140 88
Proceeds from long-term borrowings 2 10 8
Long-term debt repayments (56) (85) (71)
------ ------ ------
Net cash used for
financing activities (788) (531) (640)
------ ------ ------
Net increase (decrease)
in cash and cash equivalents (165) 123 15
Cash and cash equivalents:
At beginning of year 172 49 34
------ ------ ------
At end of year $ 7 $ 172 $ 49
====== ====== ======
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest (net of amounts capitalized) $ 60 $ 67 $ 49
Income taxes $ 217 $ 351 $ 273
See accompanying notes to consolidated financial statements.
PAGE 45
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Consolidated Statements of Changes in Stockholders' Equity
Unrealized
Serial Gain on
Preferred Common Other Marketable Retained
Stock Stock Capital Securities Income Total
--------- ------ ------- ---------- -------- -----
($ in millions)
Balance December 31, 1994 $ 55 $167 $515 $253 $4,451 $5,441
Net income - 1995 702 702
Cash dividends:
Serial preferred stock,
$2.60 per share (3) (3)
Common stock,
$17.31 per share (289) (289)
Non-cash dividends on
common stock (Note 2) (300) (300)
Contribution from NS
(Note 2) 10 10
Unrealized gain on
investments 84 84
---- ---- ---- ---- ------ ------
Balance December 31, 1995 55 167 525 337 4,561 5,645
Net income - 1996 769 769
Cash dividends:
Serial preferred stock,
$2.60 per share (3) (3)
Common stock,
$17.14 per share (286) (286)
Non-cash dividends on
common stock (Note 2) (414) (414)
Unrealized gain on
investments (Note 14) 61 61
---- ---- ---- ---- ------ ------
Balance December 31, 1996 55 167 525 398 4,627 5,772
Net income - 1997 754 754
Cash dividends:
Serial preferred stock,
$2.60 per share (3) (3)
Non-cash dividends on
common stock (Note 2) (147) (147)
Unrealized gain on
investments (Note 14) 16 16
---- ---- ---- ---- ------ ------
Balance December 31, 1997 $ 55 $167 $525 $414 $5,231 $6,392
==== ==== ==== ==== ====== ======
See accompanying notes to consolidated financial statements.
PAGE 46
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES
(A Majority-Owned Subsidiary of Norfolk Southern Corporation)
Notes to Consolidated Financial Statements
The following notes are an integral part of the consolidated financial
statements.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
- -----------------------
Norfolk Southern Railway Company, together with its consolidated
subsidiaries (collectively, NS Rail), is engaged principally in the
transportation of freight by rail, primarily in the Southeast and
Midwest. The consolidated financial statements include Norfolk Southern
Railway Company, Norfolk and Western Railway Company and their majority-
owned and controlled subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation (see Note 15 for
the Norfolk and Western Railway Company and Subsidiaries (NW) summarized
consolidated financial information).
Rail freight consists of raw materials, intermediate products, and
finished goods classified in the following market groups: coal;
chemicals; paper, clay, and forest products; automotive; agriculture,
government, and consumer products; metals and construction, and
intermodal. All groups are approximately equal in size based on revenues
except for coal, which accounts for almost one-third of total railway
operating revenues. Ultimate destinations for some of the freight and a
portion of the coal shipped are outside the United States.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires Management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash Equivalents
- ----------------
"Cash equivalents" are highly liquid investments purchased three
months or less from maturity.
Investments
- -----------
Marketable equity and debt securities are reported at amortized cost
or fair value, depending upon their classification as held-to-maturity,
trading, or available-for-sale securities. On Dec. 31, 1997 and 1996, all
"Short-term investments," consisting primarily of United States
government and federal agency securities and all marketable equity
securities consisting principally of NS Common Stock, were designated as
available-for-sale. Accordingly, unrealized gains and losses, net of
taxes, are recognized in "Stockholders' equity" (see also Note 14).
Materials and Supplies
- ----------------------
"Materials and supplies," consisting mainly of fuel oil and items
for maintenance of property and equipment, are stated at average cost.
The cost of materials and supplies expected to be used in capital
additions or improvements is included in "Properties."
PAGE 47
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Properties
- ----------
"Properties" are stated principally at cost and are depreciated
using group depreciation. Rail is primarily depreciated on the basis of
use measured by gross ton-miles. The effect of this method is to
depreciate these assets over 42 years on average. Other properties are
depreciated generally using the straight-line method over estimated
service lives at annual rates that range from 1% to 20%. In 1997, the
overall depreciation rate averaged 2.8% for roadway and 4.0% for
equipment. NS Rail capitalizes interest on major capital projects during
the period of their construction. Additions to properties, including
those under lease, are capitalized. Maintenance expense is recognized
when repairs are performed. When properties other than land and non-rail
assets are sold or retired in the ordinary course of business, the cost
of the assets, net of sale proceeds or salvage, is charged to accumulated
depreciation rather than recognized through income. Gains and losses on
disposal of land and non-rail assets are included in "Other income" (see
Note 3).
NS Rail reviews the carrying amount of properties whenever events or
changes in circumstances indicate that such carrying amount may not be
recoverable based on future undiscounted cash flows or estimated net
realizable value. Assets that are deemed impaired as a result of such
review are recorded at the lower of carrying amount or fair value.
Revenue Recognition
- -------------------
Revenue is recognized proportionally as a shipment moves from origin
to destination.
Derivatives
- -----------
NS Rail does not engage in the trading of derivatives. NS Rail is a
party to a limited number of derivative agreements that hedge interest
rate exposures on certain components of its debt portfolio. Differentials
paid or received as a result of fluctuations in market interest rates are
recognized in interest expense over the outstanding lives of the related
obligations. Unamortized balances are included in "Long-term debt" in the
Consolidated Balance Sheets.
Required Accounting Change
- --------------------------
Effective Jan. 1, 1997, NS Rail adopted AICPA Statement of Position
96-1, "Environmental Remediation Liabilities" (SOP 96-1), which provides
guidance with respect to recognition and measurement of environmental
remediation liabilities and disclosure of such liabilities in financial
statements. The adoption of SOP 96-1 did not have a material effect on NS
Rail's financial statements.
2. RELATED PARTIES
General
- -------
Norfolk Southern Corporation (NS) is the parent holding company of
NS Rail. The costs of functions performed by NS are charged to NS Rail.
Rail operations are coordinated at the holding company level by the NS
Executive Vice President-Operations.
Joint Acquisition of Conrail by NS
- ----------------------------------
On May 23, 1997, NS and CSX Corporation (CSX), through a jointly
owned entity, completed the acquisition of Conrail Inc. (Conrail) stock
that was tendered in response to the NS/CSX tender offer. On June 2,
1997, a merger subsidiary jointly controlled by NS and CSX was merged
PAGE 48
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
2. RELATED PARTIES (continued)
into Conrail. Pursuant to the merger, all previously outstanding Conrail
stock either was canceled or was converted into the right to receive $115
per share in cash. NS' share of the cost of the acquisition, plus NS'
fees, totaled $5.8 billion. NS has a 58% economic and 50% voting interest
in the entity that owns Conrail. All Conrail stock owned by NS and CSX
remains in a voting trust pending approval of the transaction by the
Surface Transportation Board (STB). STB approval, while anticipated,
cannot be assured, and a final decision is not expected to be effective
prior to Aug. 22, 1998 (the "Control Date"). Should the STB not approve
the transaction, NS could incur a significant loss on the disposition of
its investment in Conrail.
On June 10, 1997, NS and NS Rail (collectively, NSC), CSX, and
Conrail entered into an agreement (the Transaction Agreement) covering
division of Conrail's operations and use of Conrail's assets
(collectively, the Transaction). The Transaction Agreement provides,
among other things, for NSC and CSX after the Control Date: (1)
separately to operate, pursuant to lease agreements, portions of the
routes and assets now owned and operated by Conrail, and (2) jointly to
operate other Conrail properties. In addition, Conrail will continue
certain operations as agent for NSC and CSX. The Transaction Agreement
and various other agreements between and among NSC, CSX, and Conrail also
provide for the allocation between NSC and CSX of responsibility for
certain known and contingent Conrail liabilities. The Transaction will be
consummated as soon as practicable after STB approval. Closing is
contingent upon, among other things, attainment of necessary labor
implementing agreements, and a determination that implementation can be
accomplished safely and without service disruptions, either of which
might delay closing and realization of the expected transaction benefits.
The STB has the authority to modify contract terms and impose conditions,
including divestitures, grants of trackage rights, and limitations upon
proposed operations.
Until the Control Date, Conrail will continue to be managed by its
current Board of Directors and Management, and, due to regulatory
constraints, NSC will not have complete access to Conrail's related
books, records, and physical assets. Further, until the STB renders its
final decision, NSC will not know with certainty which Conrail properties
it will have responsibility for or control over pursuant to its
agreements with CSX and Conrail, or the effects of any other conditions
that may be imposed by the STB.
The Consolidated Statement of Income for the year ended Dec. 31,
1997, includes a $77 million charge incurred in conjunction with certain
now-terminated commitments that provided financing for the proposed
acquisition of all Conrail stock. This charge reduced net income by
$50 million.
Intercompany Accounts
---------------------
December 31,
------------------------------------------
1997 1996
------------------- -------------------
Average Average
Interest Interest
Balance Rate Balance Rate
------- -------- ------- --------
($ in millions)
Due from NS:
Advances $ 752 5% $ 156 4%
Due to NS:
Notes 305 7% 221 6%
----- -----
Due (to) from
NS - net $ 447 $(65)
===== =====
PAGE 49
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
2. RELATED PARTIES (continued)
Interest is applied to certain advances at the average NS yield on
short-term investments and to the notes at specified rates. Included in
"Interest income" is $15 million, $14 million, and $18 million in 1997,
1996, and 1995, respectively, related to amounts due from NS.
Included in "Other interest expense" is $17 million, $14 million,
and $10 million in 1997, 1996, and 1995, respectively, related to amounts
due to NS.
Non-cash Dividends
- ------------------
In 1997, 1996, and 1995, NS Rail declared and issued to NS non-cash
dividends of $147 million, $414 million, and $300 million, respectively,
which were settled by reduction of NS Rail's interest-bearing advances
due from NS.
Non-cash dividends are excluded from the Consolidated Statements of
Cash Flows.
Transfer of Investment from NS
- ------------------------------
In December 1995, NS transferred its $10 million equity interest in
a nonoperating subsidiary to Norfolk Southern Railway Company. This
transfer was recorded at historical cost and was reflected as a
contribution to capital.
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. On Dec. 31, 1997, and Dec. 31, 1996, NS Rail had long-
term intercompany federal income tax payables (which are included in
"Deferred income taxes" in the Consolidated Balance Sheets) of $443
million and $293 million, respectively.
Cash Required for NS Debt and NS Stock Purchase Program
- -------------------------------------------------------
To finance the cost of the Conrail transaction, NS issued and sold
commercial paper and $4.3 billion of unsecured notes. A significant
portion of the funding for the interest and repayments on this and other
NS debt is expected to be provided by NS Rail.
Since 1987, the NS Board of Directors has authorized the purchase
and retirement of up to 285 million shares (post-split) of NS Common
Stock. Since the first purchases in December 1987 and through Oct. 22,
1996, NS had purchased and retired 205.6 million shares (post-split) of
its Common Stock under these programs at a cost of $3.2 billion.
On Oct. 23, 1996, NS announced that the stock purchase program had
been suspended. Future purchase decisions are dependent on the economy,
cash needs, and alternative investment opportunities. Consistent with the
earlier purchases, a significant portion of the funding for any future NS
Common Stock purchases, either in the form of direct cash or cash used
for debt service, is expected to be provided by NS Rail.
PAGE 50
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
3. OTHER INCOME - NET
1997 1996 1995
------ ------ ------
($ in millions)
Interest income (Note 2) $ 31 $ 30 $ 36
Rental income 22 18 19
Dividends from NS 17 16 15
Gains from sales of properties 9 26 9
Corporate-owned life
insurance - net 7 6 7
Other interest expense (Note 2) (45) (44) (32)
Taxes on nonoperating property (2) (4) (2)
Other - net (11) (9) (8)
----- ----- -----
Total $ 28 $ 39 $ 44
===== ===== =====
4. INCOME TAXES
Provision for Income Taxes
- --------------------------
1997 1996 1995
------ ------ ------
($ in millions)
Current:
Federal $ 279 $ 278 $ 286
State 31 34 43
----- ----- -----
Total current taxes 310 312 329
----- ----- -----
Deferred:
Federal 75 73 35
State (5) 16 8
----- ----- -----
Total deferred taxes 70 89 43
----- ----- -----
Provision for income taxes $ 380 $ 401 $ 372
===== ===== =====
PAGE 51
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
4. INCOME TAXES (continued)
Reconciliation of Statutory Rate to Effective Rate
- --------------------------------------------------
Total income taxes as reflected in the Consolidated Statements of
Income differ from the amounts computed by applying the statutory federal
corporate tax rate as follows:
1997 1996 1995
---------------- ---------------- ----------------
Amount % Amount % Amount %
-------- ----- -------- ----- -------- -----
($ in millions)
Federal income
tax at statutory
rate $ 397 35 $ 410 35 $ 376 35
State income
taxes, net of
federal tax
benefit 17 2 33 2 33 3
Corporate-owned
life insurance (10) (1) (16) (1) (17) (1)
Other - net (24) (2) (26) (2) (20) (2)
----- -- ----- -- ----- --
Provision for
income
taxes $ 380 34 $ 401 34 $ 372 35
===== == ===== == ===== ==
Inclusion in Consolidated Return
- --------------------------------
NS Rail is included in the consolidated federal income tax return of
NS. The provision for current income taxes in the Consolidated Statements
of Income reflects NS Rail's portion of NS' consolidated tax provision.
Tax expense or tax benefit is recorded on a separate company basis.
Deferred Tax Assets and Liabilities
- -----------------------------------
Certain items are reported in different periods for financial
reporting and income tax purposes. Deferred tax assets and liabilities
were recorded in recognition of these differences. Management believes
the deferred tax assets will be realized.
PAGE 52
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
4. INCOME TAXES (continued)
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax
liabilities are as follows:
December 31,
1997 1996
-------- --------
($ in millions)
Deferred tax assets:
Reserves, including casualty
and other claims $ 143 $ 148
Employee benefits 130 148
Retiree health and death
benefit obligation 132 137
Taxes, including state
and property 159 163
Other 1 1
------- -------
Deferred tax assets 565 597
------- -------
Deferred tax liabilities:
Property (2,883) (2,839)
Unrealized holding gains (229) (220)
Other (31) (36)
------- -------
Deferred tax liabilities (3,143) (3,095)
Intercompany federal
tax payable - net (443) (293)
------- -------
Net deferred tax liability (3,021) (2,791)
Net current deferred
tax assets 100 95
------- -------
Net long-term deferred
tax liability $(3,121) $(2,886)
======= =======
Internal Revenue Service (IRS) Reviews
- --------------------------------------
Consolidated federal income tax returns have been examined and
Revenue Agent Reports have been received for all years up to and
including 1992. The consolidated federal income tax returns for 1993 and
1994 are being audited by the IRS. Management believes that adequate
provision has been made for any additional taxes and interest thereon
that might arise as a result of IRS examinations.
Tax Benefit Leases
- ------------------
In January 1995, the United States Tax Court issued a preliminary
decision that would disallow some of the tax benefits a subsidiary of NS
Rail purchased from a third party pursuant to a safe harbor lease
agreement in 1981. The Tax Court finalized this decision in February
1997. This decision has been appealed, and Management continues to
believe that NS Rail ultimately should incur no loss from this decision,
because the lease agreement provides for full indemnification if any such
disallowance is sustained.
PAGE 53
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
5. INVESTMENTS
December 31,
1997 1996
------ ------
($ in millions)
Marketable equity securities at
fair value (Note 14) $ 664 $ 639
Corporate-owned life insurance at
net cash surrender value 249 213
Other 17 19
----- -----
Total $ 930 $ 871
===== =====
6. PROPERTIES
December 31,
1997 1996
-------- --------
($ in millions)
Railway property:
Road $ 8,819 $ 8,405
Equipment 4,832 4,665
Other property 77 79
------- -------
13,728 13,149
Less: Accumulated depreciation 4,281 4,134
------- -------
Net properties $ 9,447 $ 9,015
======= =======
Capitalized Interest
- --------------------
Total interest cost incurred on debt in 1997, 1996, and 1995 was $47
million, $46 million, and $47 million, respectively, of which $17
million, $12 million, and $14 million was capitalized.
PAGE 54
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
7. CURRENT LIABILITIES
December 31,
1997 1996
------ ------
($ in millions)
Accounts payable:
Accounts and wages payable $ 245 $ 228
Casualty and other claims 171 165
Vacation liability 80 75
Equipment rents payable - net 67 61
Other 23 21
----- -----
Total $ 586 $ 550
===== =====
Other current liabilities:
Interest payable $ 35 $ 14
Liabilities for forwarded traffic 31 63
Retiree health and death
benefit obligation (Note 13) 23 23
Other 9 9
----- -----
Total $ 98 $ 109
===== =====
PAGE 55
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
8. DEBT
Long-Term Debt
- --------------
December 31,
1997 1996
------ ------
($ in millions)
Equipment obligations at an
average rate of 7.8%
maturing to 2009 $ 353 $ 393
Capitalized leases at an average
rate of 6.1% maturing to 2015 246 197
Other debt at an average rate
of 5.5% maturing to 2015 7 8
----- -----
Total long-term debt 606 598
----- -----
Less: Current maturities 59 54
----- -----
Long-term debt
less current maturities $ 547 $ 544
===== =====
Long-term debt matures as follows:
1999 $ 131
2000 62
2001 56
2002 51
2003 and subsequent years 247
-----
Total $ 547
=====
The equipment obligations and the capitalized leases are secured by
liens on the underlying equipment.
Short-Term Debt
- ---------------
Short-term debt consists of $27 million of notes assumed in
connection with the 1990 acquisition of a coal terminal facility.
Capital Lease Obligations
- -------------------------
During 1997 and 1996, NS Rail entered into capital leases covering
new locomotives. The related capital lease obligations, totaling $64
million in 1997 and $108 million in 1996, were reflected in the
Consolidated Balance Sheets as debt and, because they were non-cash
transactions, were excluded from the Consolidated Statements of Cash
Flows. The lease obligations carry an average stated interest rate of
7.0% for those entered into in 1997 and 6.5% for those entered into in
1996. All were converted to variable rate obligations using interest rate
swap agreements. The interest rates on these obligations are based on the
six-month London Interbank Offered Rate and are reset every six months
with changes in interest rates accounted for as an adjustment of interest
expense over the terms of the leases. As of Dec. 31, 1997, the average
interest rate on these locomotive leases was 6.1%. As a result, NS Rail
PAGE 56
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
8. DEBT (continued)
is exposed to the market risk associated with fluctuations in interest
rates. To date, the effects of the rate fluctuations have been favorable
and not material. Counterparties to the interest rate swap agreements are
major financial institutions believed by Management to be creditworthy.
Cash Required for NS Debt
- -------------------------
To finance the cost of the Conrail transaction, NS issued and sold
commercial paper and $4.3 billion of unsecured notes. A significant
portion of the funding for the interest and repayments on this and other
NS debt is expected to be provided by NS Rail.
9. LEASE COMMITMENTS
NS Rail is committed under long-term lease agreements, which expire
on various dates through 2067, for equipment, lines of road, and other
property. Future minimum lease payments are as follows:
Operating Leases Capital Leases
---------------- --------------
($ in millions)
1998 $ 50 $ 35
1999 47 35
2000 39 35
2001 35 34
2002 32 34
2003 and subsequent years 627 164
----- -----
Total $ 830 337
=====
Less imputed interest on
capital leases at an average
rate of 7.4% 91
-----
Present value of minimum
lease payments included
in debt $ 246
=====
Operating Lease Expense
- -----------------------
1997 1996 1995
------ ------ ------
($ in millions)
Minimum rents $ 68 $ 65 $ 59
Contingent rents 43 38 36
----- ----- -----
Total $ 111 $ 103 $ 95
===== ===== =====
PAGE 57
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
10. OTHER LIABILITIES (continued)
December 31,
1997 1996
------ ------
($ in millions)
Casualty and other claims $ 252 $ 247
Net pension obligation (Note 12) 57 82
Retiree health and death
benefit obligation (Note 13) 281 288
Other 256 269
----- -----
Total $ 846 $ 886
===== =====
11. STOCK
Preferred
- ---------
There are 10,000,000 shares of no par value serial preferred stock
authorized. This stock may be issued in series from time to time at the
discretion of the Board of Directors with any series having such voting
and other powers, dividends and other preferences as deemed appropriate
at the time of issuance. On Dec. 31, 1997 and 1996, 1,197,027 shares of
$2.60 Cumulative Preferred Stock, Series A (Series A Stock) were issued,
and 1,096,907 shares were held other than by subsidiaries. The Series A
Stock has a $50 per share stated value. The Series A Stock is callable at
any time at $50 per share plus accrued dividends and has one vote per
share on all matters, voting as a single class with holders of other
stock.
In June 1989, NS announced its intention to purchase up to 250,000
shares of the outstanding Series A Stock during the subsequent two-year
period. Subsequently, NS extended the stock purchase program through
1996. NS had purchased 176,608 shares at a total cost of approximately
$6.7 million as of Dec. 31, 1996. NS purchased the shares in regular
brokerage transactions on the open market at prevailing prices. At year
end 1997 and 1996, NS held 176,703 shares.
Preference
- ----------
There are 10,000,000 shares of no par value serial preference stock
authorized. None of these shares has been issued.
Common
- ------
There are 50,000,000 shares of no par value common stock with a
stated value of $10 per share authorized. NS owned all 16,668,997 shares
issued and outstanding at Dec. 31, 1997 and 1996.
12. PENSION PLANS
NS Rail's defined benefit pension plans, which principally cover
salaried employees, are part of NS' retirement plans. Pension benefits
are based primarily on years of creditable service with NS and its
participating subsidiary companies and compensation rates near
retirement. Contributions to the plans are made on the basis of not less
than the minimum funding standards set forth in the Employee Retirement
Income Security Act of 1974, as amended. Assets in the plans consist
mainly of common stocks. The following data relate to the combined NS
plans.
PAGE 58
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
12. PENSION PLANS (continued)
Pension Cost (Benefit) Components
- ---------------------------------
1997 1996 1995
------ ------ ------
($ in millions)
Service cost-benefits
earned during the year $ 11 $ 12 $ 10
Interest cost on projected
benefit obligation 66 67 65
Actual return on
assets in plan (273) (170) (257)
Net amortization
and deferral 171 83 172
----- ----- -----
Net pension benefit (25) (8) (10)
Cost of early
retirement benefits -- -- 23
----- ----- -----
Total $ (25) $ (8) $ 13
===== ===== =====
Pension cost is determined based on an actuarial valuation that
reflects appropriate assumptions as of the beginning of each year. The
funded status of the plans is determined using appropriate assumptions as
of each year end. A summary of the major assumptions follows:
1997 1996 1995
----- ----- -----
Discount rate for determining
funded status 7.25% 7.75% 7.25%
Future salary increases 5.25% 5.25% 6%
Return on assets in plans 9% 9% 9%
PAGE 59
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
12. PENSION PLANS (continued)
The funded status of the plans and the amounts reflected in the
accompanying balance sheets were as follows:
December 31,
--------------------------------------
1997 1996
----------------- -----------------
Funded Unfunded Funded Unfunded
Plans Plans Plans Plans
------ -------- ------ --------
($ in millions)
Actuarial present
value of benefit
obligations:
Vested benefits $ 810 $ 62 $ 759 $ 59
Non-vested
benefits 2 -- 1 --
----- ----- ----- -----
Accumulated
benefit
obligation 812 62 760 59
Effect of expected
future salary
increases 78 4 68 5
----- ----- ----- -----
Projected
benefit
obligation 890 66 828 64
Fair value of
assets in plans 1,360 -- 1,158 --
----- ----- ----- -----
Funded status 470 (66) 330 (64)
Unrecognized initial
net asset (23) -- (30) --
Unrecognized
(gain) loss (466) 24 (344) 21
Unrecognized prior
service cost (benefit) 9 (5) 2 3
----- ----- ----- -----
Net pension lia-
bility included
in the balance
sheets $ (10) $ (47) $ (42) $ (40)
===== ===== ===== =====
Early Retirement Program in 1995
- --------------------------------
During 1995, NS completed a voluntary early retirement program for
certain salaried employees. The principal benefit for those who
participated in this program was enhanced pension benefits, which are
reflected in the accumulated benefit obligation. The charge for the
272 employees who accepted the offer is included in "Compensation and
benefits" expense and totaled $34 million (including $8 million related
to postretirement benefits other than pensions).
PAGE 60
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
12. PENSION PLANS (continued)
401(k) Plans
- ------------
NS Rail provides 401(k) savings plans for employees. Under the
plans, NS Rail matches a portion of employee contributions, subject to
applicable limitations. NS Rail's expenses under these plans were $9
million, $8 million, and $7 million in 1997, 1996, and 1995,
respectively.
13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
NS Rail provides specified health care and death benefits to
eligible retired employees and their dependents by participating in
welfare benefit plans sponsored by NS. Under the present plans, which may
be amended or terminated at NS' option, a defined percentage of health
care expenses is covered, reduced by any deductibles, co-payments,
Medicare payments and, in some cases, coverage provided by other group
insurance policies. The cost of such health care coverage to a retiree
may be determined, in part, by the retiree's years of creditable service
with NS and its participating subsidiary companies prior to retirement.
Death benefits are determined based on various factors, including, in
some cases, salary at time of retirement. The following data relate to
the combined NS plans.
NS Rail continues to fund benefit costs principally on a pay-as-you-
go basis. However, in 1991, NS established a Voluntary Employee
Beneficiary Association (VEBA) account to fund a portion of the cost of
future health care benefits for retirees.
The VEBA trust holding the plan assets is not expected to be subject
to federal income taxes, as the assets are invested entirely in trust-
owned life insurance. The last corporate contribution to the VEBA was
made in 1994.
Postretirement Benefit Cost Components
- --------------------------------------
1997 1996 1995
------- ------- -------
($ in millions)
Service cost-benefits
attributable to service
during the year $ 9 $ 10 $ 9
Interest cost on accumulated
postretirement benefit
obligation 25 24 28
Actual return on plan assets (25) (14) (18)
Net amortization and deferral 6 (4) 2
----- ----- -----
Net postretirement
benefit cost 15 16 21
Cost of early
retirement benefits -- -- 8
----- ----- -----
Total $ 15 $ 16 $ 29
===== ===== =====
The weighted-average discount rate used in determining the
accumulated postretirement benefit obligation, the salary increase
assumption, and the long-term rate of return on plan assets are the same
as those used for the pension plans (see table of rate assumptions in
Note 12).
PAGE 61
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (continued)
The following table sets forth these plans' total accumulated
postretirement benefit obligation, reconciled with the accrued
postretirement benefit obligation:
December 31,
-------------------------------------------
1997 1996
------------------ ------------------
Health Health
Care Death Care Death
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
($ in millions)
Accumulated post-
retirement benefit
obligation:
Retirees $ 163 $ 85 $ 164 $ 83
Fully eligible
active plan
participants 32 9 21 7
Other active plan
participants 54 17 42 12
----- ----- ----- -----
Total 249 111 227 102
Plan assets
at fair value 111 -- 86 --
----- ----- ----- -----
Funded status (138) (111) (141) (102)
Unrecognized
loss (gain) (33) 3 (27) (3)
Unrecognized
prior service
cost (benefit) (25) -- (38) --
----- ----- ----- -----
Accrued post-
retirement
benefit
obligation $(196) $(108) $(206) $(105)
===== ===== ===== =====
For measurement purposes, increases in the per capita cost of
covered health care benefits were assumed to be 9.8% for 1998 and 10.4%
for 1997. The rate was assumed to decrease gradually to an ultimate rate
of 5.5% and remain at that level for 2005 and thereafter. The health care
cost trend rate has a significant effect on the amounts reported in the
financial statements. To illustrate, increasing the assumed trend rates
by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of Dec. 31, 1997, by about $32
million and the aggregate of the service and interest cost components of
net postretirement benefit cost for 1997 by about $4 million.
Under collective bargaining agreements, NS Rail and certain
subsidiaries participate in a multiemployer benefit plan, which provides
certain postretirement health care and life insurance benefits to
eligible agreement employees. Premiums under this plan are expensed as
incurred and amounted to $4 million in each of 1997, 1996, and 1995.
PAGE 62
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of "Cash and cash equivalents," "Short-term
investments," "Accounts receivable," "Short-term debt," and "Accounts
payable" approximate carrying values because of the short maturity of
these financial instruments.
The carrying and fair values of long-term "Investments," excluding
those accounted for under the equity method in accordance with APB
Opinion No. 18, were $921 million and approximately $1 billion on Dec.
31, 1997, and $862 million and approximately $934 million on Dec. 31,
1996, respectively. The fair value of corporate-owned life insurance
approximates carrying value. Quoted market prices were used to determine
the fair value of marketable securities that are recorded at fair value.
Carrying value adjustments, which are non-cash transactions, are not
included in the Consolidated Statement of Cash Flows. Underlying net
assets were used to estimate the fair value of other investments.
In accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities"
(SFAS 115), NS Rail increased the reported carrying value of short-term
and long-term investments classified as "available for sale" as follows:
December 31,
-------------------------------------------------
1997 1996
---------------------- -----------------------
Short- Short-
term Equity term Equity
Securities Securities Securities Securities
---------- ---------- ---------- ----------
($ in millions)
Cost $ 150 $ 21 $ 335 $ 21
Gross unrealized
holding gain
(loss) -- 643 (1) 618
------ ------ ------ ------
Fair value $ 150 $ 664 $ 334 $ 639
====== ====== ====== ======
The short-term securities are principally U.S. Treasury securities.
Equity securities consist almost entirely of 21,757,902 shares of NS
Common Stock (reflects three-for-one stock split to NS stockholders of
record on Sept. 5, 1997).
The change in the unrealized holding gain was $26 million for 1997
and $62 million for 1996. These changes primarily reflect changes in the
NS Common Stock price. As a result, stockholder's equity increased $16
million in 1997 and $61 million in 1996.
The fair value of "Long-term debt," including current maturities,
approximated $628 million on Dec. 31, 1997, and $627 million on Dec. 31,
1996. The fair values of debt were estimated based on quoted market
prices or discounted cash flows using current interest rates for debt
with similar terms, company rating, and remaining maturity (see Note 8
for carrying values of "Long-term debt"). The fair value of interest rate
swaps is immaterial.
PAGE 63
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
15. NW--SUMMARIZED CONSOLIDATED FINANCIAL INFORMATION
NW is operated as an integral part of NS Rail. Revenues are
allocated to NW based on actual traffic movements as determined by
revenue ton miles within market groups. Most expenses are charged to NW
based on usage or ownership criteria. The costs of functions performed by
NS, the parent holding company of NS Rail, are charged to its rail
operating subsidiaries. Management believes the methods used to charge
expenses to the rail operating subsidiaries are reasonable and
appropriate.
NORFOLK AND WESTERN RAILWAY COMPANY AND SUBSIDIARIES
Summarized Consolidated Statements of Income
1997 1996 1995
-------- -------- --------
($ in millions)
Railway operating
revenues $ 2,024 $ 1,959 $ 1,911
Railway operating
expenses 1,410 1,352 1,402
-------- -------- --------
Income from railway
operations 614 607 509
Other - net 54 50 39
-------- -------- --------
Income before
income taxes 668 657 548
Provision for income taxes 222 229 187
-------- -------- --------
Net income $ 446 $ 428 $ 361
======== ======== ========
NORFOLK AND WESTERN RAILWAY COMPANY AND SUBSIDIARIES
Summarized Consolidated Balance Sheets
December 31,
-----------------------
1997 1996
-------- --------
($ in millions)
Assets
Current assets $ 391 $ 354
Noncurrent assets 6,129 5,631
-------- --------
Total assets $ 6,520 $ 5,985
======== ========
Liabilities and Stockholder's Equity
Current liabilities $ 269 $ 206
Noncurrent liabilities 1,824 1,813
Stockholder's equity 4,427 3,966
-------- --------
Total liabilities and
stockholder's equity $ 6,520 $ 5,985
======== ========
PAGE 64
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
15. NW--SUMMARIZED CONSOLIDATED FINANCIAL INFORMATION (continued)
On Aug. 1, 1996, NS Rail transferred 5,294,931 (15,884,793 post-
split) shares of NS Common Stock to NW as a contribution to capital. The
transfer was recorded at historical cost, and in accordance with SFAS
115, unrealized appreciation was recognized which increased "Noncurrent
assets" $478 million, "Noncurrent liabilities" $167 million, and
"Stockholder's equity" $311 million.
16. COMMITMENTS AND CONTINGENCIES
Lawsuits
- --------
Norfolk Southern Railway Company and certain subsidiaries are
defendants in numerous lawsuits relating principally to railroad
operations. While the final outcome of these 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.
Environmental Matters
- ---------------------
NS Rail is subject to various jurisdictions' environmental laws and
regulations. It is NS Rail's policy to record a liability where such
liability or loss is probable and can be reasonably estimated. Claims, if
any, against third parties for recovery of clean-up costs incurred by NS
Rail are reflected as receivables in the balance sheet and are not netted
against the associated NS Rail liability. Environmental engineers
regularly participate in ongoing evaluations of all identified sites and
in determining any necessary adjustments to initial liability estimates.
NS Rail also has established an Environmental Policy Council, composed of
senior managers, to oversee and interpret its environmental policy.
As of Dec. 31, 1997, NS Rail's balance sheet included a reserve for
environmental exposures in the amount of $56 million (of which $12
million is accounted for as a current liability), which is NS Rail's
estimate of the probable costs based on available information at 111
identified locations. On that date, 11 sites accounted for $25 million of
the reserve, and no individual site was considered to be material. NS
Rail anticipates that much of this liability will be paid out over five
years; however, some costs will be paid out over a longer period.
At many of the 111 locations, Norfolk Southern Railway and/or
certain of its subsidiaries, usually in conjunction with a number of
other parties, have been identified as potentially responsible parties by
the Environmental Protection Agency (EPA) or similar state authorities
under the Comprehensive Environmental Response, Compensation, and
Liability Act of 1980, or comparable state statutes, which often impose
joint and several liability for clean-up costs.
With respect to known environmental sites (whether identified by NS
Rail or by the EPA or comparable state authorities), estimates of NS
Rail's ultimate potential financial exposure for a given site or in the
aggregate for all such sites are necessarily imprecise because of the
widely varying costs of currently available clean-up techniques, the
likely development of new clean-up technologies, the difficulty of
determining in advance the nature and full extent of contamination and
each potential participant's share of any estimated loss (and that
participant's ability to bear it), and evolving statutory and regulatory
standards governing liability.
The risk of incurring environmental liability -- for acts and
omissions, past, present and future -- is inherent in the railroad
business. Some of the commodities in NS Rail's traffic mix, particularly
those classified as hazardous materials, can pose special risks that NS
Rail and its subsidiaries work diligently to minimize. In addition,
several NS Rail subsidiaries own, or have owned in the past, land used as
operating property, or which is leased or may have been leased and
operated by others, or held for sale. Because environmental problems may
PAGE 65
Item 8. Financial Statements and Supplementary Data. (continued)
- ------ -------------------------------------------
15. NW--SUMMARIZED CONSOLIDATED FINANCIAL INFORMATION (continued)
exist on these properties that are latent or undisclosed, there can be no
assurance that NS Rail will not incur environmentally related liabilities
or costs with respect to one or more of them, the amount and materiality
of which cannot be estimated reliably at this time. Moreover, lawsuits
and claims involving these and other now-unidentified environmental sites
and matters are likely to arise from time to time. The resulting
liabilities could have a significant effect on financial condition,
results of operations, or liquidity in a particular year or quarter.
However, based on its assessments of the facts and circumstances now
known, Management believes that it has recorded the probable costs for
those environmental matters of which the Corporation is aware. Further,
Management believes that it is unlikely that any identified matters,
either individually or in the aggregate, will have a material adverse
effect on NS Rail's financial position, results of operations, or
liquidity.
Change-in-Control Arrangements
- ------------------------------
NS has compensation agreements with officers and certain key
employees, which become operative only upon a change in control -- as
defined in those agreements -- of that corporation. The agreements
provide generally for payments based on compensation at the time of a
covered individual's involuntary or other specified termination and for
certain other benefits.
Debt Guarantees
- ---------------
As of Dec. 31, 1997, NS Rail and certain of its subsidiaries are
contingently liable as guarantors with respect to $77 million of
indebtedness of related entities.
PAGE 66
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Norfolk Southern Railway Company:
We have audited the consolidated financial statements of Norfolk Southern
Railway Company and subsidiaries as listed in the index in Item 8. In
connection with our audits of the consolidated financial statements, we
have also audited the consolidated financial statement schedule listed in
Item 14(a)2. These consolidated financial statements and this
consolidated financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these consolidated financial statements and this consolidated financial
statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Norfolk Southern Railway Company and subsidiaries as of December 31, 1997
and 1996, and the results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 1997, in
conformity with generally accepted accounting principles. Also, in our
opinion, the related consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements
taken as a whole, presents fairly, in all material respects, the
information set forth herein.
/s/ KPMG Peat Marwick LLP
Norfolk, Virginia
January 27, 1998
PAGE 67
Item 9. Changes in and Disagreements with Accountants on Accounting
- ------ -----------------------------------------------------------
and Financial Disclosure.
------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------- --------------------------------------------------
Item 11. Executive Compensation.
- ------- ----------------------
Item 12. Security Ownership of Certain Beneficial Owners
- ------- -----------------------------------------------
and Management.
--------------
and
Item 13. Certain Relationships and Related Transactions.
- ------- ----------------------------------------------
In accordance with General Instruction G(3), the
information called for by Part III is incorporated herein by
reference from Norfolk Southern Railway's definitive Proxy Statement,
to be dated April 14, 1998, for the Norfolk Southern Railway Annual
Meeting of Stockholders to be held on May 26, 1998, which definitive
Proxy Statement will be filed electronically with the Commission
pursuant to Regulation 14A. The information regarding executive
officers called for by Item 401 of Regulation S-K is included in
Part I hereof beginning on page 17 under "Executive Officers of the
Registrant."
PAGE 68
PART IV
Item l4. Exhibits, Financial Statement Schedule, and Reports on
- ------- ------------------------------------------------------
Form 8-K.
--------
(a) The following documents are filed as part of this report:
1. Index to Consolidated Financial Statements: Page
------------------------------------------ ----
Consolidated Statements of Income
Years ended December 31, 1997, 1996 and 1995 41
Consolidated Balance Sheets
As of December 31, 1997 and 1996 42
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996 and 1995 44
Consolidated Statements of Changes in
Stockholders' Equity
Years ended December 31, 1997, 1996 and 1995 45
Notes to Consolidated Financial Statements 46
Independent Auditors' Report 66
2. Financial Statement Schedule:
The following consolidated financial
statement schedule should be read in
connection with the consolidated financial
statements:
Index to Consolidated Financial Statement Schedule Page
-------------------------------------------------- ----
Schedule II - Valuation and Qualifying Accounts 73
Schedules other than the one listed above are omitted either
because they are not required or are inapplicable, or
because the information is included in the consolidated
financial statements or related notes.
3. Exhibits
Exhibit
Number Description
- ------- -------------------------------------------------
3 Articles of Incorporation and Bylaws -
3(i) The amended Restated Articles of Incorporation
of Norfolk Southern Railway Company are
incorporated herein by reference from Exhibit 3(a)
of Norfolk Southern Railway's 1990 Annual Report
on Form 10-K.
PAGE 69
Item l4. Exhibits, Financial Statement Schedule, and Reports on
- ------- ------------------------------------------------------
Form 8-K. (continued)
--------
Exhibit
Number Description
- ------- -------------------------------------------------
3(ii) The Bylaws of Norfolk Southern Railway Company,
as last amended March 3, 1993, are incorporated
herein by reference from Exhibit 3(b) of Norfolk
Southern Railway's 1992 Annual Report on Form 10-K.
4 Instruments Defining the Rights of Security Holders,
Including Indentures -
In accordance with Item 601(b)(4)(iii) of
Regulation S-K, copies of instruments of Norfolk
Southern Railway and its subsidiaries with respect
to the rights of holders of long-term debt are
not filed herewith, or incorporated by reference,
but will be furnished to the Commission upon request.
10 Material Contracts -
(a) The Transaction Agreement, dated as of June 10,
1997, by and among CSX, CSX Transportation, Inc.,
NS, Registrant, Conrail Inc., Consolidated Rail
Corporation and CRR Holdings LLC, with certain
schedules thereto, is incorporated herein by
reference from Exhibit 10 to Norfolk Southern
Railway Company's Form 8-K filed electronically
on June 30, 1997.
(b) The Supplementary Agreement, entered into as of
January 1, 1987, between the Trustees of the
Cincinnati Southern Railway and The Cincinnati,
New Orleans and Texas Pacific Railway Company
(the latter a wholly owned subsidiary of Norfolk
Southern Railway) - extending and amending a
Lease, dated as of October 11, 1881 (both the
Lease and Supplementary Agreement, formerly
incorporated by reference from Exhibit 10(b)
to Southern's 1987 Annual Report on Form 10-K) -
is incorporated herein by reference from
Exhibit 10(a) to Norfolk Southern Railway's
1994 Annual Report on Form 10-K.
21 Subsidiaries of the Registrant.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed for the three months
ended December 31, 1997.
PAGE 70
Item l4. Exhibits, Financial Statement Schedule, and Reports on
- ------- ------------------------------------------------------
Form 8-K. (continued)
--------
Exhibit
Number Description
- ------- -------------------------------------------------
(c) Exhibits.
The Exhibits required by Item 601 of Regulation S-K
as listed in Item 14(a)3 are filed herewith or
incorporated herein by reference.
(d) Financial Statement Schedules.
Financial statement schedules and separate financial
statements specified by this Item are included in
Item 14(a)2 or are otherwise not required or are not
applicable.
PAGE 71
POWER OF ATTORNEY
-----------------
Each person whose signature appears below under "SIGNATURES"
hereby authorizes Henry C. Wolf and James C. Bishop, Jr., or either of
them, to execute in the name of each such person, and to file, any
amendment to this report and hereby appoints Henry C. Wolf and
James C. Bishop, Jr., or either of them, as attorneys-in-fact to
sign on his behalf, individually and in each capacity stated below,
and to file, any and all amendments to this report.
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Norfolk Southern Railway Company has
duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on this 17th day of March, 1998.
NORFOLK SOUTHERN RAILWAY COMPANY
By /s/ David R. Goode
-----------------------------------------
(David R. Goode, President and Chief
Executive Officer)
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below on this 17th day of March,
1998, by the following persons on behalf of Norfolk Southern Railway
Company and in the capacities indicated.
Signature Title
--------- -----
/s/ David R. Goode
- -------------------------- President and Chief Executive
(David R. Goode) Officer and Director
(Principal Executive Officer)
/s/ John P. Rathbone
- -------------------------- Vice President and Controller
(John P. Rathbone) (Principal Accounting Officer)
/s/ Henry C. Wolf
- -------------------------- Vice President-Finance
(Henry C. Wolf) (Principal Financial Officer)
PAGE 72
Signature Title
--------- -----
/s/ James C. Bishop, Jr.
- -------------------------- Director
(James C. Bishop, Jr.)
/s/ Jon L. Manetta
- -------------------------- Director
(Jon L. Manetta)
/s/ L. I. Prillaman
- -------------------------- Director
(L. I. Prillaman)
/s/ Stephen C. Tobias
- -------------------------- Director
(Stephen C. Tobias)
/s/ Henry C. Wolf
- -------------------------- Director
(Henry C. Wolf)
PAGE 73
Schedule II
Page 1 of 2
Norfolk Southern Railway Company and Subsidiaries
-------------------------------------------------
Valuation and Qualifying Accounts
Years Ended December 31, 1995, 1996 and 1997
(In millions of dollars)
Additions charged to
--------------------
Beginning Other Ending
Balance Expenses Accounts Deductions Balance
--------- -------- -------- ---------- -------
Year ended December 31, 1995
- ----------------------------
Valuation allowance(included
net in deferred tax
liability) for deferred tax
assets $ 1 $ -- $ -- $ -- $ 1
Casualty and other claims
included in other
liabilities $264 $100 $ 3 <F1> $110 <F2> $257
Current portion of casualty
and other claims included
in accounts payable $164 $ 21 $164 <F1> $185 <F3> $164
Year ended December 31, 1996
- ----------------------------
Valuation allowance (included
net in deferred tax
liability) for deferred tax
assets $ 1 $ -- $ -- $ -- $ 1
Casualty and other claims
included in other
liabilities $257 $115 $ 4 <F1> $129 <F2> $247
Current portion of casualty
and other claims included
in accounts payable $164 $ 16 $154 <F1> $169 <F3> $165
<FN>
<F1> Includes revenue overcharges provided through charges to operating
revenues and transfers from other accounts.
<F2> Payments and reclassifications to/from accounts payable.
<F3> Payments and reclassifications to/from other liabilities.
(continued)
PAGE 74
Schedule II
Page 2 of 2
Norfolk Southern Railway Company and Subsidiaries
-------------------------------------------------
Valuation and Qualifying Accounts
Years Ended December 31, 1995, 1996 and 1997 (continued)
(In millions of dollars)
Additions charged to
--------------------
Beginning Other Ending
Balance Expenses Accounts Deductions Balance
--------- -------- -------- ---------- -------
Year ended December 31, 1997
- ----------------------------
Valuation allowance (included
net in deferred tax
liability) for deferred tax
assets $ 1 $ -- $ -- $ -- $ 1
Casualty and other claims
included in other
liabilities $247 $108 $ 2 <F1> $105 <F2> $252
Current portion of casualty
and other claims included
in accounts payable $165 $ 14 $170 <F1> $178 <F3> $171
<FN>
<F1> Includes revenue overcharges provided through charges to operating
revenues and transfers from other accounts.
<F2> Payments and reclassifications to/from accounts payable.
<F3> Payments and reclassifications to/from other liabilities.
PAGE 75
EXHIBIT INDEX
-------------
Electronic
Submission
Exhibit Page
Number Description Number
- ---------- ------------------------------------------- ------
21 Subsidiaries of Norfolk Southern Railway. 76
27 Financial Data Schedule (Required to be
electronically submitted for use by the
Securities and Exchange Commission only
and not deemed part of this filing). 77