SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 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 number 1-9064 ------ CONSOLIDATED RAIL CORPORATION ---------------------------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-1989084 - ----------------------------------- ------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2001 Market Street, Philadelphia, Pennsylvania 19101 - ----------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (215) 209-4000 - ---------------------------------------------------------------------- (Registrant's telephone number, including area code) - ---------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Number of shares of common stock outstanding (as of October 31, 1997) 100 CONSOLIDATED RAIL CORPORATION INDEX Page Number ------------ PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Statements of Income - Quarters and nine months ended September 30, 1997 and 1996 3 Condensed Consolidated Balance Sheets - September 30, 1997 and December 31, 1996 4 Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 1997 and 1996 5 Notes to Condensed Consolidated Financial Statements 6 Report of Independent Accountants 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings 14 Item 6. Exhibits and Reports on Form 8-K 15 SIGNATURES 16 2 PART I. FINANCIAL INFORMATION CONSOLIDATED RAIL CORPORATION Item 1. Financial Statements. -------------------- CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) ($ In Millions) Quarters Ended Nine Months Ended September 30, September 30, ------------- ---------------- 1997 1996 1997 1996 ---- ---- ------ ------ Revenues $935 $923 $2,764 $2,750 Operating expenses Way and structures 107 106 344 365 Equipment 182 195 583 614 Transportation 334 323 1,016 1,031 General and administrative 72 65 236 249 ESOP termination charge - - 221 - Merger-related compensation costs 21 - 201 - Merger costs 2 - 63 - Voluntary separation programs - - - 135 ---- ---- ------ ------ Total operating expenses 718 689 2,664 2,394 ---- ---- ------ ------ Income from operations 217 234 100 356 Interest expense (41) (43) (125) (131) Other income, net 22 21 69 68 ---- ---- ------ ------ Income before income taxes 198 212 44 293 Income taxes 97 75 157 104 ---- ---- ------ ------ Net income (loss) $101 $137 $ (113) $ 189 ==== ==== ====== ====== Ratio of earnings to fixed charges 4.78x 4.76x 1.17x 2.64x See accompanying notes. 3 CONSOLIDATED RAIL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) ($ In Millions) September 30, December 31, 1997 1996 ------------- ------------ ASSETS Current assets Cash and cash equivalents $ 21 $ 17 Accounts receivable 664 629 Deferred tax assets 293 285 Material and supplies 111 139 Other current assets 31 22 ------ ------ Total current assets 1,120 1,092 Property and equipment, net 6,770 6,590 Other assets 692 671 ------ ------ Total assets $8,582 $8,353 ====== ====== LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities Short-term borrowings 19 99 Current maturities of long-term debt 109 130 Accounts payable 198 160 Wages and employee benefits 330 143 Casualty reserves 133 138 Accrued and other current liabilities 491 445 ------ ------ Total current liabilities 1,280 1,115 Long-term debt 1,767 1,876 Casualty reserves 195 190 Deferred income taxes 1,622 1,484 Special income tax obligation 299 346 Other liabilities 518 307 ------ ------ Total liabilities 5,681 5,318 ------ ------ Stockholder's equity Preferred stock Common stock Additional paid-in capital 1,864 2,151 Note receivable from ESOP - (294) Retained earnings 1,037 1,178 ------ ------ Total stockholder's equity 2,901 3,035 ------ ------ Total liabilities and stockholder's equity $8,582 $8,353 ====== ====== See accompanying notes. 4 CONSOLIDATED RAIL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) ($ In Millions) Nine Months Ended September 30, ---------------- 1997 1996 ----- ----- Cash flows from operating activities $ 628 $ 502 ----- ----- Cash flows from investing activities Property and equipment acquisitions (309) (233) Payments for capital lease buyouts - (20) Other (6) (10) ----- ----- Net cash used in investing activities (315) (263) ----- ----- Cash flows from financing activities Net reduction in short-term borrowings (80) (24) Loans from and redemptions of insurance policies - 95 Proceeds from long-term debt - 26 Payment of long-term debt (209) (153) Dividends paid on common stock (27) (241) Other 7 20 ----- ----- Net cash used in financing activities (309) (277) ----- ----- Increase (decrease) in cash and cash equivalents 4 (38) Cash and cash equivalents Beginning of period 17 58 ----- ----- End of period $ 21 $ 20 ===== ===== See accompanying notes. 5 CONSOLIDATED RAIL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. The unaudited financial statements contained herein present the consolidated financial position of Consolidated Rail Corporation (the "Company") as of September 30, 1997 and December 31, 1996, the consolidated results of operations for the three and nine-month periods ending September 30, 1997 and 1996 and the consolidated cash flows for the nine-month periods ended September 30, 1997 and 1996. In the opinion of management, these financial statements include all adjustments, consisting of normal recurring adjustments and those mentioned in Notes 2, 3, 4, 5, 6 and 7, necessary to present fairly the results for the interim periods included. The rules and regulations of the Securities and Exchange Commission permit certain information and footnote disclosures, ordinarily required by generally accepted accounting principles, to be condensed or omitted from interim financial reports. Accordingly, the financial statements included herein should be read in conjunction with the audited financial statements and notes for the year ended December 31, 1996, presented in the Company's Annual Report on Form 10-K. 2. A tax law was enacted during the third quarter of 1997 by a state in which the Company operates which changed the Company's method of computing taxes and resulted in a tax rate increase. Income tax expense for the third quarter includes a one-time charge of $22 million representing the effects of adjusting deferred income taxes and the special income tax obligation for the rate increase as required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". 3. During the third quarter of 1997, the Company recorded a charge of $21 million ($14 million after income taxes) representing a portion of an amount to be paid to certain non-union employees as an incentive to continue their employment with the Company through the effective date of the requisite Surface Transportation Board ("STB") approval of the joint acquisition of Conrail Inc. ("Conrail"), the Company's parent, by CSX Corporation ("CSX") and Norfolk Southern Corporation ("NSC"), and subsequent transition period. The Company has recorded a charge of $28 million ($18 million after income taxes) related to these incentive payments through the first nine months of 1997. The total amount of such payments is expected to be approximately $125 million and will continue to be accrued ratably through the fourth quarter of 1998, the expected end of the transition period. During the second quarter of 1997, the Company recorded a charge of $110 million ($103 million after income taxes) in connection with employment agreements with certain executives, which became operative upon a change in control as defined in such agreements. As a result of the acquisition of Conrail by CSX and NSC, benefits under these agreements will be paid upon the earlier of the STB's approval or disapproval of the transaction or May 31, 1998. Severance benefits to be paid to other Company employees will be determined and accrued when 6 the employees adversely affected by the transaction are identified, which is expected to occur near the time of the STB decision. 4. Merger costs of $2 million and $63 million ($39 million after income taxes) for the three and nine months ended September 30, 1997, respectively, primarily include costs for investment banking, legal and consulting services related to the acquisition of Conrail by CSX and NSC. 5. In the second quarter of 1997, the Company recorded a charge of $221 million (no related income tax effect) related to the termination of its Non-union Employee Stock Ownership Plan ("ESOP") as a result of the repayment of the ESOP note payable of $291 million to the Company. 6. In connection with the joint acquisition of Conrail by CSX and NSC, all outstanding performance shares and all outstanding unvested stock options, restricted shares and phantom shares vested during the second quarter of 1997. The Company paid all of the amounts due employees under these arrangements and recorded a $63 million charge ($39 million after income taxes). 7. During the second quarter of 1996, the Company recorded a charge of $135 million (before tax benefits of $52 million) consisting of $102 million in termination benefits to be paid to non-union employees participating in the voluntary retirement and separation programs ("voluntary separation programs") and losses of $33 million on non- cancelable leases for office space no longer required as a result of the reductions in the Company's workforce. Over 840 applications were accepted from eligible employees under both programs. Approximately $90 million of the termination benefits are being paid from the Company's overfunded pension plan. 8. Information regarding contingent liabilities and litigation was included in Note 14 to Consolidated Financial Statements and Part I, Item 3 - Legal Proceedings in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. Material developments with respect to these and other matters are discussed in Part II, Item I - Legal Proceedings in this Form 10-Q. 7 REPORT OF INDEPENDENT ACCOUNTANTS The Stockholder and Board of Directors of Consolidated Rail Corporation We have reviewed the accompanying condensed consolidated balance sheet of Consolidated Rail Corporation and its subsidiaries (the "Company") as of September 30, 1997 and the related condensed consolidated statements of income for the three and nine months ended September 30, 1997 and September 30, 1996 and the condensed consolidated statements of cash flows for the nine months ended September 30, 1997 and September 30, 1996. This financial information is the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with generally accepted accounting principles. We previously audited in accordance with generally accepted auditing standards, the consolidated balance sheet as of December 31, 1996, and the related consolidated statements of income, of stockholder's equity and of cash flows for the year then ended (not presented herein), and in our report dated January 21, 1997, except as to Note 2 to the consolidated financial statements, which is as of March 7, 1997, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1996, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. PRICE WATERHOUSE LLP Thirty South Seventeenth Street Philadelphia, PA 19103 October 15, 1997 8 CONSOLIDATED RAIL CORPORATION Item 2. Management's Discussion and Analysis of Financial ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Overview - -------- Net income for Consolidated Rail Corporation, ("CRC" or the "Company") was $101 million for the third quarter of 1997 as compared with $137 million for the third quarter of 1996. The results for the third quarter of 1997 include recognition of a one-time $22 million increase in income tax expense related to an increase in a state income tax rate enacted during the quarter and merger-related costs of $23 million ($16 million after income taxes) resulting from the acquisition of the Company's parent, Conrail Inc., (see Notes 2, 3 and 4 to the Condensed Consolidated Financial Statements). Without the income tax increase and merger-related costs, CRC's net income for the third quarter of 1997 would have been $139 million. CRC incurred a net loss of $113 million for the nine months ending September 30, 1997 as compared with net income of $189 million for the comparable period of 1996. The results for the first nine months of 1997 include the aforementioned tax charge of $22 million, an ESOP termination charge of $221 million (no related income tax effect), merger-related compensation costs of $201 million ($160 million after income taxes) and merger costs of $63 million ($39 million after income taxes), (see Notes 2, 3, 4, 5 and 6 to the Condensed Consolidated Financial Statements). Results for the first nine months of 1996 include a one-time charge of $135 million ($83 million after income taxes) related to voluntary separation programs and related costs (see Note 7 to the Consolidated Financial Statements). Without the aforementioned items, CRC's net income for the first nine months of 1997 and 1996 would have been $329 million and $272 million, respectively. The Company's continuing efforts in cost reduction and increased productivity have been primarily responsible for its operating ratio (operating expenses as a percent of revenues, excluding one-time charges) improvements in both the third quarter and first nine months of 1997 as compared with the comparable periods of 1996. The Company achieved operating ratios of 74.3% and 78.8%, excluding merger-related costs, for the third quarter and first nine months of 1997, respectively, as compared with 74.6% for the third quarter of 1996 and 82.1%, excluding the voluntary separation programs charge, for the first nine months of 1996. Increases in operating revenues of $12 million and $14 million were also experienced in the third quarter and first nine months of 1997, respectively, compared with the same periods of 1996. Acquisition of Conrail Inc. - -------------------------- On May 23, 1997, the CSX-NSC joint tender offer for the remaining outstanding shares of Conrail Inc.'s common and ESOP stock was concluded, with 53.4 million shares having been tendered. On June 2, 1997, Conrail became the surviving corporation in a merger with Green Acquisition Corp., a jointly-owned, indirect subsidiary of CSX and NSC, as a result of which the remaining outstanding capital stock of Conrail was acquired by NSC and CSX. The Company remains a wholly-owned subsidiary of Conrail. 9 Simultaneous with the merger, Conrail's common stock was delisted from the New York Stock Exchange and, through the filing of a Form 15, deregistered with the Securities and Exchange Commission. The Conrail stock acquired by NSC and CSX is being held in a voting trust pending approval of the joint acquisition by the Surface Transportation Board, which is expected to occur in the third quarter of 1998. Results of Operations - --------------------- Third Quarter 1997 compared with Third Quarter 1996 - --------------------------------------------------- Net income for the third quarter of 1997 was $101 million after merger- related costs and the one-time tax charge (see Notes 2, 3 and 4 to the Condensed Consolidated Financial Statements) compared with net income of $137 million for the third quarter of 1996. Operating revenues (primarily freight and line-haul revenues, but also including switching, demurrage and incidental revenues) increased $12 million, or 1.3%, from $923 million in the third quarter of 1996 to $935 million in the third quarter of 1997. A 4.4% increase in traffic volume in units (freight cars and intermodal trailers and containers) resulted in a $39 million increase in revenues. However, a decline in average revenue per unit decreased revenues by $21 million for the quarter, due to decreases in average rates, $12 million, and an unfavorable traffic mix, $9 million. Other revenues declined by $6 million. Operating expenses increased $29 million, or 4.2%, from $689 million in the third quarter of 1996 to $718 million in the third quarter of 1997. The following table sets forth the operating expenses for the two periods: Third Quarter -------------- Increase ($ In Millions) 1997 1996 (Decrease) ---- ---- ---------- Compensation and benefits $303 $286 $ 17 Fuel 44 44 - Material and supplies 38 38 - Equipment rents 92 94 (2) Depreciation and amortization 74 71 3 Casualties and insurance 32 43 (11) Other 112 113 (1) Merger-related compensation 21 21 Merger costs 2 2 ---- ---- ---- $718 $689 $ 29 ==== ==== ==== Compensation and benefits increased $17 million, or 5.9%, primarily as a result of increased wage rates that became effective during the quarter and increases in other employee-related costs, including incentive compensation, partially offset by reductions in employment levels. Compensation and benefits as a percent of revenues was 32.4% in the third quarter of 1997 as compared with 31.0% in the third quarter of 1996. 10 Casualties and insurance costs decreased $11 million, or 25.6%, primarily due to reductions in the number and costs of employee injuries. The Company recorded $23 million of merger-related costs (see Notes 3 and 4 to the Condensed Consolidated Financial Statements) in the third quarter of 1997. The Company's operating ratio (operating expenses as a percent of revenues) was 76.8% for the third quarter of 1997 compared with 74.6% for the third quarter of 1996. Excluding the merger-related costs, the operating ratio would have been 74.3% for the third quarter of 1997. The significant difference between the effective tax rates for the third quarter of 1997 as compared with the third quarter of 1996 primarily results from the one-time $22 million increase in income tax expense related to an increase in a state income tax rate enacted during the quarter (see Note 2 to the Condensed Consolidated Financial Statements). First Nine Months of 1997 compared with First Nine Months of 1996 - ----------------------------------------------------------------- The net loss for the first nine months of 1997 was $113 million which includes merger-related costs and a one-time tax charge (see Notes 2, 3, 4, 5 and 6 to the Condensed Consolidated Financial Statements). Net income for the first nine months of 1996 was $189 million which included the effects of the voluntary separation programs charge (see Note 7 to the Condensed Consolidated Financial Statements). Operating revenues increased $14 million, or .5%, to $2,764 million for the first nine months of 1997 from $2,750 million for the first nine months of 1996. A 4.5% increase in traffic volume resulted in a $118 million increase in revenues. A decrease in average rates and an unfavorable traffic mix reduced revenues by $42 million and $37 million, respectively. Other revenues decreased by $25 million. Operating expenses increased $270 million, or 11.3%, to $2,664 million in the first nine months of 1997, from $2,394 million in the first nine months of 1996. The following table sets forth the operating expenses for the two periods: 11 First Nine Months ----------------- Increase ($ In Millions) 1997 1996 (Decrease) ------ ------ -------- Compensation and benefits $ 915 $ 938 $ (23) Fuel 148 146 2 Material and supplies 133 144 (11) Equipment rents 276 287 (11) Depreciation and amortization 219 212 7 Casualties and insurance 107 137 (30) Other 381 395 (14) ESOP termination charge 221 221 Merger-related compensation 201 201 Merger costs 63 63 Voluntary separation programs 135 (135) ------ ------ ----- $2,664 $2,394 $ 270 ====== ====== ===== Compensation and benefits decreased $23 million, or 2.5%, primarily as a result of reductions in employment levels and less weather-related overtime costs occurring during the first quarter of 1997 as compared with the same period of 1996. These decreases were partially offset by increases in other employee-related costs, including incentive compensation, and wage rate increases that became effective during the third quarter of 1997. Compensation and benefits as a percent of revenues was 33.1% in the first nine months of 1997 as compared with 34.1% in the first nine months of 1996. Casualties and insurance costs decreased $30 million, or 21.9%, primarily due to reductions in the number and costs of employee injuries. The Company's operating ratio was 96.4% for the first nine months of 1997, compared with 87.1% for the first nine months of 1996. Without the merger- related costs and voluntary separation programs charge, the operating ratio would have been 78.8% and 82.1% for the first nine months of 1997 and 1996, respectively. The significant difference between the effective tax rates for the first nine months of 1997 as compared with the same period of 1996 results from the nondeductibility for income tax purposes of the ESOP termination charge and certain merger-related compensation costs as well as the aforementioned $22 million increase in income tax expense related to an increase in a state income tax rate enacted during the quarter (see Note 2 to the Condensed Consolidated Financial Statements). Liquidity and Capital Resources - ------------------------------- The Company's cash and cash equivalents increased $4 million in the first nine months of 1997, from $17 million at December 31, 1996 to $21 million at September 30, 1997. Cash generated from operations has been the Company's principal source of liquidity and is used primarily for capital expenditures, debt service and dividends. In the first nine months of 1997, operating activities provided cash of $628 million. 12 The principal uses of cash were for: property and equipment acquisitions, $309 million; payment of long-term debt, $209 million; net repayment of short-term borrowings, $80 million; and cash dividends on common stock, $27 million. A working capital (current assets less current liabilities) deficit of $160 million existed at September 30, 1997 as compared with a $23 million deficit at December 31, 1996. Management believes that the Company's financial position allows it sufficient access to credit sources on investment grade terms. The Company has recorded a $138 million short-term liability and a $221 million long-term liability for certain merger-related costs, neither of which are expected to require the future use of the Company's cash for settlement. During the first nine months of 1997, CRC issued $124 million of commercial paper and repaid $304 million, which included $100 million of commercial paper previously classified as long-term debt. At September 30, 1997, $19 million of commercial paper remained outstanding, all of which is classified as short-term borrowings. Other Matters - ------------- Except for the historical information contained herein, the matters discussed in this report are forward-looking statements that involve risks and uncertainties that may cause actual results to differ, including but not limited to the effect of economic conditions, competition, regulation and weather on Conrail's operations, customers, service and prices, and other factors discussed elsewhere in this report and, from time to time, in other reports filed with the Securities and Exchange Commission. 13 PART II. OTHER INFORMATION CONSOLIDATED RAIL CORPORATION Item 1. Legal Proceedings. ----------------- Englehart v. Consolidated Rail Corporation. - ------------------------------------------ On August 6, 1997, the Third Circuit Court of Appeals affirmed the U.S. District Court's grant of the Company's Motion for Summary Judgment with respect to all but one individual participant claim, and has subsequently denied plaintiffs' request for a rehearing en banc. This matter was last reported in Consolidated Rail Corporation's ("CRC") report on Form 10-K for the year ended December 31, 1996. Ohio Crossing Accident Punitive Damage Awards. - --------------------------------------------- The Ohio intermediate appellate court has affirmed the respective trial court's awards of punitive damages in Moore v. Consolidated Rail Corp. and Wightman v. Consolidated Rail Corp. CRC believes the punitive damage awards are improper and that it has meritorious defenses. Appeals from these decisions are currently pending before the Ohio Supreme Court. The Company is not presently able to reasonably estimate the ultimate outcome of these cases, and accordingly, no expense for the punitive damage awards has been recorded as of September 30, 1997. These matters were last reported in CRC's report on Form 10-Q for the period ended June 30, 1997. Bennett, et al. vs. Conrail Matched Savings Plan, Kelly, et al. vs. - ------------------------------------------------------------------- Conrail Matched Savings Plan, Gale, et al. vs. Conrail Matched Savings - ---------------------------------------------------------------------- Plan, and Bunnion, et al. vs. Conrail Matched Savings Plan. - ---------------------------------------------------------- In August 1997, four putative class action lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania by former CRC non-agreement employees alleging various violations of ERISA in connection with the Company's announced plans to distribute surplus ESOP assets. In addition, the Bunnion complaint alleges that the Company unlawfully discriminated on the basis of age and coerced employees in connection with CRC's voluntary separation programs and that former employees who returned to the Company as independent contractors are being denied the benefits afforded CRC employees. On October 30, 1997, the District Court granted CRC's Motion to Dismiss the Bennett, Kelly and Gale complaints. A Motion to Dismiss portions of the Bunnion complaint is pending before the court. 14 Item 6. Exhibits and Reports on Form 8-K. -------------------------------- (a) Exhibits 12 Computations of the ratio of earnings to fixed charges. 15 Letter re unaudited interim financial information from Price Waterhouse LLP. 27 Financial data schedule. (b) Reports on Form 8-K None 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CONSOLIDATED RAIL CORPORATION Registrant /s/ Timothy T. O'Toole --------------------------- Timothy T. O'Toole Senior Vice President - Law and Government Affairs /s/ John A. McKelvey --------------------------- John A. McKelvey Senior Vice President - Finance (Principal Financial Officer) Date: November 12, 1997 16 EXHIBIT INDEX ------------- Exhibit No. - ------- 12 Computations of the ratio of earnings to fixed charges. 15 Letter re unaudited interim financial information from Price Waterhouse LLP. 27 Financial data schedule.