-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ilow+tfHosVc5RUy1xUk3xAO+iyir5/6pXjLsElsiPKjyPuszenVKAGocsEEN2Cy 0sSduxoJI08oyyd5p9omsw== 0000702165-99-000019.txt : 19990325 0000702165-99-000019.hdr.sgml : 19990325 ACCESSION NUMBER: 0000702165-99-000019 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORFOLK SOUTHERN CORP CENTRAL INDEX KEY: 0000702165 STANDARD INDUSTRIAL CLASSIFICATION: RAILROADS, LINE-HAUL OPERATING [4011] IRS NUMBER: 521188014 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-08339 FILM NUMBER: 99571274 BUSINESS ADDRESS: STREET 1: THREE COMMERCIAL PL CITY: NORFOLK STATE: VA ZIP: 23510-2191 BUSINESS PHONE: 8046292680 10-K405 1 NSC 10-K405 FYE 12/31/98 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------- FORM 10-K405 (X)ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998. 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 1-8339 NORFOLK SOUTHERN CORPORATION --------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Virginia 52-1188014 ------------------------------------------------ ------------------ (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) 629-2680 ------------------ Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each Class on which registered ------------------- --------------------- Norfolk Southern Corporation Common Stock (Par Value $1.00) New York Stock Exchange 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) The aggregate market value of the voting stock held by nonaffiliates as of February 26, 1999: $10,656,426,108. The number of shares outstanding of each of the registrant's classes of common stock, as of February 26, 1999: 379,739,015 (excluding 21,627,904 shares held by registrant's consolidated subsidiaries). PAGE 2 DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive proxy statement (to be dated April 1, 1999), 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 17 4. Submission of Matters to a Vote of Security Holders 17 Executive Officers of the Registrant 18 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 31 7A. Quantitative and Qualitative Disclosures about Market Risk 51 8. Financial Statements and Supplementary Data 52 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 84 Part III 10. Directors and Executive Officers of the Registrant 85 11. Executive Compensation 85 12. Security Ownership of Certain Beneficial Owners and Management 85 13. Certain Relationships and Related Transactions 85 Part IV 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 86 Index to Consolidated Financial Statement Schedule 86 Power of Attorney 91 Signatures 91 Exhibit Index 95 PAGE 4 PART I Item 1. Business. - ------ -------- and Item 2. Properties. - ------ ---------- GENERAL - Norfolk Southern Corporation (Norfolk Southern) was incorporated on July 23, 1980, under the laws of the Commonwealth of Virginia. On June l, 1982, Norfolk Southern acquired control of two major operating railroads, Norfolk and Western Railway Company (NW) and Southern Railway Company (Southern) in accordance with an Agreement of Merger and Reorganization dated as of July 31, 1980, and with the approval of the transaction by the Interstate Commerce Commission (ICC) (now the Surface Transportation Board [STB]). Effective Dec. 31, 1990, Norfolk Southern transferred all the common stock of NW to Southern, and Southern's name was changed to Norfolk Southern Railway Company (Norfolk Southern Railway). Effective Sept. 1, 1998, NW was merged with and into Norfolk Southern Railway. As of Dec. 31, 1998, all the common stock of Norfolk Southern Railway and 16.1 percent of its voting preferred stock (resulting in 94.8 percent voting control) was owned directly by Norfolk Southern. On March 28, 1998, Norfolk Southern closed the sale of its motor carrier company, North American Van Lines, Inc. (NAVL) (see "Discontinued Operations" on page 42 and Note 3 on page 66). NAVL's results of operations, financial position, and cash flows are presented as "Discontinued operations" in the accompanying financial statements. Unless indicated otherwise, Norfolk Southern and its subsidiaries are referred to collectively as NS. JOINT ACQUISITION OF CONRAIL INC. - During 1997, NS and CSX Corporation (CSX) completed the acquisition of Conrail Inc., the owner of Consolidated Rail Corporation, the major freight railroad in the Northeast. Norfolk Southern Railway will begin providing rail freight services on portions of Conrail's route system after the Closing Date, which NS and CSX have agreed will be June 1, 1999 (see "Joint Acquisition of Conrail" on page 44 and Note 2 on page 62). Implementation of the Conrail transaction will expand NS' railroads' service area considerably, adding approximately 7,200 route-miles through an operating agreement, and giving them access to most of the major ports on the East Coast, to New York City and the Northeast, and to the Midwest. In addition, the equipment fleet will be augmented by approximately 1,100 locomotives, 27,200 freight cars, and 1,200 intermodal containers that Norfolk Southern Railway will lease from a Conrail subsidiary on the Closing Date. PAGE 5 CONTINUING OPERATIONS: RAILROAD OPERATIONS - As of Dec. 31, 1998, NS' railroads 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, 12,115 miles are owned with the balance operated under lease or trackage rights; most of this total is main line track. In addition, its railroads operate 10,780 miles of passing, industrial, yard, and side tracks. NS' railroads have 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 Norfolk Southern and the North Carolina Railroad Company (NCRR), the U.S. District Court in Raleigh ruled that there was no quorum at the stockholders' meeting where the agreement had been approved and enjoined the parties from performing under the extension agreement. NCRR has suits pending against Norfolk Southern 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' railroads' continued use and the compensation therefor. NS' railroads presently are 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' consolidated financial statements. NS' railroads 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. They 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. The lines of NS' railroads 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' railroads to provide single-line service to and from south Florida, including PAGE 6 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). Buffalo, Chicago, Hagerstown, Jacksonville, Kansas City, Memphis, New Orleans, and St. Louis are major gateways for interterritorial system traffic. NS' railroads 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 were so affected, it could receive daily indemnities from non-affected parties; if parties other than NS were affected, NS could be required to pay indemnities to those parties. If NS 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. TRIPLE CROWN OPERATIONS - Until April 1993, NS' intermodal subsidiary, Triple Crown Services, Inc. (TCS), offered intermodal service using RoadRailer (Registered Trademark hereinafter abbreviated RT) equipment and domestic containers. RoadRailer(RT) units are enclosed vans which can be pulled over highways in tractor-trailer configuration and over the rails by locomotives. On April 1, 1993, the business, name, and operations of TCS were transferred to Triple Crown Services Company (TCSC), a partnership in which subsidiaries of NS and Conrail are equal partners. RoadRailer(RT) equipment owned or leased by TCS (which was renamed TCS Leasing, Inc.) is operated by TCSC. The revenues of TCSC since April 1, 1993, have not been consolidated with the results of NS; however, beginning with the Closing Date (see "Joint Acquisition of Conrail" on page 44), NS expects to gain control of TCSC, and, therefore, include TCSC's results in its consolidated financial statements. TCSC offers door-to- door intermodal service using RoadRailer(RT) equipment and domestic containers in the corridors previously served by TCS, as well as service to the New York and New Jersey markets via Conrail. Major traffic corridors include those between New York and Chicago, Chicago and Atlanta, and Atlanta and New York. PAGE 7 RAILWAY OPERATING REVENUES - NS' total railway operating revenues were $4.2 billion in 1998. 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 1998 1997 1996 1995 1994 - -------------------- ---- ---- ---- ---- ---- (Revenues in millions, shipments in thousands, revenue yield in dollars per shipment) COAL Revenues $1,252 $1,301 $1,305 $1,268 $1,290 % of total revenues 30% 31% 32% 32% 33% Shipments 1,310 1,324 1,310 1,267 1,274 % of total shipments 27% 28% 29% 29% 30% Revenue Yield $ 956 $ 983 $ 996 $1,001 $1,013 CHEMICALS Revenues $ 574 $ 585 $ 560 $ 541 $ 538 % of total revenues 13% 14% 14% 14% 14% Shipments 401 405 385 374 376 % of total shipments 8% 8% 8% 8% 9% Revenue Yield $1,431 $1,446 $1,456 $1,447 $1,433 AUTOMOTIVE Revenues $ 566 $ 492 $ 489 $ 449 $ 429 % of total revenues 13% 11% 12% 11% 11% Shipments 487 361 354 328 317 % of total shipments 10% 8% 8% 7% 7% Revenue Yield $1,162 $1,364 $1,379 $1,368 $1,352 PAPER/CLAY/FOREST Revenues $ 534 $ 539 $ 513 $ 537 $ 522 % of total revenues 13% 13% 12% 13% 13% Shipments 445 457 438 459 464 % of total shipments 9% 9% 10% 10% 11% Revenue Yield $1,200 $1,178 $1,171 $1,170 $1,124 AGRI./CONSUMER/GOVT. Revenues $ 383 $ 391 $ 393 $ 394 $ 380 % of total revenues 9% 9% 9% 10% 10% Shipments 355 366 376 391 383 % of total shipments 8% 8% 8% 9% 9% Revenue Yield $1,079 $1,065 $1,045 $1,007 $ 992 METALS/CONSTRUCTION Revenues $ 373 $ 368 $ 354 $ 349 $ 330 % of total revenues 9% 9% 9% 8% 8% Shipments 372 374 359 367 366 % of total shipments 8% 8% 8% 8% 8% Revenue Yield $1,003 $ 985 $ 986 $ 951 $ 902
PAGE 8
Year Ended December 31, Principal Sources of ------------------------------------------ Railway Operating Revenues 1998 1997 1996 1995 1994 - -------------------- ---- ---- ---- ---- ---- (Revenues in millions, shipments in thousands, revenue yield in dollars per shipment) INTERMODAL (Trailers, Containers, and RoadRailers) Revenues $ 539 $ 547 $ 487 $ 474 $ 429 % of total revenues 13% 13% 12% 12% 11% Shipments 1,443 1,472 1,331 1,263 1,127 % of total shipments 30% 31% 29% 29% 26% Revenue Yield $ 374 $ 372 $ 366 $ 376 $ 380 Total Railway Operating Revenues $4,221 $4,223 $4,101 $4,012 $3,918 Total Railway Shipments 4,813 4,759 4,553 4,449 4,307 Railway Revenue Yield $ 877 $ 887 $ 901 $ 902 $ 910
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 9 COAL TRAFFIC - Coal, coke, and iron ore -- most of which is bituminous coal -- is NS' railroads' principal commodity group. They originated 119 million tons of coal, coke, and iron ore in 1998 and handled a total of 134 million tons. Originated tonnage and total tons handled remained stable compared with 1997. Revenues from coal, coke, and iron ore account for about 30 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) --------------------------------------------
1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Originated 119 119 117 114 115 Received 15 15 13 11 11 --- --- --- --- --- Handled 134 134 130 125 126 === === === === ===
Of the 119 million tons of coal, coke, and iron ore originated on NS' railroads' lines in 1998, the approximate breakdown by origin state was as follows:
Origin State Millions of Tons ------------ ---------------- West Virginia 41 Virginia 34 Kentucky 27 Indiana 7 Alabama 5 Illinois 3 Tennessee 1 Other 1 --- 119 ===
Of the 134 million tons handled, approximately 25 million moved for export, principally through NS' pier facilities at Norfolk (Lamberts Point), Virginia; 18 million moved to domestic and Canadian steel industries; 83 million of steam coal moved to electric utilities; and 8 million moved to other industrial and miscellaneous users. NS' railroads moved 6 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' railroads was terminated in states situated east of the Mississippi River. Total coal handled through all system ports in 1998 was 39 million tons. Of this total, 69 percent, or 27 million tons (including coastwise traffic), moved through Lamberts Point, a 16 percent decrease, compared with the 32 million tons handled in 1997. PAGE 10 The quantities of NS export coal handled through Lamberts Point for the past five years were as follows: Export Coal through Lamberts Point (Millions of tons) ----------------------------------
1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- 24 28 26 25 24
See the discussion of coal traffic, by type of coal, in Part II, Item 7, "Management's Discussion and Analysis." Merchandise Traffic - The merchandise traffic group consists of intermodal and general merchandise, which consists of five major commodity groupings: chemicals; automotive; paper, clay, and forest products; agriculture, consumer products, and government; and metals and construction. Total merchandise revenues in 1998 were $3.0 billion, a 2 percent increase, compared with 1997. Merchandise carloads and intermodal units handled in 1998 were 3.50 million, compared with 3.43 million handled in 1997, an increase of 2 percent. In 1998, 113 million tons of merchandise freight, or approximately 67 percent of total merchandise tonnage handled by NS, originated on line. The balance of merchandise traffic was received from connecting carriers, usually at interterritorial gateways. The principal interchange points for NS-received traffic included Chicago, Memphis, New Orleans, Cincinnati, Kansas City, Detroit, Hagerstown, St. Louis/East St. Louis, and Louisville. Revenues in only two of the six market groups comprising merchandise traffic improved in 1998. The only large gain was in the automotive group, up $74 million. See the discussion of general merchandise rail traffic by commodity group and intermodal rail traffic in Part II, Item 7, "Management's Discussion and Analysis." RAIL OPERATING STATISTICS - The following table sets forth certain statistics relating to NS' railroads' operations for the past five years:
Year Ended December 31, ---------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Revenue ton miles (billions) 133 136 130 127 122 Freight train miles traveled (millions) 53.0 49.7 49.4 48.5 46.0 Revenue per ton mile $0.0316 $0.0311 $0.0316 $0.0317 $0.0320 Revenue tons per train 2,517 2,732 2,625 2,611 2,655 Revenue ton miles per man-hour worked 2,635 2,905 2,764 2,679 2,579 Percentage ratio of railway operating expenses to railway operating revenues 75.1% 71.3% 71.6% 73.5% 73.4%
PAGE 11 FREIGHT RATES - In 1998, NS' railroads continued their reliance on private contracts and exempt price quotes as their predominant pricing mechanisms. Thus, a major portion of NS' railroads' freight business is not currently 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 1998, NS' railroads were found by the STB to be "revenue adequate" based on results for the year 1997. 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' 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 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. NS also leases the Chicago to Manhattan, Illinois, line to the Commuter Rail Division of the Regional Transportation Authority of Northeast Illinois. After the Closing Date (see "Joint Acquisition of Conrail" on page 44), Norfolk Southern Railway will operate that portion of Conrail's routes and assets allocated to Conrail's wholly owned subsidiary, Pennsylvania Lines LLC. As a result, Norfolk Southern Railway will provide freight service over lines with significant ongoing Amtrak and commuter passenger operations, and will conduct freight operations over some trackage owned by Amtrak or by commuter entities. NONCARRIER OPERATIONS - NS' noncarrier subsidiaries engage principally in the acquisition and subsequent leasing of coal, oil, gas, and timberlands, the development of commercial real estate, and the leasing or sale of rail property and equipment. In 1998, no such noncarrier subsidiary or industry segment grouping of noncarrier subsidiaries met the requirements for a reportable business segment set forth in Statement of Financial Accounting Standards No. 131. PAGE 12 RAILWAY PROPERTY: EQUIPMENT - As of Dec. 31, 1998, NS owned or leased the following units of equipment:
Number of Units ---------------------------- Capacity Owned* Leased Total of Equipment ----- ------ ----- ------------ Type of Equipment - ----------------- Locomotives: (Horsepower) Multiple purpose 2,094 0 2,094 6,798,350 Switching 110 0 110 162,300 Auxiliary units 60 0 60 0 ------ ------ ------ --------- Total locomotives 2,264 0 2,264 6,960,650 ====== ====== ====== ========= Freight Cars: (Tons) Hopper 20,668 1,302 21,970 2,306,342 Box 19,047 758 19,805 1,559,165 Covered Hopper 12,154 2,231 14,385 1,568,234 Gondola 28,236 1,053 29,289 3,150,884 Flat 4,250 858 5,108 383,976 Caboose 197 0 197 0 Other 1,027 0 1,027 75,234 ------ ------ ------ --------- Total freight cars 85,579 6,202 91,781 9,043,835 ====== ====== ====== ========= Other: Work equipment 6,275 3 6,278 Vehicles 3,546 0 3,546 Highway trailers and containers 1,901 2,548 4,449 RoadRailers(RT) 329 0 329 Miscellaneous 1,495 1,798 3,293 ------ ------ ------ Total other 13,546 4,349 17,895 ====== ====== ======
* Includes equipment leased to outside parties and equipment subject to equipment trusts, condition sale agreements, and capitalized leases. PAGE 13 The following table indicates the number and year of purchase for locomotives and freight cars owned at Dec. 31, 1998:
Year Built ------------------------------------------------------- 1988- 1982- 1981 & 1998 1997 1996 1995 1994 1993 1987 Before Total ---- ---- ---- ---- ---- ---- ---- ------ ----- Locomotives: Number of units 116 120 119 125 25 288 396 1,075 2,264 Percent of fleet 5 5 5 6 1 13 17 48 100% Freight cars: Number of units 1,105 531 787 1,036 780 6,595 2,599 72,146 85,579 Percent of fleet 1 1 1 1 1 8 3 84 100%
The average age of the freight car fleet at Dec. 31, 1998, was 23.6 years. During 1998, 1,338 freight cars were retired. As of Dec. 31, 1998, the average age of the locomotive fleet was 15.4 years. During 1998, 52 locomotives, the average age of which was 20.6 years, were retired. The average age of retired locomotives decreased in 1998 due to: (1) a disproportionate share of early retirements due to casualties and service failures, and (2) retention of older units in anticipation of the Closing Date. Since 1988, about 27,000 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 overage 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 1997, the locomotive bad order ratio had returned to a more historic level. Annual Average Bad Order Ratio --------------------------------
1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Freight Cars (excluding cabooses): NS Rail 4.1% 4.6% 4.8% 5.8% 6.7% Locomotives: NS Rail 4.3% 5.0% 4.5% 4.7% 4.7%
PAGE 14 TRACKAGE - All NS 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 22,382 miles of track maintained as of Dec. 31, 1998, 15,955 were laid with welded rail. The density of traffic on running tracks (main line trackage plus passing tracks) during 1998 was as follows:
Gross tons of freight carried per track mile Track miles of Percent (Millions) running tracks* of total --------------- -------------- -------- 0-4 4,334 27 5-19 5,050 31 20 and over 6,709 42 ------ --- 16,093 100 ====== ===
* Excludes trackage rights. The following table summarizes certain information about NS' track roadway additions and replacements during the past five years:
1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Track miles of rail installed 429 451 401 403 480 Miles of track surfaced 4,715 4,703 4,686 4,668 4,760 New crossties installed (millions) 2.0 2.2 1.9 2.0 1.7
MICROWAVE SYSTEM - The NS 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, 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, Georgia. 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 PAGE 15 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, 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 has under way a project to review, and modify as necessary, computer and other systems for Year-2000 compliance. See discussion of Year-2000 compliance efforts on page 46 in Part II, Item 7, "Management's Discussion and Analysis." OTHER - The railroads have extensive facilities for support of 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 $725 million as of Dec. 31, 1998, and $601 million at Dec. 31, 1997. CAPITAL EXPENDITURES - Capital expenditures for road, equipment, and other property for the past five years were as follows (including capitalized leases): Capital Expenditures ----------------------------------------
1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (In millions of dollars) Road $ 612 $ 599 $ 438 $ 386 $ 385 Equipment 442 306 326 338 240 Other property 6 24 25 33 82 ------ ------ ------ ------ ------ Total $1,060 $ 929 789 $ 757 $ 707 ====== ====== ====== ====== ======
Capital spending and maintenance programs are and have been designed to assure the ability to provide safe, efficient, and reliable transportation services. For 1999, NS has budgeted $1.07 billion of capital spending, of which $300 million are initial outlays for facilities and equipment related to the Conrail transaction. Capital spending is expected to remain at historically high levels, as projects related to the operation of Conrail's routes and assets will continue after the Closing Date. ENVIRONMENTAL MATTERS - Compliance with federal, state, and local laws and regulations relating to the protection of the environment is a principal NS goal. To date, such compliance has not affected materially NS' capital additions, earnings, liquidity, or competitive position. See the discussion of "Environmental Matters" on page 48 in Part II, Item 7, "Management's Discussion and Analysis," and in Note 16 to the Consolidated Financial Statements on page 80. PAGE 16 EMPLOYEES - NS employed an average of 24,300 employees in 1998, compared with an average of 25,817 (which includes 2,407 NAVL employees) in 1997. The approximate average cost per employee during 1998 was $49,700 in wages and $17,600 in employee benefits. Approximately 85 percent of NS' railroad employees are represented by labor unions under collective bargaining agreements with 15 different labor organizations. The agreements currently in force will remain in effect through Dec. 31, 1999, and thereafter until new agreements are reached or until the Railway Labor Act's procedures are exhausted. GOVERNMENT REGULATION - In addition to environmental, safety, securities, and other regulations generally applicable to all businesses, NS' railroads are subject to regulation by the STB, which succeeded the ICC on Jan. 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 effectively remove those shipments from regulation as well. Over 80 percent of NS' freight revenues come from either exempt traffic or traffic moving under transportation contracts. Efforts will be made in 1999 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 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, 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. PAGE 17 NS' 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 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 1998. PAGE 18 Executive Officers of the Registrant. - ------------------------------------ Norfolk Southern'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, 1999, relating to these officers: Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ----------------------------------- David R. Goode, 58, Present position since September Chairman, President, and 1992. Chief Executive Officer L. I. Prillaman, 55, Present position since August 1, Vice Chairman and 1998. Served as Executive Vice Chief Marketing Officer President-Marketing from October 1995 to August 1998, and prior thereto was Vice President- Properties. Stephen C. Tobias, 54, Present position since August 1, Vice Chairman and 1998. Served as Executive Vice Chief Operating Officer President-Operations from July 1994 to August 1998, and prior thereto was Senior Vice President- Operations. Henry C. Wolf, 56, Present position since August 1, Vice Chairman and 1998; prior thereto was Chief Financial Officer Executive Vice President-Finance. James C. Bishop, Jr., 62, Present position since March Executive Vice President- 1996; prior thereto was Vice Law President-Law. R. Alan Brogan, 58, Present position since April 1, Executive Vice President- 1998; prior thereto was Executive Corporate Vice President-Transportation Logistics. John F. Corcoran, 58, Present position since August Senior Vice President- 1997; prior thereto was Vice Public Affairs President-Public Affairs. PAGE 19 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ----------------------------------- Jon L. Manetta, 60, Present position since August 1, Senior Vice President- 1998. Served as Vice President- Operations Transportation & Mechanical from December 1995 to August 1998, Vice President-Transportation from June 1994 to December 1995, and prior thereto was Assistant Vice President-Transportation. James W. McClellan, 59, Present position since August 1, Senior Vice President- 1998; prior thereto was Vice Planning President-Strategic Planning. Phillip R. Ogden, 58, Present position since August 1, Senior Vice President- 1998; prior thereto was Vice Engineering President-Engineering. Paul N. Austin, 55, Present position since September 22, Vice President- 1998. Served as Vice President- Human Resources and Personnel and Assistant to Assistant to Chairman Chairman from September 1, 1998, to September 21, 1998, Vice President-Personnel from June 1994 to September 1998, and prior thereto was Assistant Vice President-Personnel. David A. Cox, 63, Present position since December Vice President- 1995; prior thereto was Assistant Properties Vice President-Industrial Development. Timothy P. Dwyer, 49, Present position since August 23, Vice President- 1998. Served as Senior Vice Marketing Services President-Operations of Conrail from June 1998 to August 1998, Senior Vice President-Unit Train Service Group of Conrail from November 1994 to June 1998, and prior thereto was Vice President- Unit Train Service Group of Conrail. Thomas L. Finkbiner, 46, Present position since August 1993. Vice President- Intermodal Nancy S. Fleischman, 51, Present position since August Vice President 1997; prior thereto was Assistant Vice President-Strategic Planning. PAGE 20 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ----------------------------------- Robert C. Fort, 54, Present position since December Vice President- 1996; prior thereto was Assistant Public Relations Vice President-Public Relations. John W. Fox, Jr., 51, Present position since October Vice President- 1995; prior thereto was Assistant Coal Marketing Vice President-Coal Marketing. James L. Granum, 62, Present position since March 1992. Vice President- Public Affairs Lewis D. Hale, Jr., 52, Present position since August 1, Vice President- 1998. Served as Assistant Vice Transportation President-Mechanical from December 1995 to August 1998, and prior thereto was General Manager Western Region. James A. Hixon, 45, Present position since June 1993. Vice President- Taxation Thomas C. Hostutler, 62, Present position since August 16, Vice President- 1998; prior thereto was Senior Internal Audit Assistant Vice President- Corporate Accounting. H. Craig Lewis, 54, Present position since August 1, Vice President- 1998. Served as Regional Vice Corporate Affairs President from August 1997 to August 1998, and prior thereto was a partner in a Pennsylvania law firm. Mark D. Manion, 46, Present position since August 1, Vice President- 1998. Served as General Manager Mechanical Western Region from December 1995 to August 1998, Assistant Vice President-Transportation from July 1994 to December 1995, and prior thereto was Division Superintendent, Lake Division. Harold C. Mauney, Jr., 60, Present position since August 1997. Vice President- Served as Vice President- Public Affairs Operations Planning and Budget from December 1996 to August 1997, and prior thereto was Vice President-Quality Management. PAGE 21 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ----------------------------------- Donald W. Mayberry, 55, Present position since December Vice President- 1995; prior thereto was Vice Research and Tests President-Mechanical. Kathryn B. McQuade, 42, Present position since August 16, Vice President- 1998; prior thereto was Vice Financial Planning President-Internal Audit. Charles W. Moorman, 47, Present position since October Vice President- 1993. Information Technology John P. Rathbone, 47, Present position since December Vice President and 1992. Controller William J. Romig, 54, Present position since April 1992. Vice President and Treasurer John M. Samuels, 55, Present position since January Vice President- 1998. Served as Vice President- Operations Planning Operating Assets of Conrail from and Budget 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. Donald W. Seale, 46, Present position since August 1993. Vice President- Merchandise Marketing Robert S. Spenski, 64, Present position since June 1994; Vice President- prior thereto was Senior Labor Relations Assistant Vice President-Labor Relations. Rashe W. Stephens, Jr., 57, Present position since December Vice President- 1996; prior thereto was Assistant Quality Management Vice President-Public Affairs. Charles J. Wehrmeister, 49, Present position since August 1, Vice President- 1998. Served as Assistant Vice Safety and Environmental President-Safety and Environmental from January 1995 to August 1998, and prior thereto was Division Superintendent, Virginia Division. PAGE 22 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ----------------------------------- William C. Wooldridge, 56, Present position since March 1996; Vice President- prior thereto was General Law Counsel-Corporate. Dezora M. Martin, 51, Present position since April 1995; Corporate Secretary prior thereto was Assistant Corporate Secretary-NS. PAGE 23 PART II Item 5. Market for Registrant's Common Stock and Related - ------ ------------------------------------------------ Stockholder Matters. ------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES STOCK PRICE AND DIVIDEND INFORMATION (Unaudited) The common stock of Norfolk Southern Corporation, owned by 51,727 stockholders of record as of Dec. 31, 1998, is traded on the New York Stock Exchange with the symbol NSC. The following table shows the high and low sales prices and dividends per share, by quarter, for 1998 and 1997, after restatement for the Sept. 5, 1997, three-for-one stock split.
Quarter ---------------------------------------------- 1998 1st 2nd 3rd 4th ---- --- --- --- --- Market price High $ 41-3/4 $ 39-1/16 $ 31-1/2 $ 34-15/16 Low 29-1/2 28-5/8 27-7/16 27-7/16 Dividends per share $ 0.20 $ 0.20 $ 0.20 $ 0.20 1997 1st 2nd 3rd 4th ---- --- --- --- --- Market price High $ 32-3/4 $ 35-1/8 $ 38-1/8 $ 34-7/8 Low 28-3/8 28-3/16 31-9/16 29-7/16 Dividends per share $ 0.20 $ 0.20 $ 0.20 $ 0.20
PAGE 24 Item 6. Selected Financial Data. - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1995 - 1998 Page One
1998 1997(1) 1996 1995 ---- ---- ---- ---- ($ in millions, except per share amounts) RESULTS OF OPERATIONS: Railway operating revenues $ 4,221 $ 4,223 $ 4,101 $ 4,012 Railway operating expenses 3,169 3,010 2,936 2,950 --------- --------- --------- --------- Income from railway operations 1,052 1,213 1,165 1,062 Other income - net 309 170 117 140 Interest expense on debt 516 385 116 113 --------- --------- --------- --------- Income from continuing operations before income taxes 845 998 1,166 1,089 Provision for income taxes 215 299 413 391 --------- --------- --------- --------- Income from continuing operations before accounting changes 630 699 753 698 Discontinued operations (2) 104 22 17 15 Cumulative effect of accounting changes -- -- -- -- --------- --------- --------- --------- Net income $ 734 $ 721 $ 770 $ 713 ========= ========= ========= ========= PER SHARE DATA: Net income - Basic $ 1.94 $ 1.91 $ 2.03 $ 1.81 Net income - Diluted $ 1.93 $ 1.90 $ 2.01 $ 1.80 Dividends $ 0.80 $ 0.80 $0.74-2/3 $0.69-1/3 Stockholders' equity at year-end $ 15.61 $ 14.44 $ 13.26 $ 12.47
PAGE 25 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1995 - 1998 Page Two
1998 1997(1) 1996 1995 ---- ---- ---- ---- ($ in millions, except per share amounts) FINANCIAL POSITION: Total assets $ 18,180 $ 17,350 $ 11,234 $ 10,718 Total long-term debt, including current maturities $ 7,624 $ 7,459 $ 1,856 $ 1,638 Stockholders' equity $ 5,921 $ 5,445 $ 4,977 $ 4,829 OTHER: Capital expenditures $ 1,060 $ 929 $ 789 $ 757 Average number of shares outstanding (thousands) 378,749 376,593 379,372 392,987 Number of stockholders at year-end 51,727 50,938 50,748 53,401 Average number of employees: Rail 24,185 23,323 23,361 24,488 Nonrail (2) 115 2,494 2,469 2,456 --------- --------- --------- --------- Total 24,300 25,817 25,830 26,944 ========= ========= ========= =========
All share and per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. NOTES: (1) 1998 and 1997 results include several Conrail-related items. These principally consist of: (1) interest expense of $402 million in 1998 and $264 million in 1997 on debt issued to finance NS' share of the NS/CSX joint acquisition of Conrail stock, (2) NS' equity in earnings of Conrail, net of amortization, of $194 million in 1998 and $117 million in 1997, (3) integration costs of $119 million in 1998 and $3 million in 1997, and (4) credit facility costs including a $77 million charge in 1997 incurred in conjunction with certain now- terminated commitments that provided financing for NS' then- proposed acquisition of all Conrail stock. These items reduced net income by $156 million, or 41 cents per diluted share, in 1998, and $107 million, or 29 cents per diluted share, in 1997. (2) In 1998, NS sold all the common stock of its motor carrier subsidiary, North American Van Lines, Inc. (NAVL), for $207 million, and recorded a $90 million pretax ($105 million, or 28 cents per diluted share, after-tax) gain. Accordingly, NAVL's results of operations, financial position, and cash flows are presented as "Discontinued operations." PAGE 26 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1991 - 1994 Page One
1994 1993(3) 1992 1991(4) ---- ---- ---- ---- ($ in millions, except per share amounts) RESULTS OF OPERATIONS: Railway operating revenues $ 3,918 $ 3,746 $ 3,777 $ 3,654 Railway operating expenses 2,875 2,831 2,851 3,345 --------- --------- --------- --------- Income from railway operations 1,043 915 926 309 Other income - net 86 135 97 131 Interest expense on debt 101 98 109 99 --------- --------- --------- --------- Income from continuing operations before income taxes 1,028 952 914 341 Provision for income taxes 372 370 328 112 --------- --------- --------- --------- Income from continuing operations before accounting changes 656 582 586 229 Discontinued operations (2) 12 (33) (28) (199) Cumulative effect of accounting changes -- 223 -- -- --------- --------- --------- --------- Net income $ 668 $ 772 $ 558 $ 30 ========= ========= ========= ========= PER SHARE DATA: Net income - Basic $ 1.63 $ 1.85 $ 1.31 $ 0.07 Net income - Diluted $ 1.62 $ 1.83 $ 1.30 $ 0.07 Dividends $ 0.64 $ 0.62 $ 0.60 $0.53-1/3 Stockholders' equity at year-end $ 11.73 $ 11.12 $ 10.05 $ 9.55
PAGE 27 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1991 - 1994 Page Two
1994 1993(3) 1992 1991(4) ---- ---- ---- ---- ($ in millions, except per share amounts) FINANCIAL POSITION: Total assets $ 10,403 $ 10,301 $ 10,188 $ 9,959 Total long-term debt, including current maturities $ 1,619 $ 1,594 $ 1,648 $ 1,387 Stockholders' equity $ 4,685 $ 4,621 $ 4,233 $ 4,093 OTHER: Capital expenditures $ 707 $ 639 $ 628 $ 688 Average number of shares outstanding (thousands) 408,904 418,243 424,378 443,276 Number of stockholders at year-end 52,442 51,884 51,200 53,725 Average number of employees: Rail 24,710 25,531 25,650 27,366 Nonrail 2,458 3,773 4,485 4,586 --------- --------- --------- --------- Total 27,168 29,304 30,135 31,952 ========= ========= ========= =========
All share and per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. NOTES: (3) 1993 results include an increase in the provision for income taxes reflecting a 1% increase in the federal income tax rate, which reduced net income by $54 million, or 13 cents per diluted share. "Discontinued operations" includes a $50 million pretax restructuring charge for the disposition of two NAVL businesses. Net income also reflects two accounting changes, the cumulative effect of which increased 1993 net income by $223 million, or 53 cents per diluted share: a change in accounting for income taxes increased net income by $467 million, with a corresponding reduction in deferred taxes, and changes in accounting for postretirement and postemployment benefits decreased net income by $244 million. (4) 1991 operating expenses include a $483 million special charge primarily for labor force reductions. "Discontinued operations" includes a $197 million charge primarily for the write-down of the goodwill portion of NS' investment in NAVL. These charges reduced net income by $498 million, or $1.12 per diluted share. PAGE 28 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1988 - 1990 Page One
1990 1989 1988 ---- ---- ---- ($ in millions, except per share amounts) RESULTS OF OPERATIONS: Railway operating revenues $ 3,786 $ 3,694 $ 3,617 Railway operating expenses 2,969 2,864 2,680 --------- --------- --------- Income from railway operations 817 830 937 Other income - net 142 155 103 Interest expense on debt 78 50 53 --------- --------- --------- Income from continuing operations before income taxes 881 935 987 Provision for income taxes 316 323 358 --------- --------- --------- Income from continuing operations before accounting changes 565 612 629 Discontinued operations (2) (9) (6) 6 Cumulative effect of accounting changes -- -- -- --------- --------- --------- Net income $ 556 $ 606 $ 635 ========= ========= ========= PER SHARE DATA: Net income - Basic $ 1.14 $ 1.16 $ 1.17 Net income - Diluted $ 1.14 $ 1.15 $ 1.17 Dividends $0.50-2/3 $ 0.46 $ 0.42 Stockholders' equity at year-end $ 10.52 $ 10.15 $ 9.58
PAGE 29 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1988 - 1990 Page Two
1990 1989 1988 ---- ---- ---- ($ in millions, except per share amounts) FINANCIAL POSITION: Total assets $ 10,326 $ 10,049 $ 9,845 Total long-term debt, including current maturities $ 1,122 $ 838 $ 778 Stockholders' equity $ 4,912 $ 5,169 $ 5,153 OTHER: Capital expenditures $ 605 $ 620 $ 482 Average number of shares outstanding (thousands) 486,284 523,109 543,113 Number of stockholders at year-end 56,187 61,630 64,974 Average number of employees: Rail 28,697 29,667 30,330 Nonrail 4,584 4,645 4,209 --------- --------- --------- Total 33,281 34,312 34,539 ========= ========= =========
All share and per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. PAGE 30 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Table of Graphs Included with the Eleven-Year Financial Review The following financial information appears as two (2) separate graphs with the Eleven-Year Financial Review in the 1998 Norfolk Southern Corporation Annual Report to Stockholders. All per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split.
(Percent) 1993 1994 1995 1996 1997 1998 - --------- ---- ---- ---- ---- ---- ---- RETURN ON AVERAGE STOCKHOLDERS' EQUITY 13.7%* 14.4% 15.4%* 15.7% 13.8%* 12.9* * 1993 excludes the cumulative effect of required accounting changes and the prior years' effect of a federal tax rate increase. 1995 excludes a charge for an early retirement program. 1997 and 1998 include Conrail-related items. Return on average stockholders' equity, excluding Conrail-related items, would have been 15.7% in 1997 and 15.2% in 1998. (Dollars) 1993 1994 1995 1996 1997 1998 - --------- ---- ---- ---- ---- ---- ---- DIVIDENDS PER SHARE $0.62 $0.64 $0.69-1/3 $0.74-2/3 $0.80 $0.80
Since 1983, NS' first full year after consolidation, the annual dividend has grown at a compound annual rate of 6.5%. Stockholders received a dividend yield of 2.5% in 1998, compared with less than 1.2% for all S&P 500 stocks. PAGE 31 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES 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 and Notes beginning on page 54 and the Eleven-Year Financial Review beginning on page 24. SUMMARIZED RESULTS OF OPERATIONS 1998 Compared with 1997 - ----------------------- Net income in 1998 was $734 million, an increase of 2%, and includes a $105 million gain from the sale of NS' former motor carrier subsidiary, North American Van Lines, Inc. (NAVL) (see Note 3 on page 66). Income from continuing operations, which excludes both NAVL's results of operations prior to its sale and the gain from its sale, was $630 million, a decrease of 10%. Included in both of these results were Conrail-related items that are estimated to have reduced income from continuing operations by $156 million in 1998 and $107 million in 1997 (see Note 2 on page 62). Excluding the effects of these items, income from continuing operations would have been down 2%, attributable to a decline in income from railway operations. Diluted earnings per share of $1.93 were up 2%. Diluted earnings per share from continuing operations of $1.65 were down 10%. Excluding the effects of the Conrail-related items, diluted earnings per share from continuing operations would have been down 3%. 1997 Compared with 1996 - ----------------------- Net income in 1997 was $721 million, a decrease of 6%. Income from continuing operations was $699 million, down 7%. Excluding the effects of Conrail-related items, net income would have been up 8% over 1996's record result, and income from continuing operations would have been up 7%. Income from railway operations increased 4%. Increased nonoperating income (see Note 4 on page 67) and a lower effective income tax rate (see Note 5 on page 67) also contributed to the improvement in net income. Diluted earnings per share of $1.90 were down 5%. Diluted earnings per share from continuing operations of $1.84 were down 6%. Excluding the effects of the Conrail-related items, both earnings per share amounts would have been up 9% over 1996's record result. INCOME FROM RAILWAY OPERATIONS (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998* 1997* 1996 1995* 1994 1993 ---- ---- ---- ---- ---- ---- $1,052 $1,213 $1,165 $1,096 $1,043 $ 915
Excluding Conrail-related items, income from railway operations decreased 4% in 1998, compared with the record result of 1997. *1998 and 1997 include Conrail-related integration expenses. Excluding such expenses, income from railway operations would have been $1,171 million in 1998 and $1,216 million in 1997. 1995 excludes a $34 million charge for an early retirement program. PAGE 32 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- DETAILED RESULTS OF OPERATIONS Railway Operating Revenues - -------------------------- Railway operating revenues were $4.2 billion in 1998, compared with $4.2 billion in 1997 and $4.1 billion in 1996. The following table presents a three-year comparison of revenues by market group. RAILWAY OPERATING REVENUES BY MARKET GROUP
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Coal $1,252 $1,301 $1,305 General merchandise: Chemicals 574 585 560 Automotive 566 492 489 Paper/clay/forest 534 539 513 Agriculture/consumer/ government 383 391 393 Metals/construction 373 368 354 ------ ------ ------ General merchandise 2,430 2,375 2,309 Intermodal 539 547 487 ------ ------ ------ Total $4,221 $4,223 $4,101 ====== ====== ======
In 1998, revenue increases in the automotive and metals and construction groups were offset by revenue decreases in the remaining market groups. As shown in the following table, volume gains were more than offset by lower revenue per unit. However, almost all of the volume increase and revenue per unit decrease reflect the effects of the new mixing centers (see the discussion under the "Automotive" caption, below). Revenues for the remaining market groups declined $76 million, $58 million of which resulted from lower traffic volume and $18 million of which resulted from lower revenue per unit. In 1997, revenues increased or remained steady for all market groups, and volume gains produced all of the revenue improvement. RAILWAY OPERATING REVENUE VARIANCE ANALYSIS Increases (Decreases)
($ in millions) 1998 vs. 1997 1997 vs. 1996 --------------- ------------- ------------- Volume $ 114 $ 130 Revenue per unit (116) (8) ----- ----- Total $ (2) $ 122 ===== =====
Following the Closing Date of the Conrail transaction (see "Joint acquisition of Conrail," on page 44), total railway operating revenues are expected to increase by about one-half: coal revenues are expected to increase by about one-third; general merchandise revenues are expected to increase by about one-half; and intermodal revenues are expected to about double. PAGE 33 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- COAL tonnage was unchanged in 1998, but revenues decreased 4%; an increase in utility tonnage, especially shorter-haul (lower average revenue) traffic, offset decreases in longer-haul (higher average revenue) export and domestic metallurgical traffic. Coal revenues represented 30% of total railway operating revenues in 1998, and 89% of coal shipments originated on NS' lines. In 1997, coal tonnage increased 3%, primarily due to increased export and utility tonnage; however, revenues decreased slightly as a result of shorter hauls. TOTAL COAL, COKE, AND IRON ORE TONNAGE
(In millions of tons) 1998 1997 1996 --------------------- ---- ---- ---- Utility 83 76 75 Export 25 29 27 Steel 18 21 20 Other 8 8 8 --- --- --- Total 134 134 130 === === ===
Utility coal traffic increased 9% in 1998, due to rising electricity production in NS' service area, the return of some traffic to rail, and increased business from several customers. In 1997, utility coal traffic increased 2%. Several of NS' utility customers 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. The near-term outlook for utility coal remains positive. U.S. demand for electricity continues to increase at a rate greater than generation capacity is being added, and coal-fired generation continues to be the cheapest marginal source of electricity. Increased price competition resulting from utility deregulation could cause utilities to seek to reduce costs and increase plant utilization. These factors, coupled with excess capacity at certain low-cost, coal- fired generating plants, could provide an opportunity for utility coal volume growth. However, competitive pressures on utilities to reduce costs also could put price pressure on generation source fuels, including NS-delivered coal. Moreover, many of the mines served by NS produce coals that satisfy both the Phase I and Phase II requirements of the Clean Air Act Amendments. In addition, an increasing bank of sulfur dioxide allowances held by many NS-served utilities should continue to provide a market for other NS-served mines for nearly a decade. However, several recently adopted or proposed environmental regulations could increase the cost of coal-fired generation. After the Closing Date, NS will gain direct access to 27 utility plants and to mines with an abundant supply of low-cost, high-quality steam coal located on Conrail lines. Export coal tonnage decreased 14% in 1998, due to weak economies in Asia and a strong U.S. dollar. The dollar gained 20% or more compared with the currencies of countries (such as Australia, South Africa, and Indonesia) that provide the primary competition for U.S. export coal. A significant decline in Asian demand for coal created supplies that competed at deeply discounted prices with U.S. export coal in Europe and South America. Steam coal exports declined to 0.4 million tons in 1998, compared with 1.7 million tons in 1997. U.S. low-sulfur coals were not price-competitive due to the strength of the dollar. In addition, natural gas has displaced much of the coal-fired generation in Europe. PAGE 34 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- In 1997, export coal tonnage increased 7%, reaching the highest level since 1992. Higher metallurgical coal demand from NS-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. The same factors that led to the decrease in 1998 volume are expected to continue in 1999. The Asian recession in steel production showed signs of moving into Europe in late 1998. In addition, competition from Australian coal is expected to intensify, and U.S. coal exports may drop further if demand decreases for blast furnace raw materials in Western Europe. Finally, the recent Kyoto Protocol on climate change, if adopted, could put added downward pressure, worldwide, on coal-fired power demand. Conrail and its coal-producing customers are well established in the export steam coal market, which might help NS achieve greater levels of participation. Furthermore, current NS and Conrail coal exporters should benefit from being able to ship their coal single- line through both Baltimore, Md., and Norfolk, Va. Steel coal domestic traffic declined 14% in 1998, due to plant closures, reduced blast furnace operations, and the continuation of aggressive producer pricing of higher volatile metallurgical coals not located on NS' lines. In 1997, steel coal domestic traffic increased 5%, due to growth in coke and iron ore shipments that more than offset decreased metallurgical coal shipments. Steel coal domestic traffic is expected to be adversely affected by competition in domestic and foreign steel markets. Producers in weak markets such as Russia, Japan, and Brazil are exporting much of their steel at low prices to the United States and Canada. Furthermore, with the reduction in 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 in the long term. However, alternative uses for steel coal are increasing, and NS continues to pursue opportunities for the movement of noncoking coal used in alternative iron-making technologies. With its access to the Northeast after the Closing Date, NS expects to increase its participation in shipments of raw materials for the steel industry by gaining single-line access to most domestic integrated steel plants and merchant coke plants. Other coal traffic, primarily steam coal shipped to manufacturing plants, was largely unchanged in 1998 and 1997. COAL (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- Export $ 314 $ 380 $ 374 $ 353 $ 340 $ 366 Domestic 938 921 931 915 950 873 ------ ------ ------ ------ ------ ------ $1,252 $1,301 $1,305 $1,268 $1,290 $1,239 ====== ====== ====== ====== ====== ======
Revenues decreased 4% in 1998 due to lower export traffic. Total tonnage handled in 1998 was equal to 1997, as increased utility coal tonnage offset decreased export and steel coal tonnage. This group includes utility coal, export coal, domestic metallurgical coal, industrial coal, coke, and iron ore. PAGE 35 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- GENERAL MERCHANDISE traffic volume increased 5%, and revenues increased 2%, in 1998, driven by higher automotive revenues. In 1997, both general merchandise traffic volume and revenues increased 3%, as all market groups, except the agriculture, consumer products, and government group posted revenue gains. Chemicals traffic volume decreased 1%, and revenues decreased 2%, in 1998, the first decline since 1989. The weak economies in Asia and softness in certain domestic markets adversely affected shipments of products for the vinyl, polyester, and pulp markets. In addition, nationwide rail service problems, particularly early in the year, caused some customers to divert traffic to truck and barge. However, several NS-served facilities with new and expanded plant capacity increased shipments of plastics and petroleum products, somewhat offsetting these negative effects. NS also increased traffic through its Thoroughbred Bulk Transfer (TBT) facilities that handle chemicals and bulk commodities to customers not located on its lines. In 1997, chemicals traffic volume increased 5%, 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 is expected to rebound in 1999, supported by plant expansions, expected increases in U.S. chemical production, and extended market reach made possible by new TBT facilities. After the Closing Date, NS will gain a competitive route to northern New Jersey, where Conrail currently originates or terminates annually about 40,000 carloads of chemicals. CHEMICALS (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 574 $ 585 $ 560 $ 541 $ 538 $ 501
Revenues decreased $11 million, or 2%, in 1998, the only decline this decade. This group includes fertilizers, sulfur, and related chemicals, petroleum products, chlorine and bleaching compounds, plastics, industrial chemicals, chemical wastes, and municipal wastes. Automotive carloads increased 35%, and revenues increased 15%, in 1998, exceeding the record levels achieved in 1997. Finished vehicles led the growth, as carloads increased 54% and revenues increased 19%, primarily due to new business through the Ford mixing centers. Full production volume at the Mercedes-Benz plant in Vance, Ala., and the Toyota minivan line at Georgetown, Ky., also contributed to the increases. Vehicle parts traffic volume and revenues remained steady despite the effects of the mid-year strike at General Motors. A substantial portion of the 1998 increase in carloads resulted from the nature of the mixing centers. Previously, carloads of vehicles went from plant to distribution center, where vehicles were classified and loaded onto trucks for transport to dealers. Now, carloads of vehicles, mostly in unit-train service, go from plant to the mixing centers, where vehicles are sorted by destination and loaded onto other trains in a mix suitable for direct transport to dealers. As a result, carload counts have been increased: each vehicle that is handled through the centers arrives on one carload and departs on another carload. This hub-and-spoke method of distribution is intended to improve Ford's delivery logistics and reduce its inventory costs and order-to-delivery times. PAGE 36 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- In 1997, automotive traffic volume increased 2%, and revenues rose 1%. A 12% increase in auto parts traffic volume more than offset a 3% decline in vehicles traffic that resulted from industrywide railcar shortages, rail traffic congestion, unexpected downtime at certain plants, and modest sales for some of the models transported by NS. The automotive market group is expected to continue to experience growth in 1999, supported by the Ford mixing centers, a new Toyota truck assembly plant at Princeton, Ind., two new just-in-time rail parts distribution facilities, and the introduction of a new BMW sport utility vehicle to be produced at Greer, S.C. After the Closing Date, NS will gain direct access to 15 assembly plants, and NS will serve 32 of the 58 rail-served assembly plants in the United States. NS' network of auto distribution terminals will increase from 26 to 38. AUTOMOTIVE (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 566 $ 492 $ 489 $ 449 $ 429 $ 426
Revenues increased $74 million, or 15%, in 1998. Since 1993, revenues have increased $140 million, or 33%. This group includes finished vehicles for BMW, DaimlerChrysler, Ford, General Motors, Honda, Isuzu, Jaguar, Land Rover, Mazda, Mitsubishi, Nissan, Saab, Subaru, Suzuki, Toyota, and Volkswagen, and auto parts for Ford, DaimlerChrysler, General Motors, and Toyota. Since 1988, eight of 11 major new automotive plants in the East have located on NS lines. Paper, clay, and forest products traffic volume decreased 3%, and revenues declined 1%, in 1998. Traffic volume increases in the first three quarters were offset by a sudden and pronounced weakness in the paper industry in the fourth quarter, adversely affecting shipments of paper, wood fiber, and kaolin clay. Decreased domestic and foreign demand resulted in both widespread paper mill downtime late in the year and indefinite closure of several NS-served paper mills. Shipments of lumber and wood products partially offset the effects of these declines, posting record carloads and revenues due to continued strong demand from the housing construction industry. In 1997, paper, clay, and forest products traffic volume rose 4%, and revenues increased 5%. Shipments of wood chips increased, as did lumber traffic, supported by demand for southern yellow pine to replace timber from Pacific Northwest sources. Kaolin clay traffic also increased, and shipments of paper products were up slightly. The paper industry is expected to continue to experience reduced demand in 1999, due to the weak economies in Asia and consolidation within the industry. Moreover, growth in lumber is expected to slow, as housing starts are forecast to decline from the record levels of 1998. After the Closing Date, NS will have direct access to 33 paper mills and 26 lumber reload centers located on Conrail lines. PAGE 37 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- PAPER, CLAY, AND FOREST PRODUCTS (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 534 $ 539 $ 513 $ 537 $ 522 $ 522
Revenues decreased $5 million, or 1%, in 1998. This group includes lumber and wood products, pulpboard and paper products, wood fibers, woodpulp, scrap paper, and clay. NS serves 50 paper mills, more than 30 lumber reload centers, and numerous general commodity warehouses. Agriculture, consumer products, and government traffic volume declined 3%, and revenues decreased 2%, in 1998. Weak export and soybean meal markets adversely affected shipments. Sweeteners volume and revenues declined, as a strong beet sugar crop negatively affected cane sugar shipments out of the South. Increased revenues from grain, soybeans, and feed ingredients from the longer-haul Southeast feed and corn processing markets somewhat offset the effects of the declines. In 1997, agriculture, consumer products, and government traffic volume decreased 3%, and revenues decreased 1%. Most of the decline resulted from decreases in the bulk agriculture commodities. Weak export markets, declines in corn shipments to processors, and an unfavorable soybean market resulting from higher prices led to traffic declines that began early in the year. Moderate growth is expected in 1999; low prices and an abundant supply should continue to increase domestic consumption of corn for feed and processing. In addition, moderating worldwide competition should lead to a small recovery in the U.S. export market. After the Closing Date, NS expects to increase its direct-line accessed grain elevator capacity by about 10%. AGRICULTURE, CONSUMER PRODUCTS, AND GOVERNMENT (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 383 $ 391 $ 393 $ 394 $ 380 $ 357
Revenues decreased $8 million, or 2%, in 1998. This group includes grain, soybeans, animal feed, feed ingredients, sweeteners, food oils, flour, beverages, canned goods, consumer products, and items for the military. Metals and construction traffic volume was unchanged, and revenues increased 1%, in 1998. The strong performance in the metals market during 1997 was repeated in the first half of 1998, due to improved efficiency at integrated mills and the continued growth of new mini-mills and steel processors in NS' service territory. However, the domestic metals market weakened in the second half of 1998, due to an increase in the supply of lower-priced, imported steel. Construction traffic and revenues increased, due to increased highway and housing construction activity in the Southeast. In 1997, both traffic and revenues in metals and construction increased 4%. Construction traffic benefited from increased highway building activity in the Southeast. Metals traffic increased due to gains in domestic sheet steel movements resulting from record steel production and increased pipe shipments. PAGE 38 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- The metals and construction market group is expected to grow moderately in 1999. Production at new industries locating on NS' lines is expected to mitigate traffic losses attributable to imports of steel and scrap metal. Traffic is expected to continue to benefit from increased highway construction activity. After the Closing Date, NS will have direct access to 43 steel production facilities and 38 metal distribution centers located on Conrail lines. METALS AND CONSTRUCTION (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 373 $ 368 $ 354 $ 349 $ 330 $ 309
Revenues increased $5 million, or 1%, in 1998, marking the seventh consecutive year of growth. Since 1993, revenues have increased $64 million, or 21%. This group includes steel, aluminum products, machinery, scrap metals, cement, aggregates, bricks, and minerals. INTERMODAL traffic volume decreased 2%, and revenues decreased 1%, in 1998. The decline, which was the first in 12 years, resulted from a service network redesign that was implemented in August. The redesign is expected to improve on-time performance and eliminate complexity, thereby positioning NS to achieve the traffic volume anticipated from the Conrail transaction. As a result, trailer traffic volume declined 16%, but this decrease was largely offset by increases in both container traffic volume and revenues (respectively, 2% and 5%) and Triple Crown Services Company (TCSC) traffic volume and revenues (respectively, 5% and 9%). NS' intermodal revenues includes rail-haul services performed for TCSC (a partnership in which subsidiaries of NS and Conrail are equal partners). After the Closing Date, NS expects to gain control of TCSC and, therefore, include TCSC's results in its consolidated financial statements. In 1997, intermodal traffic volume increased 11%, and revenues increased 12%, each setting a record. Capacity expansions on major terminals and trains, combined with a healthy domestic and international economy, enabled NS to achieve the third year of double- digit growth in four years. Volume increases were balanced, and NS outperformed the market in all intermodal traffic segments. Container traffic volume increased 12%, supported by new steamship business under contract. Intermodal revenues are expected to increase in 1999, supported by the redesigned service network, expanded terminal capacity, and extension of NS' double-stack services. After the Closing Date, NS will gain direct-line access to the Northeast consumer markets and most major East Coast ports. This, along with the inclusion of TCSC's revenues in NS' reported revenues, is expected nearly to double NS' intermodal revenues. PAGE 39 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- INTERMODAL (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 539 $ 547 $ 487 $ 474 $ 429 $ 392
Revenues decreased $8 million, or 1%, in 1998, the first decline in 12 years. This group handles trailers, domestic and international containers, Triple Crown equipment, and equipment for intermodal marketing companies, international steamship lines, truckers, and other shippers. Railway Operating Expenses - -------------------------- Railway operating expenses increased 5% in 1998, while carloadings increased 1%. The expense increase was mostly attributable to Conrail-related integration expenses, and additional expenses, including start-up costs, related to the Ford mixing centers. Railway operating expenses increased only 3% in 1997, despite a 5% increase in traffic volume. As a result, the railway operating ratio, which measures the percentage of railway revenues consumed by railway expenses, was 75.1% in 1998, compared with the record-low 71.3% in 1997 and 71.6% in 1996. NS' railway operating ratio continues to be the best among the major railroads in the United States. In addition to reflecting Conrail-related integration expenses, the railway operating ratio in 1998 was also adversely affected by a change in traffic mix related to growth in automotive traffic coupled with the change in coal traffic mix. Automotive traffic includes some of NS' most time-sensitive and resource-intensive business, requiring more trains, increased handling costs, and higher equipment rents. The railway operating ratio is expected to be even higher in 1999, due to expenses associated with the portion of Conrail's routes and assets that NS will operate, as well as additional integration expenses, prior to and after the Closing Date, and because the Closing Date is later than previously anticipated. The following table shows the changes in railway operating expenses summarized by major classifications. RAILWAY OPERATING EXPENSES Increases (Decreases)
($ in millions) 1998 vs. 1997 1997 vs. 1996 --------------- ------------- ------------- Compensation and benefits $ 87 $ 5 Materials, services, and rents 121 61 Depreciation 16 13 Diesel fuel (53) (6) Casualties and other claims (28) -- Other 16 1 ----- ----- Total $ 159 $ 74 ===== =====
Compensation and benefits, which represents about half of total railway operating expenses, increased 6% in 1998, and only slightly in 1997. PAGE 40 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- In 1998, higher wages and salaries -- results of additional staffing in anticipation of the Closing Date and union wage increases, including the effect of an increase in the BLE bonus fund -- were offset somewhat by lower accruals for pension benefits, due to favorable investment returns on pension plan assets. Also contributing to the increase were new FRA train inspection requirements and a higher Railroad Unemployment Tax rate. In 1997, higher wages resulting from union 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. To a large extent, productivity improvements and train efficiencies offset the effects of the higher traffic volume. 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 18% in 1998 and 10% in 1997. The 1998 increase was principally due to Conrail-related integration costs and higher-than-anticipated mixing center costs associated with the increase in automotive traffic. Higher equipment rents and locomotive repair expenses also contributed to the increase. The 1997 increase resulted primarily from higher volume-related intermodal expenses, as well as from higher equipment rents, partially a result of a change in the mix of received versus forwarded traffic. Higher locomotive repair expenses and costs for contract programmers to make computer processes Year-2000 compliant (see "Year-2000 compliance" discussion under "Other matters," below) also contributed to the increase. Equipment rents, which represent the cost to NS of using equipment (mostly freight cars) owned by other railroads or private owners, less the rent paid to NS for the use of its equipment, were up 18% in 1998 and 11% in 1997. The 1998 increase was due to: (1) rents for equipment needed to support the increase in automotive traffic; (2) reduced rents received from the leasing of owned locomotives; and (3) increased lease expenses for equipment obtained to meet anticipated demand after the Closing Date. These increases were somewhat offset by higher receipts on NS-owned freight cars and auto racks. 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. Locomotive repair costs increased in 1998 and 1997 due to the higher traffic levels and an increase in the average number of locomotives in service, reflecting retention of older units. Depreciation expense (see Note 1, "Properties," on page 61 for NS' depreciation policy) was up 4% in 1998 and 3% in 1997. Increases in both years were due to property additions, reflecting recent substantial levels of capital spending. Diesel fuel costs declined 23% in 1998 and 3% in 1997. The 1998 decrease was due to a 26% drop in the average price per gallon, which was the lowest since 1988, somewhat offset by a 3% increase in consumption. The 1997 decrease was due to the net effect of a 5% drop in the average price per gallon and a 3% increase in consumption. PAGE 41 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Casualties and other claims expenses (including the estimates of costs related to personal injury, property damage, and environmental matters) decreased 23% in 1998 and were unchanged in 1997. The 1998 decline was due to cost recoveries from third parties and lower accruals for environmental remediation costs and to reduced personal injury expenses. In 1997, a reduction in personal injury expenses was offset by higher freight damage costs. The largest component of casualties and other claims expense is personal injury costs. Although NS experienced an increase in the number of reportable employee injuries in 1998, the number of claims declined, compared with 1997. Costs associated with employee and third- party injuries were lower in 1998, continuing the favorable trend experienced in recent years. However, these improvements were partially offset by an increase in costs related to so-called "occupational" injuries. Within the past decade, there has been a dramatic increase in the number of these types of claims. In 1998, almost two-thirds of the total employee injury cases settled and one- third of settlement payments made were related to occupational claims. These claims do not generally relate to a specific accident or event, but rather result from a claimed exposure over time to some condition of employment. As a result, many of these claims are asserted by employees who have retired or who no longer work for NS. NS continues to work actively to eliminate all accidents and exposure risks and to control 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 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 nonrail competitors and other employers 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 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. In 1998, in recognition of ever-increasing jury awards, NS elected to increase the limit of liability insurance maintained, which did not result in a significant increase in premium expense. Other expenses increased 11% in 1998 and 1% in 1997. The 1998 increase was principally due to: (1) higher property and other taxes, due to the effects of favorable adjustments in prior years resulting from settlements with taxing authorities, and (2) increased travel expenses, mostly attributable to planning for the Conrail transaction. Income Taxes - ------------ Income tax expense in 1998 was $215 million, for an effective rate of 25%, compared with an effective rate of 30% in 1997 and 35% in 1996. Excluding the equity in Conrail's after-tax earnings, the effective rate was 33% in 1998 and 34% in 1997. The effective rates in all three years were below the statutory federal and state rates -- results of investments in corporate-owned life insurance and in coal-seam gas properties and of favorable adjustments upon filing the prior year tax returns. In addition, 1998 benefited from favorable adjustments resulting from settlement of federal income tax years 1993-1994. 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. PAGE 42 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Discontinued Operations - ----------------------- Income from discontinued operations includes the $105 million after-tax gain from the sale of NAVL (see Note 3 on page 66). Motor carrier operations in 1998 (January 1 through March 28) produced a $1 million loss; these same operations produced income of $22 million in 1997 and $17 million in 1996. FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES Cash provided by operating activities, NS' principal source of liquidity, decreased $260 million, or 23%, in 1998, and $48 million, or 4%, in 1997. Since consolidation in 1982, cash provided by operating activities has been sufficient to fund dividend requirements, debt repayments, and a significant portion of capital spending. The decrease in 1998 was principally the result of the decline in income from operations and higher interest payments related to the debt issued in mid-1997 in connection with the Conrail transaction. The decrease in 1997 was primarily the result of higher interest payments. CASH PROVIDED BY OPERATIONS (Shown as a graph in the Annual Report to Stockholders) ($ in millions)
1998* 1997* 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- $ 890 $1,150 $1,198 $1,234 $1,144 $ 875
Cash provided by operations declined in 1998, due to Conrail- related items that consumed a substantial amount of cash. * Excluding Conrail-related items, cash provided by operations would have been $1,240 million in 1998 and $1,241 million in 1997. Cash used for investing activities in 1998, 1997, and 1996 includes costs related to NS' acquisition in 1997 of a 58% economic interest in Conrail, and 1998 includes proceeds from the sale of NAVL. Excluding the investment in Conrail and NAVL sale proceeds, cash used for investing activities increased 8% in 1998 and 50% in 1997. Property additions account for most of the recurring spending in this category. The following tables show capital spending, track, and equipment statistics for the past five years. Capital expenditures include amounts relating to capitalized leases, which are excluded from the Consolidated Statements of Cash Flows (see Note 8 "Capital lease obligations" on page 72). CAPITAL EXPENDITURES (Also shown as a graph in the Annual Report to Stockholders)
($ in millions) 1998 1997 1996 1995 1994 --------------- ---- ---- ---- ---- ---- Road $ 612 $ 599 $ 438 $ 386 $ 385 Equipment 442 306 326 338 240 Other property 6 24 25 33 82 ------ ------ ------ ------ ------ Total $1,060 $ 929 $ 789 $ 757 $ 707 ====== ====== ====== ====== ======
NS' capital expenditures have increased 66% since 1993 -- demonstrating commitment to make the investments necessary to support safe, efficient operations and revenue growth. PAGE 43 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Capital expenditures increased 14% in 1998 and 18% in 1997. The increase in 1998 was due to significant outlays for roadway projects and equipment in anticipation of the Closing Date. The increase in 1997 was due to higher roadway additions that included construction costs for four Ford mixing centers. TRACK STRUCTURE STATISTICS (CAPITAL AND MAINTENANCE)
1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Track miles of rail installed 429 451 401 403 480 Miles of track surfaced 4,715 4,703 4,686 4,668 4,760 New crossties installed (millions) 2.0 2.2 1.9 2.0 1.7
AVERAGE AGE OF RAILWAY EQUIPMENT
(Years) 1998 1997 1996 1995 1994 ------- ---- ---- ---- ---- ---- Freight cars 23.6 23.0 22.3 22.0 21.9 Locomotives 15.4 15.3 15.4 15.7 15.8 Retired locomotives 20.6 23.3 24.4 22.6 23.6
The 1998 decrease in the average age of retired locomotives resulted from: (1) a disproportionate share of early retirements due to casualties and service failures, and (2) retention of older units in anticipation of the Closing Date. Since 1988, NS has rebodied about 27,000 coal cars, and plans to continue that program. This work, performed at NS' 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 began an orderly disposition of approximately 17,000 freight cars in October 1994. This was completed in 1997, and "Property sales and other transactions" in the 1997 and 1996 Consolidated Statements of Cash Flows includes proceeds from such dispositions. For 1999, NS has budgeted $1.07 billion of capital expenditures, of which $300 million is related to Conrail properties to be operated by NS after the Closing Date. Some of the Conrail-related projects may be constructed by Conrail, which would reduce NS' capital spending. Approximately $650 million of the total projected spending is for roadway projects, including nearly $400 million for rail and bridge program work. Also included are projects to improve signaling and communications; track improvements, such as installation of second main lines and passing sidings to increase line capacity and upgrade service; and new and expanded intermodal and auto distribution terminals. Equipment purchases of almost $390 million include 138 six-axle, high-adhesion locomotives; multi-level automobile racks; high-cubic capacity, 60-foot boxcars for automotive parts; and covered coil cars to handle steel traffic. Also included in equipment spending is $87 million to support ongoing programs to improve equipment utilization, including the coal car rebody program and rebuilding of multi-level automobile racks, high-cubic capacity boxcars, covered hopper cars, and open-top coil cars. Capital expenditures are expected to remain at historically high levels, as projects related to the operation of Conrail's routes and assets will continue after the Closing Date. PAGE 44 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Cash used for financing activities was $252 million in 1998 and included proceeds from the sale of additional commercial paper and equipment trust certificates. Cash provided by financing activities in 1997 included net proceeds from the issuance of $4.3 billion principal amount of unsecured notes and proceeds from the sale of commercial paper to finance NS' share of the cost of acquiring Conrail stock. Also included was $72 million of credit facility costs related to certain now-terminated commitments under credit agreements that were in place to support NS' tender offer for all shares of Conrail. Debt repayments in 1998 and 1997 included repayment of some commercial paper. NS' debt-to-total capitalization ratio was 56% at the end of 1998 and 58% at the end of 1997. Cash spent to purchase and retire common stock was $389 million in 1996. On Oct. 23, 1996, NS announced that the share purchase program had been suspended (see Note 13 on page 78). NS currently has in place a $2.8 billion credit facility to support its commercial paper program. In addition, NS registered $1 billion of securities on Form S-3 (see Note 8 on page 70). During 1999, as in prior years, NS expects to finance a portion of its equipment acquisitions using equipment trusts and other traditional mechanisms. JOINT ACQUISITION OF CONRAIL NS and CSX, through a jointly owned entity, control Conrail (see Note 2 on page 62). NS will begin providing rail freight services on portions of Conrail's route system after the Closing Date, which NS and CSX have agreed will be June 1, 1999. Selection of that date permits additional programming and testing of information technology and other systems necessary for safe and efficient integration of operations -- matters as to which the parties must give assurances required under the STB's order approving the transaction. NS has negotiated (or has out for ratification) all but two of the labor implementing agreements necessary for closing. Arbitration awards (which set forth the implementing agreement provisions) have been received in the remaining two cases. NS plans to implement its own information technology systems on the portion of Conrail's routes and assets it will operate. While some systems will be operational on the Closing Date, others -- particularly the transportation systems -- will be integrated geographically over a period of several months after the Closing Date. Accordingly, some of Conrail's systems are being modified to be compatible with NS' systems. Most of this programming is completed, and testing has begun. Moreover, in the Shared Assets Areas, many of Conrail's existing systems will continue to be used and, therefore, must be able to work with both NS' and CSX's systems and be made Year-2000 compliant (see also the discussion on page 46 concerning Conrail's Year-2000 compliance efforts). In anticipation of the Closing Date, NS has accumulated resources to enable it to operate its portion of Conrail's routes and assets. This has included maintaining or increasing its work force (particularly hiring and training additional train crews and management employees), acquiring or leasing equipment based on projected requirements, and beginning expansions to its facilities. These actions have resulted in increased operating expenses in 1998, and expenses of this type are anticipated to continue even after the Closing Date. The Closing Date marks the point at which Norfolk Southern Railway Company (NSR) actually can begin to operate certain of the assets and routes of Conrail, thereby permitting NS to begin to realize many of the anticipated transaction benefits. Realization of these benefits is dependent upon, among other things: (1) successful integration of NS' portion of Conrail's system into its railroad system; (2) successful operations within the Shared Assets Areas; and (3) successful coordination of NSR's (and CSXT's) operations with the PAGE 45 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Shared Assets Areas' operations. In addition, increased rail competition in the Northeast could affect the extent of benefits realized. A failure by NS or CSX to integrate successfully their respective portions of Conrail, including information technology systems, could have a substantial impact on NS' financial position, results of operations, or liquidity. Conrail's Results of Operations, Financial Condition, and Liquidity - ------------------------------------------------------------------- Conrail's net income was $267 million in 1998, compared with $7 million in 1997. Both years included transactions related to the acquisition and control of Conrail by NS and CSX that were excluded in determining NS' equity in earnings of Conrail. Conrail's operating revenues increased $98 million, or 3%, in 1998, due to a 4% increase in traffic volume, as all market groups except automotive posted increases for the year. Conrail's operating expenses decreased $95 million, or 3%, in 1998, and included a $170 million charge ($105 million after taxes) for severance benefits covering nonunion employees and $132 million ($82 million after taxes) of other charges and reserves. Operating expenses in 1997 included a $221 million charge in conjunction with the termination of the Conrail ESOP (which had no related income tax effect) and a $173 million charge ($142 million after taxes) for stock compensation and executive severance costs related to the change in ownership. In addition, Conrail's operating expenses reflect transition-related expenses of $149 million in 1998 (principally technology integration costs and employee stay bonuses) and $114 million in 1997 (principally investment banking, legal and consulting fees and employee stay bonuses). Excluding the effects of the acquisition-related compensation and transition costs, operating expenses increased 3%, compared with the 4% increase in traffic volume. Volume-related expense increases and higher casualty and other claims expenses were offset somewhat by lower diesel fuel costs. Conrail's cash provided by operations decreased $157 million, or 18%, in 1998, principally due to the higher incentive compensation payments and transition-related costs. Cash generated from operations has been the principal source of liquidity and is primarily used for capital expenditures and debt repayments. Capital expenditures totaled $550 million in 1998, and included $214 million for track program work and $198 million of equipment acquisitions. Debt repayments in 1998 were $119 million. Conrail had a working capital deficit of $202 million at Dec. 31, 1998, compared with a deficit of $254 million at Dec. 31, 1997. The deficit at year-end 1998 includes $234 million of employee-related liabilities, such as severance and stay bonus accruals, which are expected to be funded using assets from an employee benefits trust and Conrail's over-funded pension plan. During 1998, Conrail terminated its status as an SEC registrant and, therefore, it presently cannot issue any publicly traded securities. Conrail also terminated its $440 million uncollateralized bank credit facility that was used for general corporate purposes and to support its now-terminated commercial paper program. Conrail should continue to have sufficient cash flow to meet its ongoing obligations both before and after the integration of rail operations with NS and CSX. NS' equity in earnings of Conrail, net of amortization, was $194 million in 1998, and $117 million in 1997 (see Note 2). PAGE 46 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- OTHER MATTERS Year-2000 Compliance - -------------------- General -- In October 1995, NS initiated a project to review and modify, as necessary, its computer applications, hardware, and other equipment to make them Year-2000 compliant. NS has engaged outside consultants and independent contractors to assist with its Year-2000 project. The progress of the project is reviewed regularly by NS' senior management and by the Board's Audit Committee. The project is organized into three principal areas: mainframe systems, nonmainframe systems, and enterprise systems (operations and embedded processors), and for each such system involves: inventory, assessment, remediation, testing, and implementation. NS expects to have all business-critical systems remediated, tested, and implemented by mid-1999. State of readiness -- For mainframe systems (data center infrastructure, purchased or leased software, and mainframe applications), remediation and unit testing for business-critical systems are in the final stages. Systems testing and implementation began in February 1999, and both are expected to be substantially completed in June 1999 but require use of the same resources needed for testing related to the Conrail transaction (see "Joint acquisition of Conrail," above). For most business-critical nonmainframe and enterprise systems, assessment has been completed. Remediation of some systems has begun, and completion for all business-critical systems is expected by April 1999. Testing and implementation will follow with expected completion for business-critical systems by mid-year 1999. NS also has initiated formal communications with third parties having a substantial relationship to its business (including other railroads, significant suppliers, larger customers, and financial institutions) to determine the extent to which NS may be vulnerable to any such third party's failure to achieve Year-2000 compliance. Thus far, NS has no information that indicates that a significant third party may be unable to provide goods or services or to request NS' services because of Year-2000 issues. Cost -- NS has allocated existing information technology resources and has incurred incremental costs, mostly for contract programmers and consultants, in connection with its Year-2000 compliance project. Since the project began, Management estimates that up to 10% of NS' in-house programming resources have been used for Year-2000 compliance efforts. The effects of deferring other information technology projects to accommodate the Year-2000 effort have been minor. Incremental costs incurred through Dec. 31, 1998, which were expensed, are immaterial to NS' results of operations. Total incremental costs are expected to be approximately $25 million. Contingency plans -- In all areas, the project includes extensive testing to ensure that remediation successfully addresses Year-2000 compliance. Rather than adopting contingency plans, NS has established a series of initiatives to focus on business-critical systems to ensure continued operations in the event of a Year-2000 problem. If contingency plans for business-critical systems are warranted, they will be developed as needed. Conrail -- As a part of its preparations to integrate its railroad system with a portion of Conrail's system, NS is working with Conrail and CSX to ensure that certain Conrail computer applications, hardware, and other equipment are Year-2000 compliant. Conrail's core transportation system is being made Year-2000 compliant, with a projected completion date for all programming and testing of September 1999. Conrail's other information technology systems are expected to PAGE 47 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- be replaced by NS and CSX systems within six months after the Closing Date, or by Dec. 1, 1999. A delay in replacing these systems, which are not Year-2000 compliant, could result in their failure. Conrail also has under way a project to inventory, assess, and remediate all of its business-critical enterprise systems that will continue to operate after the Closing Date. This Conrail project is scheduled for completion in June 1999. Risks -- Failure to achieve Year-2000 compliance -- by NS, other railroads, its principal suppliers and customers, and certain financial institutions with which it has relationships -- could negatively affect NS' ability to conduct business for an extended period. Unanticipated delays in either the Conrail systems integration effort or the Year-2000 project could adversely affect NS' ability to complete the other. Management believes that NS will be successful in its Year-2000 compliance effort; however, there can be no assurance that all NS information technology systems and components will be fully Year-2000 compliant. In addition, other companies on which NS systems and operations rely may or may not be fully compliant on a timely basis, and any such failure could have a material adverse effect on NS' financial position, results of operations, or liquidity. Market Risks and Hedging Activities - ----------------------------------- NS does not engage in the trading of derivatives. NS 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' total debt outstanding (see Note 8 on page 70), all is fixed-rate debt, except for commercial paper and $348 million of capital leases. As a result, NS' debt subject to interest rate exposure totaled $2.2 billion on Dec. 31, 1998. A 1% increase in interest rates would increase NS' total annual interest expense related to all its variable debt by approximately $22 million. Management considers it unlikely that interest rate fluctuations applicable to these instruments will result in a material adverse effect on NS' financial position, results of operations, or liquidity. The average interest rate on commercial paper was 6.0% on Dec. 31, 1998 and 1997. During 1998, interest rates on NS' commercial paper ranged from 5.2% to 6.4%. The capital leases, which carry an average fixed rate of 7.1%, were effectively converted to variable rate obligations using interest rate swap agreements. On Dec. 31, 1998, the average pay rate under these agreements was 6.1%, and the average receive rate was 7.1%. During 1998, 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 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 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. Accounting Changes and New Accounting Pronouncements - ---------------------------------------------------- As discussed in Note 1 under "Required Accounting Changes" on page 61, NS adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income," and SFAS No. 132, "Employers' Disclosures About Pension and Other Postretirement Benefits," in 1998. During 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and AICPA Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," were issued. NS expects to adopt SFAS 133 effective Jan. 1, 2000, and SOP 98-1 effective Jan. 1, 1999. Neither adoption is expected to have a material effect on NS' consolidated financial statements. PAGE 48 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Lawsuits - -------- Norfolk Southern and certain subsidiaries are defendants in numerous lawsuits relating principally to railroad operations. The Corporation is the defendant in a class action suit filed in federal district court in Birmingham, Ala., on behalf of African Americans currently employed or working since Dec. 16, 1989, who allege that the Corporation has discriminated against them in promotion to nonagreement positions because of their race. The nonjury trial on liability, which the Corporation vigorously defended, concluded in June 1997, and the matter is with the court for requesting briefs and decision. In the meantime, the parties have begun mediation of the case. On Sept. 8, 1997, a state court jury in New Orleans returned a verdict awarding $175 million in punitive damages against The Alabama Great Southern Railroad Company (AGS), a subsidiary of Norfolk Southern Railway Company, all of the common stock of which is owned by NS. 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. As of Feb. 19, 1999, the trial court had not ruled on motions filed by defendants seeking relief from the jury's verdicts. The trial court has, however, ordered that another case involving 20 plaintiffs be set for trial on March 22, 1999. The defendants are challenging in the Louisiana Supreme Court the trial court's action in setting additional cases for trial prior to a final determination of the validity of the original trial. Management will continue to monitor the progress of this litigation, and will, if necessary, pursue appropriate appeals. Management believes that the jury verdicts are both grossly excessive and without factual or legal justification. While the final outcome of these matters 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' ultimate liability is unlikely to have a material adverse effect on NS' financial position, results of operations, or liquidity. Environmental Matters - --------------------- NS is subject to various jurisdictions' environmental laws and regulations. It is NS' policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably. Claims, if any, against third parties for recovery of clean-up costs incurred by NS are reflected as receivables (when collection is probable) in the balance sheet and are not netted against the associated NS liability. Environmental engineers regularly participate in ongoing evaluations of all identified sites and in determining any necessary adjustments to initial liability estimates. NS 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 $4 million in 1998, $21 million in 1997, and $25 million in 1996, and capital expenditures totaled approximately $7 million in 1998 and $6 million in both 1997 and 1996. Operating expenses were substantially lower in 1998 compared with recent years, principally due PAGE 49 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- to a combination of increased recoveries from third parties of amounts paid by NS in prior years for environmental clean-up and remediation, and favorable development experience on identified sites. Operating expenses in 1999 are expected to return to a level more consistent with that experienced prior to 1998. Capital expenditures in 1999 are expected to be somewhat higher than in 1998. As of Dec. 31, 1998, NS' 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' estimate of the probable clean-up and remediation costs based on available information at 132 identified locations. On that date, 15 sites accounted for $23 million of the reserve, and no individual site was considered to be material. NS 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 some of the 132 locations, certain NS 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 and certain other potentially responsible parties (PRP) were responsible for past and future clean-up and monitoring costs at the Bayou Bonfouca NPL Superfund site located in Slidell, La. The EPA indicated that it has expended $140 million at the site and expects to expend still more in connection with its groundwater "pump and treat" program. Because all other solvent PRP had settled or been dismissed, and because of an unfavorable district court ruling in February 1999, NS agreed to settle all claims by the EPA and Louisiana for $13 million, thereby avoiding litigation and possible appeal costs. With respect to known environmental sites (whether identified by NS or by the EPA or comparable state authorities), estimates of NS' 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' traffic mix, particularly those classified as hazardous materials, can pose special risks that NS and its subsidiaries work diligently to minimize. In addition, several NS subsidiaries own, or have owned, 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 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 dealing with 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' financial position, results of operations, or liquidity. PAGE 50 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Labor Agreements - ---------------- Approximately 85% of NS' railroad employees are represented by labor unions under collective bargaining agreements with 15 different labor organizations. The agreements currently in force will remain in effect through Dec. 31, 1999, and thereafter until new agreements are reached or the Railway Labor Act's procedures are exhausted. 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, a capital-intensive company, has most of its capital 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 may be made in 1999 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 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, 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 and on its customers cannot be predicted with certainty; however, NS serves a number of efficient power producers and is working diligently to assure that its customers remain competitive in this evolving environment. 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 PAGE 51 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- or of actual future results; nor will they necessarily prove to be accurate indications of the times at or by which any such performance or result will be achieved. Accordingly, actual outcomes and results may differ materially from those expressed in such forward-looking statements. This caveat has particular importance in the context of all such statements that relate to Year-2000 compliance and to the realization and the timing of benefits expected to result from consummation of the Conrail transaction. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. - ------- ---------------------------------------------------------- The information required by this item is included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 47 under the heading "Market Risks and Hedging Activities." PAGE 52 Item 8. Financial Statements and Supplementary Data. - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES QUARTERLY FINANCIAL DATA (Unaudited)
Three Months Ended ------------------------------------------ March 31 June 30 Sept. 30 Dec. 31 -------- ------- -------- ------- (In millions of dollars except per share amounts) 1998 ---- Railway operating revenues $1,066 $1,079 $1,048 $1,028 Income from railway operations 251 293 258 250 Income from continuing operations 132 187 151 160 Net income 229 187 158 160 Earnings per share - Basic $ 0.61 $ 0.49 $ 0.42 $ 0.42 - Diluted $ 0.61 $ 0.48 $ 0.42 $ 0.42 1997 ---- Railway operating revenues $1,046 $1,067 $1,048 $1,062 Income from railway operations 281 321 297 314 Income from continuing operations 125 186 169 219 Net income 128 190 179 224 Earnings per share - Basic $ 0.34 $ 0.51 $ 0.47 $ 0.59 - Diluted $ 0.34 $ 0.50 $ 0.47 $ 0.59
NOTE: All per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. PAGE 53 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- Index to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1998, 1997, and 1996 54 Consolidated Balance Sheets As of December 31, 1998 and 1997 55 Consolidated Statements of Cash Flows Years ended December 31, 1998, 1997, and 1996 57 Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1998, 1997, and 1996 59 Notes to Consolidated Financial Statements 60 Independent Auditors' Report 83 The Index to Consolidated Financial Statement Schedule appears in Item 14 on page 86. PAGE 54 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Statements of Income
Years ended December 31, 1998 1997 1996 ---- ---- ---- ($ in millions, except earnings per share) RAILWAY OPERATING REVENUES $ 4,221 $ 4,223 $ 4,101 RAILWAY OPERATING EXPENSES Compensation and benefits 1,492 1,405 1,400 Materials, services, and rents 806 685 624 Depreciation 437 421 408 Diesel fuel 174 227 233 Casualties and other claims 95 123 123 Other 165 149 148 ------- ------- ------- Total railway operating expenses 3,169 3,010 2,936 ------- ------- ------- Income from railway operations 1,052 1,213 1,165 Equity in earnings of Conrail (Note 2) 194 117 -- Charge for credit facility costs (Note 2) -- (77) -- Other income - net (Note 4) 115 130 117 Interest expense on debt (Note 6) (516) (385) (116) ------- ------- ------- Income from continuing operations before income taxes 845 998 1,166 Provision for income taxes (Note 5) 215 299 413 ------- ------- ------- Income from continuing operations 630 699 753 Discontinued operations (Note 3): Income (loss) from motor carrier operations, net of taxes (1) 22 17 Gain on sale of motor carrier, net of taxes 105 -- -- ------- ------- ------- Income from discontinued operations 104 22 17 ------- ------- ------- NET INCOME $ 734 $ 721 $ 770 ======= ======= ======= EARNINGS PER SHARE (NOTE 14) Income from continuing operations - Basic $ 1.66 $ 1.85 $ 1.98 - Diluted $ 1.65 $ 1.84 $ 1.96 Net income - Basic $ 1.94 $ 1.91 $ 2.03 - Diluted $ 1.93 $ 1.90 $ 2.01
See accompanying notes to consolidated financial statements. PAGE 55 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets
As of December 31, 1998 1997 ---- ---- ($ in millions) ASSETS Current assets: Cash and cash equivalents $ 5 $ 34 Short-term investments 58 125 Accounts receivable, net of allowance for doubtful accounts of $4 million and $3 million, respectively 519 552 Materials and supplies 59 58 Deferred income taxes (Note 5) 141 114 Other current assets 131 119 Net assets of discontinued operations -- 101 ------- ------- Total current assets 913 1,103 ------- ------- Investment in Conrail (Note 2) 6,210 5,888 Properties less accumulated depreciation (Note 6) 10,477 9,904 Other assets 580 455 ------- ------- TOTAL ASSETS $18,180 $17,350 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable (Note 7) $ 600 $ 624 Income and other taxes 151 169 Other current liabilities (Note 7) 225 212 Current maturities of long-term debt (Note 8) 141 61 Short-term debt (Note 8) -- 27 ------- ------- Total current liabilities 1,117 1,093 ------- ------- Long-term debt (Note 8) 7,483 7,398 Other liabilities (Note 10) 1,065 885 Minority interests 49 49 Deferred income taxes (Note 5) 2,545 2,480 ------- ------- TOTAL LIABILITIES 12,259 11,905 ------- -------
(continued) PAGE 56 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (continued)
As of December 31, 1998 1997 ---- ---- ($ in millions) Stockholders' equity: Common stock $1.00 per share par value, 1,350,000,000 shares authorized (Note 13); issued 401,031,994 shares and 398,912,698 shares, respectively 401 399 Additional paid-in capital 296 241 Accumulated other comprehensive income (Note 13) (8) 5 Retained income 5,252 4,821 Less treasury stock at cost, 21,627,904 shares and 21,757,902 shares, respectively (20) (21) ------- ------- TOTAL STOCKHOLDERS' EQUITY 5,921 5,445 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $18,180 $17,350 ======= =======
See accompanying notes to consolidated financial statements. PAGE 57 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows
Years ended December 31, 1998 1997 1996 ---- ---- ---- ($ in millions) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 734 $ 721 $ 770 Reconciliation of net income to net cash provided by continuing operations: Depreciation 450 432 419 Deferred income taxes 114 75 92 Equity in earnings of Conrail (194) (117) -- Charge for credit facility costs -- 77 -- Nonoperating gains and losses on properties and investments (51) (63) (57) Income from discontinued operations (104) (22) (17) Changes in assets and liabilities affecting continuing operations: Accounts receivable 33 (23) (1) Materials and supplies (1) 3 (1) Other current assets (16) (8) (13) Current liabilities other than debt (23) 115 (8) Other - net (50) (44) (16) ------- ------- ------- Net cash provided by continuing operations 892 1,146 1,168 Net cash provided by (used for) discontinued operations (2) 4 30 ------- ------- ------- Net cash provided by operating activities 890 1,150 1,198 CASH FLOWS FROM INVESTING ACTIVITIES Property additions (956) (875) (680) Property sales and other transactions 83 74 130 Investment in Conrail (40) (5,741) (10) Investments, including short-term (116) (185) (209) Investment sales and other transactions 155 217 245 Proceeds from sale of motor carrier 207 -- -- ------- ------- ------- Net cash used for investing activities (667) (6,510) (524) CASH FLOWS FROM FINANCING ACTIVITIES Dividends (303) (301) (284) Common stock issued - net 34 24 29 Purchase and retirement of common stock -- -- (389) Commercial paper proceeds 129 1,540 -- Credit facility costs paid -- (72) (5) Proceeds from long-term borrowings 67 4,241 209 Debt repayments (179) (245) (93) ------- ------- ------- Net cash provided by (used for) financing activities (252) 5,187 (533) Net increase (decrease) in cash and cash equivalents (29) (173) 141
PAGE 58 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued)
Years ended December 31, 1998 1997 1996 ---- ---- ---- ($ in millions) CASH AND CASH EQUIVALENTS At beginning of year 34 207 66 ------- ------- ------- At end of year $ 5 $ 34 $ 207 ======= ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest (net of amounts capitalized) $ 519 $ 379 $ 128 Income taxes $ 76 $ 209 $ 324
See accompanying notes to consolidated financial statements. PAGE 59 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity
Accumu- lated Addi- Other tional Compre- Common Paid-In hensive Retained Treasury Stock Capital Income Income Stock Total ------- ------- ------- ------- -------- ----- ($ in millions) BALANCE DECEMBER 31, 1995 $ 136 $ 431 $ 3 $4,280 $ (21) $4,829 Comprehensive income - 1996 Net income 770 770 Other comprehen- sive income (Note 13) -- -- ------ Total compre- hensive income 770 Dividends on Common Stock (284) (284) Purchase and retire- ment of Common Stock (5) (15) (365) (385) Other 1 46 47 ------ ------ ------ ------ ------ ------ BALANCE DECEMBER 31, 1996 132 462 3 4,401 (21) 4,977 Comprehensive income - 1997 Net income 721 721 Other comprehen- sive income (Note 13) 2 2 ------ Total compre- hensive income 723 Dividends on Common Stock (301) (301) 3-for-1 stock split, effective Sept. 5 266 (266) -- -- Other 1 45 46 ------ ------ ------ ------ ------ ------ BALANCE DECEMBER 31, 1997 399 241 5 4,821 (21) 5,445 Comprehensive income - 1998 Net income 734 734 Other comprehen- sive income (Note 13) (13) (13) ------ Total compre- hensive income 721 Dividends on Common Stock (303) (303) Other 2 55 1 58 ------ ------ ------ ------ ------ ------ BALANCE DECEMBER 31, 1998 $ 401 $ 296 $ (8) $5,252 $ (20) $5,921 ====== ====== ====== ====== ====== ======
See accompanying notes to consolidated financial statements. PAGE 60 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES 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 Corporation is a Virginia-based holding company engaged principally in the transportation of freight by rail, currently operating approximately 14,400 route miles primarily in the Southeast and Midwest. After the Closing Date (see Note 2), operations will extend into the Northeast. The consolidated financial statements include Norfolk Southern Corporation (Norfolk Southern) and its majority-owned and controlled subsidiaries (collectively NS). Norfolk Southern's major subsidiary is Norfolk Southern Railway Company (NSR). Financial results of a former motor carrier subsidiary, North American Van Lines, Inc. (NAVL), are reflected as "Discontinued operations" (see Note 3). All significant intercompany balances and transactions have been eliminated in consolidation. The railroad transports raw materials, intermediate products, and finished goods classified in the following market groups: coal; paper, clay, and forest products; chemicals; automotive; agriculture, consumer products, and government; metals and construction; and intermodal. Except for coal, all groups are approximately equal in size based on revenues; coal accounts for about 30% of total railway operating revenues. Ultimate points of origination or destination for some of the freight (particularly coal bound for export and intermodal containers) are outside the United States. Through a jointly owned entity, Norfolk Southern and CSX Corporation (CSX) own the stock of Conrail Inc., which owns the major freight railroad in the Northeast that operates approximately 10,800 route miles. Norfolk Southern has a 58% economic and 50% voting interest in the jointly owned entity (see Note 2). 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 securities "held-to-maturity," "trading," or "available-for-sale." On Dec. 31, 1998 and 1997, all "Short-term investments," consisting primarily of United States government and federal agency securities, were designated as "available-for-sale." Accordingly, unrealized gains and losses, net of taxes, are recognized in "Accumulated other comprehensive income." PAGE 61 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 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." Properties - ---------- "Properties" are stated principally at cost and are depreciated using group depreciation. Rail is depreciated primarily 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 17%. In 1998, the overall depreciation rate averaged 2.8% for roadway and 4.0% for equipment. NS 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 nonrail 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 nonrail assets are included in "Other income" (see Note 4). NS 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 does not engage in the trading of derivatives. NS has entered into a limited number of derivative agreements to hedge interest rate exposures on certain components of its debt portfolio. All of these derivative instruments are designated as hedges, have high correlation with the underlying exposure, and are highly effective in offsetting underlying price movements. Accordingly, payments made or received under interest rate swap agreements are recorded in the income statement with the corresponding interest expense. Payments made to hedge interest rate exposure related to the anticipated issuance of debt were deferred as a reduction of the debt proceeds and are being amortized to interest expense over the life of the underlying debt. Required Accounting Changes - --------------------------- Effective Jan. 1, 1998, NS adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This statement requires presentation of comprehensive income (net income plus all other changes to net assets from nonowner sources) and its components in the financial statements. NS presents comprehensive income in its Consolidated Statements of Changes in Stockholders' Equity and has reclassified prior years' amounts to conform to the new presentation. Adoption of SFAS 130 had no impact on total stockholders' equity or net income (see Note 13). PAGE 62 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) NS adopted Statement of Financial Accounting Standards No. 132 (SFAS 132), "Employers' Disclosures about Pension and Other Postretirement Benefits," in its 1998 Annual Report. SFAS 132 revises disclosures about pension and other postretirement benefit plans, but does not change the measurement or recognition of liabilities associated with such plans (see Note 11). Reclassifications - ----------------- Certain amounts in the financial statements and notes thereto have been reclassified to conform to the 1998 presentation. 2. JOINT ACQUISITION OF CONRAIL Background and Overview - ----------------------- On April 8, 1997, NS and CSX agreed jointly to acquire Conrail Inc. (Conrail), the owner of Consolidated Rail Corporation, the major freight railroad in the Northeast. On May 23, 1997, NS and CSX, through a jointly owned entity, completed the acquisition of tendered Conrail stock which they placed in a voting trust pending the issuance and effectiveness of the Surface Transportation Board's (STB) written decision approving their joint application to control Conrail. NS has a 58% economic and 50% voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests. On June 17, 1997, NS and CSX executed the Transaction Agreement, dated as of June 10, 1997, which generally outlined the methods of governing and operating Conrail and its subsidiaries when they became subject to NS' and CSX's joint control. On Aug. 22, 1998, the STB's written decision approving the control application became effective (the "Control Date"). As a result, NS and CSX: (1) dissolved the voting trust, and (2) are authorized, among other things, to implement the transactions contemplated in the Transaction Agreement. A new Conrail Board of Directors was elected which consists of an equal number of NS- appointed and CSX-appointed directors. It is expected that Conrail's operations will continue substantially unchanged until NS and CSX commence operating the respective Conrail properties that will be leased to their railroad subsidiaries, an event that NS and CSX have agreed will occur on June 1, 1999 (the "Closing Date"). A failure by NS or CSX to integrate successfully their respective portions of Conrail, including information technology systems, could have a substantial impact on NS' financial position, results of operations, and liquidity. After the Closing Date, NS and CSX will provide substantially all rail freight services on Conrail's route system, perform or be responsible for performance of most services incident to customer freight contracts, and employ the majority of Conrail's work force. From time to time, NS and CSX, as the indirect owners of Conrail, may need to fund Conrail's cash requirements through capital contributions, loans, or advances. Until the Closing Date, NS' railroad subsidiaries will continue to have transactions in the normal course of business with Conrail's railroad subsidiary. The Transaction Agreement and Operating Agreements - -------------------------------------------------- The Transaction Agreement provides, among other things, that after the Closing Date, the railroads of NS and CSX (Norfolk Southern Railway Company [NSR] and CSX Transportation, Inc. [CSXT], respectively) will: (1) separately operate, pursuant to operating and lease agreements with two limited liability companies (Pennsylvania Lines LLC [PRR] and New York Central Lines LLC [NYC]) that will be wholly owned by Conrail, portions of the routes and assets now owned PAGE 63 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. JOINT ACQUISITION OF CONRAIL (continued) and operated by Conrail (the "Allocated Assets"), and (2) have joint and exclusive access to other Conrail properties that will continue to be owned and operated by Conrail (the "Shared Assets Areas"). Conrail will continue to provide certain system support operations for the benefit of itself, NSR, and CSXT. All pre-existing Conrail obligations, including environmental liabilities, will remain obligations of Conrail (or, in some cases, of PRR or NYC). The Operating Agreement between NSR and PRR, which governs all nonequipment assets to be used by NSR, will have an initial 25-year term, renewable at the option of NSR for two 10-year terms; payments under that agreement will be fair market rental values that are subject to adjustment every six years to reflect changes in such values. NSR also will lease from PRR a number of equipment assets at fair market rentals. NS' payments to PRR under the Operating Agreement and equipment lease agreements will be significant in amount. In addition, all costs necessary to operate the PRR assets will be borne by NSR. CSXT will enter into an Operating Agreement and lease agreements with NYC that contain terms and conditions identical to those in the comparable agreements between NSR and PRR, and it will bear all costs necessary to operate the NYC assets. NSR also will pay a portion of the costs (CSXT will pay the remainder) to operate over the Shared Assets Areas, which will be based on fair value and percentage usage. Many employees of Conrail will be employed by NS or NSR, and, in some cases, relocated at NS' or NSR's cost. Some Conrail employees not hired by either NS or CSX will remain at Conrail and perform services in the Shared Assets Areas or carry out general corporate functions. Other Conrail employees were or will be separated from service, after a transition period, and will be entitled to contractual or STB-imposed severance benefits. The Transaction Agreement provides that: (1) separation costs related to Conrail's nonunion employees are to be borne by Conrail, and (2) separation costs related to Conrail's union employees are to be borne primarily by either NSR or CSXT. NS will direct the appointment of the directors of PRR, and CSX will direct the appointment of the directors of NYC. It is expected that the directors of PRR and NYC will have control over the daily operations of these companies, but certain key decisions, including all modifications and changes to either Operating Agreement, must be made by the Conrail board. By virtue of their indirect ownership of Conrail, NS and CSX will each have an indirect economic interest of 58% and 42%, respectively, in both PRR and NYC. Investment in Conrail - --------------------- NS is applying the equity method of accounting to its investment in Conrail in accordance with APB No. 18, "The Equity Method of Accounting for Investments in Common Stock." In August 1998, the effective date of the STB decision, NS' investment in Conrail exceeded its 58% of Conrail's net equity by $4.1 billion. This excess has been allocated to the fair values of Conrail's assets and liabilities, using the principles of purchase accounting, as follows:
($ in millions) --------------- Property, equipment, and investments in railroads $6,514 Other assets, principally pension and other employee benefit plans and trusts 274 Debt revaluation and other liabilities (85) Deferred taxes (2,579) ------ Total $4,124 ======
PAGE 64 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. JOINT ACQUISITION OF CONRAIL (continued) NS is amortizing this excess based principally on the estimated remaining useful lives of Conrail's property and equipment, net of the related deferred tax effect of the differences in tax and accounting bases for certain assets. At Dec. 31, 1998, the difference between NS' investment in Conrail and its share of Conrail's underlying net equity was $4.1 billion, and the related amortization amounted to $72 million annually. NS' investment in Conrail includes $165 million ($101 million after taxes) of costs that will be paid by NS. These costs consist principally of: (1) contractual obligations to Conrail employees imposed by the STB when it approved the transaction, and (2) costs to relocate Conrail employees. Most of NS' costs are expected to be paid in the two years following the Closing Date, and $60 million of such are classified on NS' balance sheet as "Current liabilities." However, certain contractual obligations by their terms will be paid out over a longer period and are classified as "Other liabilities" on NS' balance sheet. In 1998, NS charged $5 million of costs to these liabilities. Conrail's underlying net equity reflects liabilities recognized by Conrail primarily for separations of nonunion employees and for change-in-control obligations. In 1997 and 1998, Conrail recorded $550 million of after-tax charges for these liabilities (see "Summary financial information -- Conrail," below). The liabilities recorded by NS and Conrail are based on preliminary estimates of separation, relocation, and other labor- related contractual obligations to Conrail employees. These liability estimates, along with the fair value allocation, may be modified as more information becomes available, as Management's integration plans evolve, and as labor implementing agreements are negotiated. Severance and relocation plans are expected to be finalized shortly after the Closing Date. As a consequence, amounts ultimately included in the allocation could differ from the original estimates; however, any such differences are not now expected to be material to NS' financial position, results of operations, or liquidity. As definitive plans are determined and communicated, costs, if any, for severing or relocating NS employees and for disposing of NS facilities will be charged to operating expense. Income and Pro Forma Effects - ---------------------------- Since May 23, 1997 (the date on which NS and CSX completed their joint acquisition of Conrail stock), NS' financial statements have reflected its 58% economic interest in Conrail, using the equity method of accounting. NS' Consolidated Statements of Income for the years ended Dec. 31, 1998 and 1997, include several Conrail-related items. Increasing NS' income over these periods is its equity in the earnings of Conrail, net of amortization, adjusted for the effects of certain transactions related to the acquisition and control of Conrail by NS and CSX. Decreasing NS' income over the same periods are principally: (1) interest expense on debt issued to finance NS' share of the joint acquisition of Conrail stock, (2) credit facility costs, including a $77 million charge expensed in the first quarter of 1997 related to a previous attempt to acquire 100% of Conrail's stock, and (3) integration expenses (which have been included in "Railway operating expenses"). PAGE 65 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. JOINT ACQUISITION OF CONRAIL (continued) Had NS acquired its investment in Conrail on Jan. 1, 1997, NS' net income and diluted earnings per share for the year ended Dec. 31, 1997, would have been $671 million and $1.77, respectively. These pro forma results reflect only the application of the equity method of accounting and the specific financing costs previously identified. They reflect neither costs of operating PRR's assets nor any synergies expected to result from NS' operation of PRR's assets and access to the Shared Assets Areas. Accordingly, such results do not include or otherwise take into account any potential increase in NS' revenues or operating income, estimated cost savings, effects of increased competition in the Northeast, or future integration costs. The effects of the foregoing will be substantial. As a result, this pro forma information is not, and is not intended to be, indicative of the results of operations after the Closing Date. Following the Closing Date and commencement of operations over lines leased from PRR and in the Shared Assets Areas, NS will begin to report rail operating revenues and expenses associated with these leased assets in its financial statements. Summary Financial Information -- Conrail - ---------------------------------------- The following summary financial information was provided by Conrail's Management and should be read in conjunction with Conrail's audited financial statements included as an exhibit to NS' Annual Report on Form 10-K for 1998 filed with the Securities and Exchange Commission. Summarized Consolidated Statements of Income -- Conrail - -------------------------------------------------------
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Operating revenues $3,863 $3,765 $3,714 Operating expenses 3,348 3,443 3,113 ------ ------ ------ Operating income 515 322 601 Other - net (81) (87) (70) ------ ------ ------ Income before income taxes 434 235 531 Provision for income taxes 167 228 189 ------ ------ ------ Net income $ 267 $ 7 $ 342 ====== ====== ======
Note: This Conrail financial information includes the effects of the following transactions that related to the acquisition and control of Conrail by NS and CSX, and, accordingly, were excluded in determining NS' equity in Conrail's net income. Conrail's operating expenses for 1998 include a $187 million after-tax charge for the following: (1) $105 million for estimated nonunion severance obligations and (2) $82 million of other charges and reserves. Conrail's operating expenses for 1997 included the following: (1) a $221 million (no related tax effect) charge in conjunction with the termination of the Conrail ESOP and (2) a $142 million after-tax charge for transaction- related stock compensation costs and change-in-control benefits. PAGE 66 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. JOINT ACQUISITION OF CONRAIL (continued) Summarized Consolidated Balance Sheets -- Conrail - -------------------------------------------------
December 31, ($ in millions) 1998 1997 --------------- ---- ---- Assets: Current assets $1,005 $ 954 Noncurrent assets 7,895 7,530 ------ ------ Total assets $8,900 $8,484 ====== ====== Liabilities and stockholders' equity: Current liabilities $1,207 $1,208 Noncurrent liabilities 4,037 4,111 Stockholders' equity 3,656 3,165 ------ ------ Total liabilities and stockholders' equity $8,900 $8,484 ====== ======
3. DISCONTINUED OPERATIONS -- MOTOR CARRIER On March 28, 1998, NS sold all the common stock of North American Van Lines, Inc. (NAVL), its motor carrier subsidiary. Total proceeds from the sale were $207 million, resulting in a $90 million pretax gain ($105 million, or 28 cents per basic and diluted share, after taxes). The higher after-tax gain was the result of differences between book and tax bases and the realization of deferred tax benefits. NAVL's results of operations, financial position, and cash flows are presented as "Discontinued operations" in the accompanying financial statements. A summary of NAVL's results of operations follows:
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Motor carrier revenues $ 207 $ 942 $ 930 Motor carrier expenses 208 907 898 Other income (expense) -- -- (1) Provision for income taxes -- 13 14 ------ ------ ------ Income (loss) from operations (1) 22 17 Gain on sale, net of taxes 105 -- -- ------ ------ ------ Income from discontinued operations $ 104 $ 22 $ 17 ------ ------ ------ Earnings per share (basic and diluted) from discon- tinued operations $ 0.28 $ 0.06 $ 0.05 ====== ====== ======
"Net assets of discontinued operations" of $101 million at Dec. 31, 1997, consisted of $192 million of current assets, $100 million of long-term assets, $130 million of current liabilities, and $61 million of long-term liabilities. PAGE 67 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 4. OTHER INCOME -- NET
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Royalties from coal $ 57 $ 58 $ 59 Gains from sale of properties and investments 51 56 57 Rental income 26 22 20 Interest income 12 30 22 Corporate-owned life insurance - net 11 7 6 Gain from partial redemption of partnership interest -- 7 -- Other interest expense (21) (27) (29) Nonoperating depletion and depreciation (13) (11) (11) Taxes on nonoperating property (4) (5) (8) Other - net (4) (7) 1 ------ ------ ------ Total $ 115 $ 130 $ 117 ====== ====== ======
5. INCOME TAXES Provision for Income Taxes - --------------------------
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Current: Federal $ 89 $ 197 $ 280 State 12 27 41 ------ ------ ------ Total current taxes 101 224 321 Deferred: Federal 100 78 75 State 14 (3) 17 ------ ------ ------ Total deferred taxes 114 75 92 ------ ------ ------ Provision for income taxes $ 215 $ 299 $ 413 ====== ====== ======
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: PAGE 68 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 5. INCOME TAXES (continued)
1998 1997 1996 ($ in millions) Amount % Amount % Amount % --------------- ------ -- ------ -- ------ -- Federal income tax at statutory rate $296 35 $349 35 $408 35 State income taxes, net of federal tax benefit 17 2 16 2 37 3 Equity in earnings of Conrail (68) (8) (41) (4) -- -- Corporate-owned life insurance (11) (1) (10) (1) (15) (1) Other - net (19) (3) (15) (2) (17) (2) ---- -- ---- -- ---- -- Provision for income taxes $215 25 $299 30 $413 35 ==== == ==== == ==== ==
Tax Benefit Leases - ------------------ In January 1995, the United States Tax Court issued a preliminary decision that disallowed some of the tax benefits a subsidiary of NS purchased from a third party pursuant to a safe harbor lease agreement in 1981. The Tax Court finalized this decision in February 1997, and all avenues of appeal have been exhausted. NS has requested payment and filed suit to collect from the third party in accordance with indemnification provisions of the lease agreement, and Management believes that this receivable will be collected. Deferred Tax Assets and Liabilities - ----------------------------------- Certain items are reported in different periods for financial reporting and income tax purposes. Deferred tax assets and liabilities were recorded in recognition of these differences. Except for amounts for which a valuation allowance is provided, Management believes the deferred tax assets will be realized. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows: PAGE 69 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 5. INCOME TAXES (continued)
December 31, ($ in millions) 1998 1997 --------------- ---- ---- Deferred tax assets: Reserves, including casualty and other claims $ 157 $ 144 Employee benefits 209 155 Retiree health and death benefit obligation 127 133 Taxes, including state and property 173 171 Other 41 52 ------- ------- Total gross deferred tax assets 707 655 Less valuation allowance (3) (2) ------- ------- Net deferred tax assets 704 653 ------- ------- Deferred tax liabilities: Property (3,023) (2,925) Other (85) (94) ------- ------- Total gross deferred tax liabilities (3,108) (3,019) ------- ------- Net deferred tax liability (2,404) (2,366) Net current deferred tax assets 141 114 ------- ------- Net long-term deferred tax liability $(2,545) $(2,480) ======= =======
Internal Revenue Service (IRS) Reviews - -------------------------------------- Consolidated federal income tax returns have been examined and Revenue Agent Reports have been received for all years up to and including 1994. The consolidated federal income tax returns for 1995 and 1996 are being audited by the IRS. Management believes that adequate provision has been made for any additional taxes and interest thereon that might arise as a result of IRS examinations. 6. PROPERTIES
December 31, ($ in millions) 1998 1997 --------------- ---- ---- Railway property: Road $ 9,267 $ 8,853 Equipment 5,157 4,881 Other property 639 605 ------- ------- 15,063 14,339 Less: Accumulated depreciation 4,586 4,435 ------- ------- Net properties $10,477 $ 9,904 ======= =======
PAGE 70 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 6. PROPERTIES (continued) Capitalized Interest - -------------------- Total interest cost incurred on debt in 1998, 1997, and 1996 was $537 million, $402 million, and $128 million, respectively, of which $21 million, $17 million, and $12 million was capitalized. 7. CURRENT LIABILITIES
December 31, ($ in millions) 1998 1997 --------------- ---- ---- Accounts payable: Accounts and wages payable $ 283 $ 281 Casualty and other claims 144 172 Vacation liability 81 80 Equipment rents payable - net 72 67 Other 20 24 ------ ------ Total $ 600 $ 624 ====== ====== Other current liabilities: Interest payable $ 91 $ 115 Accrued Conrail-related costs (Note 2) 67 25 Liabilities for forwarded traffic 27 31 Retiree health and death benefit obligation (Note 11) 24 23 Other 16 18 ------ ------ Total $ 225 $ 212 ====== ======
8. DEBT Shelf Registration - ------------------ In November 1998, NS filed with the Securities and Exchange Commission a shelf registration statement on Form S-3 covering the issuance of up to $1 billion of securities; as of Dec. 31, 1998, no such securities had been issued. PAGE 71 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 8. DEBT (continued) Long-Term Debt - --------------
December 31, ($ in millions) 1998 1997 --------------- ---- ---- Commercial paper classified as long-term debt at an average rate of 6.0% $1,889 $1,871 Notes at average rates and maturities as follows: 6.85%, maturing 2000 to 2002 1,097 1,096 7.45%, maturing 2004 to 2007 1,192 1,191 8.10%, maturing 2017 to 2021 798 798 7.80%, maturing 2027 792 792 7.05%, maturing 2037 746 745 7.90%, maturing 2097 350 350 Railroad equipment obligations at an average rate of 7.4%, maturing to 2009 376 355 Capitalized leases at an average rate of 6.1%, maturing to 2015 349 246 Other debt at an average rate of 5.4%, maturing to 2015 35 15 ------ ------ Total long-term debt 7,624 7,459 ------ ------ Less: current maturities 141 61 ------ ------ Long-term debt less current maturities $7,483 $7,398 ====== ====== Long-term debt matures as follows: 2000 $ 472 2001 267 2002 563 2003 65 2004 and subsequent years 6,116 ------ Total $7,483 ======
The railroad equipment obligations and the capitalized leases are secured by liens on the underlying equipment. PAGE 72 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 8. DEBT (continued) Commercial Paper - ---------------- Commercial paper debt is due within one year, but has been classified as long-term because NS has the ability through a $2.8 billion credit agreement to convert this obligation into longer term debt. The credit agreement expires in 2002 and provides for interest on borrowings at prevailing rates. NS intends to refinance the commercial paper either by issuing additional commercial paper or by replacing commercial paper notes with long-term debt. Capital Lease Obligations - ------------------------- During 1998, 1997, and 1996, NSR entered into capital leases covering new locomotives. The related capital lease obligations, totaling $127 million in 1998, $64 million in 1997, and $108 million in 1996, were reflected in the Consolidated Balance Sheets as debt, and, because they were noncash transactions, were excluded from the Consolidated Statements of Cash Flows. The lease obligations carry an average stated interest rate of 6.5% for those entered into in 1998, 7.0% for those entered into in 1997, and 6.5% for those entered into in 1996. All were effectively converted to variable rate obligations using interest rate swap agreements. The interest rates on these obligations are based on the six-month London Interbank Offered Rate and are reset every six months with changes in interest rates accounted for as an adjustment of interest expense over the terms of the leases. As of Dec. 31, 1998, the average interest rate on these locomotive leases was 6.1%. As a result, NS is exposed to the market risk associated with fluctuations in interest rates. To date, the effects of the rate fluctuations have been favorable and not material. Counterparties to the interest rate swap agreements are major financial institutions believed by Management to be creditworthy. Debt Covenants - -------------- NS is subject to various financial covenants with respect to its debt and under its credit agreement, including a minimum net worth requirement and certain restrictions on issuance of further debt. At Dec. 31, 1998, NS believes it was in compliance with all debt covenants. 9. LEASE COMMITMENTS NS is committed under long-term lease agreements, which expire on various dates through 2067, for equipment, lines of road, and other property. Future minimum lease payments are as follows (these amounts do not include payments under the Operating Agreement and lease agreements with PRR - see Note 2): PAGE 73 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 9. LEASE COMMITMENTS (continued)
($ in millions) Operating Leases Capital Leases --------------- ---------------- -------------- 1999 $ 76 $ 47 2000 69 47 2001 44 47 2002 37 47 2003 36 46 2004 and subsequent years 605 232 ------ ------ Total $ 867 466 ====== Less imputed interest on capital leases at an average rate of 7.1% 117 ------ Present value of minimum lease payments included in debt $ 349 ======
Operating lease expense - -----------------------
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Minimum rents $ 75 $ 68 $ 65 Contingent rents 40 43 38 ------ ------ ------ Total $ 115 $ 111 $ 103 ====== ====== ======
10. OTHER LIABILITIES
December 31, ($ in millions) 1998 1997 --------------- ---- ---- Casualty and other claims $ 271 $ 253 Retiree health and death benefit obligation (Note 11) 268 281 Accrued Conrail-related costs 100 -- Pension benefit liability (Note 11) 72 57 Other 354 294 ------ ------ Total $1,065 $ 885 ====== ======
11. PENSIONS AND OTHER POSTRETIREMENT BENEFITS Norfolk Southern and certain subsidiaries have both funded and unfunded defined benefit pension plans covering principally salaried employees. Norfolk Southern and certain subsidiaries also provide specified health care and death benefits to eligible retired employees and their dependents. 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 under other group insurance policies. PAGE 74 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 11. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued)
Pension Benefits Other Benefits ($ in millions) 1998 1997 1998 1997 --------------- ---- ---- ---- ---- CHANGE IN BENEFIT OBLIGATIONS Benefit obligation at beginning of year $ 956 $ 892 $ 360 $ 329 Service cost 13 11 10 9 Interest cost 67 66 24 25 Amendment 40 -- -- -- Actuarial (gains) losses 61 62 (9) 18 Benefits paid (74) (75) (23) (21) ------ ------ ------ ------ Benefit obligation at end of year 1,063 956 362 360 ------ ------ ------ ------ CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year 1,360 1,158 111 86 Actual return on plan assets 253 273 28 25 Employer contribution 5 4 23 21 Benefits paid (74) (75) (23) (21) ------ ------ ------ ------ Fair value of plan assets at end of year 1,544 1,360 139 111 ------ ------ ------ ------ Funded status 481 404 (223) (249) Unrecognized initial net asset (16) (23) -- -- Unrecognized (gain) loss (517) (442) (57) (30) Unrecognized prior service cost (benefit) 44 4 (12) (25) ------ ------ ------ ------ Net amount recognized $ (8) $ (57) $ (292) $ (304) ====== ====== ====== ====== Amounts recognized in the Consolidated Balance Sheets consist of: Prepaid benefit cost $ 41 $ -- $ -- $ -- Accrued benefit liability (72) (57) (292) (304) Accumulated other comprehensive income 23 -- -- -- ------ ------ ------ ------ Net amount recognized $ (8) $ (57) $ (292) $ (304) ====== ====== ====== ======
Of the pension plans included above, the nonqualified pension plans were the only plans with an accumulated benefit obligation in excess of plan assets. These plans' accumulated benefit obligations were $72 million at Dec. 31, 1998, and $62 million at Dec. 31, 1997. These plans' projected benefit obligations were $77 million at Dec. 31, 1998, and $66 million at Dec. 31, 1997. Because of the nature of such plans, there are no plan assets in the nonqualified plans. After the Closing Date, when Conrail employees are hired by NS, should any pension obligation be assumed by NS that was earned under the Conrail plan, such obligation will be transferred to the NS plans, along with pension assets. PAGE 75 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 11. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued) NS amended its qualified pension plans, effective after the Closing Date, to conform certain provisions of its plan with the Conrail plan and to provide prior service credit to Conrail employees for benefits under the NS plan. The amendment, as it relates to NS employees, increased the pension benefit obligation at Dec. 31, 1998, by $40 million. The amendment, as it will relate to former Conrail employees hired by NS, will result in a further increase to the pension benefit obligation. Pension and other postretirement benefit costs are determined based on actuarial valuations that reflect appropriate assumptions as of the beginning of each year. The funded status of the plans is determined using appropriate assumptions as of each year end. A summary of the major assumptions follows:
1998 1997 1996 ---- ---- ---- Funded status: Discount rate 6.75% 7.25% 7.75% Future salary increases 5% 5.25% 5.25% Pension cost: Discount rate 7.25% 7.75% 7.25% Return on assets in plans 9% 9% 9% Future salary increases 5.25% 5.25% 6%
Pension and Other Postretirement Benefit Costs Components - ---------------------------------------------------------
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- PENSION BENEFITS Service cost $ 13 $ 11 $ 12 Interest cost 67 66 67 Expected return on plan assets (106) (90) (83) Amortization of prior service cost 1 1 1 Amortization of initial net asset (7) (6) (7) Recognized net actuarial (gain) loss (12) (7) 2 ------ ------ ------ Net cost (benefit) $ (44) $ (25) $ (8) ====== ====== ====== OTHER POSTRETIREMENT BENEFITS Service cost $ 10 $ 9 $ 10 Interest cost 24 25 24 Expected return on plan assets (9) (7) (6) Amortization of prior service cost (12) (12) (12) Recognized net actuarial (gain) loss (2) -- -- ------ ------ ------ Net cost $ 11 $ 15 $ 16 ====== ====== ======
For measurement purposes, increases in the per capita cost of covered health care benefits were assumed to be 8.0% for 1999 and 9.8% for 1998. The rate was assumed to decrease gradually to an ultimate rate of 5.0% for 2003 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported in the financial statements. To illustrate, a one-percentage-point change in assumed health care cost trend would have the following effects: PAGE 76 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 11. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued)
One percentage point ($ in millions) Increase Decrease --------------- -------- -------- Increase (decrease) in: Total service and interest cost components $ 4 $ (3) Postretirement benefit obligation $ 28 $ (24)
Under collective bargaining agreements, NS and certain subsidiaries participate in a multi-employer 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 $5 million in 1998 and $4 million in each of 1997 and 1996. 401(k) Plans - ------------ Norfolk Southern and certain subsidiaries provide 401(k) savings plans for employees. Under the plans, NS matches a portion of employee contributions, subject to applicable limitations. NS' expenses under these plans were $10 million in 1998, $9 million in 1997, and $8 million in 1996. 12. LONG-TERM INCENTIVE PLAN Under the stockholder-approved Long-Term Incentive Plan, a committee of nonemployee directors of the Board may grant stock options, stock appreciation rights (SARs), restricted stock, and performance share units (PSUs), up to a maximum 53,025,000 shares of Norfolk Southern Common Stock ("Common Stock"). Options may be granted for a term not to exceed 10 years but may not be exercised prior to the first anniversary of the date of grant. Options are exercisable at the fair market value of Common Stock on the date of grant. The plan also permits the payment -- on a current or a deferred basis and in cash or in stock -- of dividend equivalents on shares of Common Stock covered by options or PSUs granted after Dec. 31, 1989, in an amount commensurate with dividends paid on Common Stock. Tax absorption payments, in amounts estimated to equal the federal and state income taxes applicable to shares of Common Stock issued subject to a share retention agreement, also are authorized. Accounting Method - ----------------- NS applies APB Opinion 25 and related interpretations in accounting for awards made under the plan. Accordingly, PSUs, restricted stock, dividend equivalents, tax absorption payments, and SARs result in charges to net income, while stock options have no effect on net income. Related compensation costs were $25 million in 1998, $29 million in 1997, and $35 million in 1996. Had such compensation costs been determined in accordance with SFAS 123, net income would have been $718 million in 1998, $714 million in 1997, and $763 million in 1996; basic earnings per share would have been $1.90 in 1998, $1.90 in 1997, and $2.01 in 1996; and diluted earnings per share would have been $1.89 in 1998, $1.89 in 1997, and $1.99 in 1996. These pro forma amounts include compensation costs as calculated using the Black-Scholes option-pricing model with an expected option life of five years; risk-free interest rates of 5.5% in 1998, 6.3% in 1997, and 5.2% in 1996; stock-price volatilities of 15% in 1998, 16% in 1997, and 18% in 1996; and, because dividend equivalents are paid, no dividend yield was assumed. PAGE 77 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 12. LONG-TERM INCENTIVE PLAN (continued) Stock Option Activity - ---------------------
Weighted Average Option Shares Exercise Price ------------- --------------- Balance 12/31/95 10,627,857 $ 18.89 Granted 2,061,000 26.02 Exercised (1,648,743) 17.96 Surrendered for SAR (15,000) 7.42 Cancelled (140,577) 19.62 ---------- Balance 12/31/96 10,884,537 20.38 Granted 1,986,000 29.46 Exercised (1,477,226) 17.62 Surrendered for SAR (6,393) 7.42 Cancelled (13,500) 29.46 ---------- Balance 12/31/97 11,373,418 22.32 Granted 3,625,000 32.16 Exercised (1,908,370) 19.22 Cancelled (31,000) 29.46 ---------- Balance 12/31/98 13,059,048 25.48 ==========
Except for those granted during 1998, all outstanding options were exercisable on Dec. 31, 1998. The difference between the weighted average exercise prices for all outstanding options and those exercisable on Dec. 31, 1998, was not significant. Stock Options Outstanding - -------------------------
Exercise Price Number Weighted Average ------------------------------- Outstanding Remaining Range Weighted Average at 12/31/98 Contractual Life ----- ---------------- ----------- ---------------- $11.02 to $14.25 $13.57 1,078,848 1.7 years 18.81 to 21.08 20.40 3,449,700 4.6 years 24.31 to 26.02 25.22 3,122,500 6.2 years 29.46 to 32.16 31.25 5,408,000 8.7 years ---------- $11.02 to $32.16 $25.48 13,059,048 6.5 years ==========
Performance Share Units - ----------------------- PSUs provide for awards based upon achievement of certain predetermined corporate performance goals at the end of a three-year cycle. PSU grants and grant-date fair values were 565,500 and $32.16 in 1998; 529,500 and $29.46 in 1997; and 601,200 and $26.02 in 1996, respectively. PSUs may be paid in the form of shares of Common Stock, cash, or a combination. Shares earned and issued may be subject to share retention agreements and held by NS for up to five years. PAGE 78 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 12. LONG-TERM INCENTIVE PLAN (continued) Shares Available and Issued - --------------------------- Shares of stock available for future grants issued in connection with all features of the Long-Term Incentive Plan are as follows:
1998 1997 1996 ---- ---- ---- Available for future grants 12/31 16,233,600 19,928,853 22,391,937 Shares of common stock issued 2,212,323 1,933,703 2,072,616
13. STOCKHOLDERS' EQUITY Accumulated Other Comprehensive Income - -------------------------------------- "Accumulated other comprehensive income" reported in "Stockholders' equity" included unrealized gains, net of taxes, on securities of $6 million at Dec. 31, 1998, $5 million at Dec. 31, 1997, and $3 million at Dec. 31, 1996, and minimum pension liability of $14 million at Dec. 31, 1998. "Other comprehensive income" reported in the Consolidated Statements of Changes in Stockholders' Equity consisted of the following:
($ in millions) 1998 1997 1996 --------------- ---- ---- ---- Unrealized gains on securities $ 1 $ 4 $ -- Minimum pension liability (23) -- -- Income taxes 9 (2) -- ---- ---- ---- Other comprehensive income $(13) $ 2 $ -- ==== ==== ====
"Unrealized gains on securities" included reclassification adjustments for gains realized in income from the sale of the securities of less than $1 million in each year. Undistributed Earnings of Equity Investees - ------------------------------------------ "Retained income" includes undistributed earnings of equity investees, principally attributable to NS' equity in the earnings of Conrail, of $314 million at Dec. 31, 1998, and $120 million at Dec. 31, 1997. Stock Split - ----------- On July 22, 1997, the Board of Directors approved an amendment of the Articles of Incorporation to increase the number of authorized shares of Common Stock from 450 million to 1,350 million in connection with a three-for-one split to stockholders of record on Sept. 5, 1997. This stock split, with no change in the par value of $1 per share, resulted in the issuance of approximately 266 million additional shares of Common Stock. All share and per share amounts in this report have been restated to reflect the split. PAGE 79 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. STOCKHOLDERS' EQUITY (continued) Stock Purchase Programs - ----------------------- Since 1987, the Board of Directors has authorized the purchase and retirement of up to 285 million shares of Common Stock. Purchases under the programs have been made with internally generated cash, and with proceeds from the sale of commercial paper notes and from the issuance of long-term debt. Since the first purchases in December 1987 and through Oct. 22, 1996, NS had purchased and retired 205.6 million shares of its Common Stock under these programs at a cost of $3.2 billion. On Oct. 23, 1996, NS announced that the stock purchase program had been suspended. Reinstatement of the program and any purchases thereunder are dependent on the economy, cash needs, and alternative investment opportunities. 14. EARNINGS PER SHARE The following table sets forth the calculation of basic and diluted earnings per share:
($ in millions except per share, shares in millions) 1998 1997 1996 ------------------------------- ---- ---- ---- Basic earnings per share: Income available to common stockholders for basic and diluted computations $ 734 $ 721 $ 770 ----- ----- ----- Weighted-average shares outstanding 379 377 379 ----- ----- ----- Basic earnings per share $1.94 $1.91 $2.03 ----- ----- ----- Diluted earnings per share: Weighted-average shares outstanding per above 379 377 379 Dilutive effect of outstanding options, PSUs, and SARs (as determined by the application of the treasury stock method) 2 3 5 ----- ----- ----- Adjusted weighted-average shares outstanding 381 380 384 ----- ----- ----- Diluted earnings per share $1.93 $1.90 $2.01 ===== ===== =====
The options granted in 1998 were excluded from the calculation of diluted earnings per share in the third and fourth quarters because their exercise price exceeded the average market price of Common Stock. There are no adjustments to "Net income" or "Income from continuing operations" for the diluted earnings per share computations. PAGE 80 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 15. FAIR VALUES OF FINANCIAL INSTRUMENTS The fair values of "Cash and cash equivalents," "Accounts receivable," "Short-term debt," and "Accounts payable" approximate carrying values because of the short maturity of these financial instruments. The fair value of corporate-owned life insurance approximates carrying value. The carrying amounts and estimated fair values of other financial instruments, excluding investments accounted for under the equity method in accordance with APB Opinion No. 18, consisted of the following at December 31:
1998 1997 ---- ---- Carrying Fair Carrying Fair ($ in millions) Amount Value Amount Value --------------- -------- ----- -------- ----- Investments $ 100 $ 105 $ 170 $ 170 Long-term debt 7,624 8,182 7,459 7,890 Interest rate swaps -- 20 -- 10
Quoted market prices were used to determine the fair value of marketable securities, all of which were classified as "available-for- sale." Underlying net assets were used to estimate the fair value of other investments. 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. The fair value of interest rate swaps were estimated based on discounted cash flows, reflecting the difference between estimated future variable-rate payments and future fixed-rate receipts. Carrying amounts of marketable securities reflect unrealized holding gains of $9 million on Dec. 31, 1998, and $8 million on Dec. 31, 1997. Sales of "available-for-sale" securities were immaterial for years ended Dec. 31, 1998 and 1997. 16. COMMITMENTS AND CONTINGENCIES Lawsuits - -------- Norfolk Southern 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' ultimate liability is unlikely to have a material adverse effect on NS' financial position, results of operations, or liquidity. Environmental Matters - --------------------- NS is subject to various jurisdictions' environmental laws and regulations. It is NS' policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably. Claims, if any, against third parties for recovery of clean-up costs incurred by NS are reflected as receivables in the balance sheet and are not netted against the associated NS liability. Environmental engineers regularly participate in ongoing evaluations of all identified sites and in determining any necessary adjustments to initial liability estimates. NS also has established an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy. PAGE 81 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 16. COMMITMENTS AND CONTINGENCIES (continued) As of Dec. 31, 1998, NS' 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' estimate of the probable clean-up and remediation costs based on available information at 132 identified locations. On that date, 15 sites accounted for $23 million of the reserve, and no individual site was considered to be material. NS 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 some of the 132 locations, certain NS 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 or by the EPA or comparable state authorities), estimates of NS' 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' traffic mix, particularly those classified as hazardous materials, can pose special risks that NS and its subsidiaries work diligently to minimize. In addition, several NS subsidiaries own, or have owned, 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 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 dealing with 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' financial position, results of operations, or liquidity. Change-In-Control Arrangements - ------------------------------ Norfolk Southern has compensation agreements with officers and certain key employees that become operative only upon a change in control of the Corporation, as defined in those agreements. 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, 1998, certain Norfolk Southern subsidiaries are contingently liable as guarantors with respect to $113 million of indebtedness of related entities. PAGE 82 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 16. COMMITMENTS AND CONTINGENCIES (continued) Year-2000 Compliance - -------------------- NS has under way a project to review and modify, as necessary, its computer applications, hardware, and other equipment to make them Year-2000 compliant. NS has also initiated formal communications with third parties having a substantial relationship to its business, including other railroads, significant suppliers, larger customers, and financial institutions, to determine the extent to which NS may be vulnerable to such third parties' failures to achieve Year-2000 compliance. Failure to achieve Year-2000 compliance -- by NS, or by any such third party, including Conrail and CSXT -- could negatively affect NS' ability to conduct business for an extended period. There can be no assurance that all NS information technology systems and components will be fully Year-2000 compliant; in addition, other companies on which NS' systems and operations rely may or may not be fully compliant on a timely basis, and any such failure could have a material adverse effect on NS' financial position, results of operations, or liquidity. PAGE 83 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors Norfolk Southern Corporation: We have audited the consolidated financial statements of Norfolk Southern Corporation 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 Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, 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 therein. /s/ KPMG LLP Norfolk, Virginia January 26, 1999 PAGE 84 Item 9. Changes in and Disagreements with Accountants on Accounting - ------ ----------------------------------------------------------- and Financial Disclosure. ------------------------ None. PAGE 85 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's definitive Proxy Statement, to be dated April 1, 1999, for the Norfolk Southern Annual Meeting of Stockholders to be held on May 13, 1999, 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 18 under "Executive Officers of the Registrant." PAGE 86 PART IV Item 14. 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, 1998, 1997, and 1996 54 Consolidated Balance Sheets As of December 31, 1998 and 1997 55 Consolidated Statements of Cash Flows Years ended December 31, 1998, 1997, and 1996 57 Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1998, 1997, and 1996 59 Notes to Consolidated Financial Statements 60 Independent Auditors' Report 83 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 93 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. PAGE 87 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------ Form 8-K. (continued) -------- 3. Exhibits Exhibit Number Description - ------- -------------------------------------------------- 3 Articles of Incorporation and Bylaws - 3(i) The Restated Articles of Incorporation of Norfolk Southern Corporation are incorporated herein by reference from Exhibit 3(i) to Norfolk Southern's 1995 Annual Report in Form 10-K. 3(ii) The Bylaws of Norfolk Southern Corporation, as amended January 26, 1999, are filed herewith. 4 Instruments Defining the Rights of Security Holders, Including Indentures - Indentures related to the issuance of notes in the principal amount of $4.3 billion are incorporated herein by reference from Exhibits 4.1 and 4.2 to Norfolk Southern Corporation's Amendment No. 3 to Form S-3, Registration No. 333-24051 filed on May 12, 1997. In accordance with Item 601(b)(4)(iii) of Regulation S-K, copies of other instruments of Norfolk Southern Corporation 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., Registrant, Norfolk Southern Railway Company, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC, with certain schedules thereto, is incorporated herein by reference from Exhibit 10 to Norfolk Southern Corporation's Form 8-K filed electronically on June 30, 1997. PAGE 88 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------ Form 8-K. (continued) -------- Exhibit Number Description - ------- -------------------------------------------------- (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's 1994 Annual Report on Form 10-K. Management Compensation Plans ----------------------------- (c) The Norfolk Southern Corporation Management Incentive Plan, as amended effective January 1, 1996, is incorporated herein by reference from Exhibit 10(b) to Norfolk Southern's 1995 Annual Report on Form 10-K. (d) The Norfolk Southern Corporation Executive Management Incentive Plan, effective January 1, 1996, is incorporated herein by reference from Exhibit 10(c) to Norfolk Southern's 1995 Annual Report on Form 10-K. (e) The Norfolk Southern Corporation Long-Term Incentive Plan, as amended effective November 24, 1998, is filed herewith. (f) The Norfolk Southern Corporation Officers' Deferred Compensation Plan, as amended effective November 24, 1998, is filed herewith. (g) The Directors' Deferred Fee Plan of Norfolk Southern Corporation, as amended effective May 9, 1996, is incorporated herein by reference from Exhibit 10(f) to Norfolk Southern's Form 10-Q Report for the quarter ended June 30, 1996. (h) The Norfolk Southern Corporation Directors' Restricted Stock Plan, effective January 1, 1994, as restated November 24, 1998, is filed herewith. PAGE 89 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------ Form 8-K. (continued) -------- Exhibit Number Description - ------- -------------------------------------------------- (i) Form of Severance Agreement, dated as of June 1, 1996, between Norfolk Southern Corporation and certain executive officers (including those defined as "named executive officers" and identified in the Corporation's Proxy Statement for the 1997 and 1998 Annual Meeting of Stockholders) is incorporated herein by reference from Exhibit 10 to Norfolk Southern's Form 10-Q Report for the quarter ended June 30, 1996. (j) Norfolk Southern Corporation Supplemental (formerly, Excess) Benefit Plan, effective as of January 1, 1996, is incorporated herein by reference from Exhibit 10(i) to Norfolk Southern Corporation's 1996 Annual Report on Form 10-K. (k) The Norfolk Southern Corporation Directors' Charitable Award Program, effective February 1, 1996, is incorporated herein by reference from Exhibit 10(j) to Norfolk Southern's Form 10-Q Report for the quarter ended June 30, 1996. (l) The Norfolk Southern Corporation Directors' Pension Plan, as amended effective June 1, 1996, is incorporated herein by reference from Exhibit 10(k) to Norfolk Southern's Form 10-Q Report for the quarter ended June 30, 1996. (m) The Norfolk Southern Corporation Outside Directors' Deferred Stock Unit Program, as amended on September 23, 1997, is incorporated herein by reference from Exhibit 10(m) to Norfolk Southern's 1997 Annual Report on Form 10-K. (n) The Excess Long-Term Disability Plan of Norfolk Southern Corporation and Participating Subsidiary Companies, effective October 1, 1995, is incorporated herein by reference from Exhibit 10(m) to Norfolk Southern's Form 10-Q Report for the quarter ended June 30, 1996. (o) Description of Norfolk Southern Corporation's 1999 Special Incentive Bonus Program, adopted November 24, 1998, is filed herewith. PAGE 90 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------- Form 8-K. (continued) -------- Exhibit Number Description - ------- -------------------------------------------------- 12 Statement re: Computation of Ratio of Earnings to Fixed Charges. 21 Subsidiaries of the Registrant. 23 Consents of Experts and Counsel - (a) Consent of KPMG LLP. (b) Consent of PricewaterhouseCoopers LLP. 27 Financial Data Schedule. 99 Conrail Inc. 1998 Annual Report to Stockholders. (b) Reports on Form 8-K. The Registrant filed no reports on Form 8-K for the three months ended December 31, 1998. (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 91 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 or her 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 Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 23rd day of March, 1999. NORFOLK SOUTHERN CORPORATION By /s/ David R. Goode ----------------------------------------- (David R. Goode, Chairman, President, and Chief Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 23rd day of March, 1999, by the following persons on behalf of Norfolk Southern Corporation and in the capacities indicated. Signature Title - --------- ----- /s/ David R. Goode - ------------------------------ Chairman, President, and Chief (David R. Goode) Executive Officer and Director (Principal Executive Officer) /s/ Henry C. Wolf - ------------------------------ Vice Chairman and (Henry C. Wolf) Chief Financial Officer (Principal Financial Officer) /s/ John P. Rathbone - ------------------------------ Vice President and Controller (John P. Rathbone) (Principal Accounting Officer) /s/ Gerald L. Baliles - ------------------------------ Director (Gerald L. Baliles) PAGE 93 Signature Title - --------- ----- /s/ Carroll A. Campbell, Jr. - ------------------------------ Director (Carroll A. Campbell, Jr.) /s/ Gene R. Carter - ------------------------------ Director (Gene R. Carter) /s/ L. E. Coleman - ------------------------------ Director (L. E. Coleman) /s/ Steven F. Leer - ------------------------------ Director (Steven F. Leer) /s/ T. Marshall Hahn, Jr. - ------------------------------ Director (T. Marshall Hahn, Jr.) /s/ Landon Hilliard - ------------------------------ Director (Landon Hilliard) /s/ Arnold B. McKinnon - ------------------------------ Director (Arnold B. McKinnon) /s/ Jane Margaret O'Brien - ------------------------------ Director (Jane Margaret O'Brien) /s/ Harold W. Pote - ------------------------------ Director (Harold W. Pote) PAGE 93 Schedule II Page 1 of 2 Norfolk Southern Corporation and Subsidiaries --------------------------------------------- Valuation and Qualifying Accounts Years Ended December 31, 1996, 1997 and 1998 (In millions of dollars)
Additions charged to -------------------- Beginning Other Ending Balance Expenses Accounts Deductions Balance ------- -------- -------- ---------- ------- Year ended December 31, - ---------------------- 1996 ---- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 1 $ 1 $ -- $ -- $ 2 Casualty and other claims included in other liabilities $ 257 $ 116 $ 4(1) $ 129(2) $ 248 Current portion of casualty and other claims included in accounts payable $ 165 $ 16 $ 154(1) $ 169(3) $ 166 Year ended December 31, - ---------------------- 1997 ---- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 2 $ -- $ -- $ -- $ 2 Casualty and other claims included in other liabilities $ 248 $ 108 $ 2(1) $ 105(2) $ 253 Current portion of casualty and other claims included in accounts payable $ 166 $ 14 $ 170(1) $ 178(3) $ 172
(1) Includes revenue overcharges provided through charges to operating revenues, and transfers from other accounts. (2) Payments and reclassifications to/from accounts payable. (3) Payments and reclassifications to/from other liabilities. Note: Prior year amounts have been conformed with the current year presentation, which excludes valuation and qualifying accounts of discontinued operations. (continued) PAGE 94 Schedule II Page 2 of 2 Norfolk Southern Corporation and Subsidiaries --------------------------------------------- Valuation and Qualifying Accounts Years Ended December 31, 1996, 1997 and 1998 (continued) (In millions of dollars)
Additions charged to -------------------- Beginning Other Ending Balance Expenses Accounts Deductions Balance ------- -------- -------- ---------- ------- Year ended December 31, - ---------------------- 1998 ---- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 2 $ -- $ -- $ -- $ 2 Casualty and other claims included in other liabilities $ 253 $ 86 $ 22(1) $ 90(2) $ 271 Current portion of casualty and other claims included in accounts payable $ 172 $ 11 $ 149(1) $ 188(3) $ 144
(1) Includes revenue overcharges provided through charges to operating revenues, and transfers from other accounts. (2) Payments and reclassifications to/from accounts payable. (3) Payments and reclassifications to/from other liabilities. Note: Prior year amounts have been conformed with the current year presentation, which excludes valuation and qualifying accounts of discontinued operations. PAGE 95 EXHIBIT INDEX ------------- Electronic Submission Exhibit Page Number Description Number - ---------- ------------------------------------------------- ------ 3 (ii) The Bylaws of Norfolk Southern Corporation, as amended January 26, 1999, and effective May 14, 1998. 96-106 10 (e) The Norfolk Southern Corporation Long-Term Incentive Plan, as amended effective November 24, 1998. 107-126 10 (f) The Norfolk Southern Corporation Officers' Deferred Compensation Plan, as amended effective November 24, 1998. 127-134 10 (h) The Norfolk Southern Corporation Directors' Restricted Stock Plan, as restated November 24, 1998. 135-136 10 (o) Description of Norfolk Southern Corporation's 1999 Special Incentive Bonus Program, adopted November 24, 1998. 137 12 Statement re: Computation of Ratio of Earnings to Fixed Charges. 138 21 Subsidiaries of Norfolk Southern Corporation. 139-140 23 (a) Consent of KPMG LLP. 141 23 (b) Consent of PricewaterhouseCoopers LLP. 142 27 Financial Data Schedule (This exhibit is required to be submitted electronically pursuant to the rules and regulations of the Securities and Exchange Commission and shall not be deemed filed for purposes of Section 11 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934). 143 99 Conrail Inc. 1998 Annual Report to Stockholders. 144-173 Exhibits 3(ii), 10(e), 10(f), 10(h), 10(o), and 27 are not included in copies assembled for public dissemination. If you have a need for this type of information, we will be pleased to send it to you. Write to: Office of Corporate Secretary Norfolk Southern Corporation Three Commercial Place Norfolk, Virginia 23510-9219 EX-3.II 2 NSC BYLAWS AS AMENDED 01/26/99 PAGE 96 EXHIBIT 3(ii), Page 1 of 11 TITLE PAGE B Y L A W S OF NORFOLK SOUTHERN CORPORATION AS AMENDED JANUARY 26, 1999 PAGE 97 EXHIBIT 3(ii), Page 2 of 11 BYLAWS OF NORFOLK SOUTHERN CORPORATION --------------------------- ARTICLE I STOCKHOLDERS' MEETINGS SECTION 1. ANNUAL MEETING - --------- -------------- The annual meeting of the stockholders of the corporation shall be held on such date in March, April, May or June as the board of directors may designate. If the date of the annual meeting shall be a legal holiday, the meeting shall be held on the next succeeding day not a legal holiday. SECTION 2. SPECIAL MEETINGS - --------- ---------------- Special meetings of the stockholders shall be held whenever called by the chief executive officer or by a majority of the directors. SECTION 3. TIME AND PLACE - --------- -------------- All meetings of the stockholders shall be held at the time and place stated in the notice of meeting. SECTION 4. QUORUM - --------- ------ The holders of a majority of the outstanding shares of capital stock entitled to vote, represented in person or by proxy, shall constitute a quorum at any meeting of the stockholders. If less than a quorum is present at an annual or special meeting, then a majority in interest of the stockholders present in person or by proxy may from time to time adjourn the meeting to a fixed time and place, no further notice of any adjourned meeting being required. Each stockholder shall be entitled to one vote in person or by proxy for each share entitled to vote then outstanding in his name on the books of the corporation. PAGE 98 EXHIBIT 3(ii), Page 3 of 11 SECTION 5. RECORD DATE - --------- ----------- The board of directors may fix in advance a date as the record date for a determination of stockholders for any purpose, such date to be not more than seventy days before the meeting or action requiring a determination of stockholders. SECTION 6. CONDUCT OF MEETINGS - --------- ------------------- The chief executive officer, or any officer or director he may designate, shall preside over all meetings of the stockholders. The secretary of the corporation, or an assistant secretary, shall act as secretary of all the meetings, if present. If the secretary or an assistant secretary is not present, the chairman of the meeting shall appoint a secretary. The board of directors, prior to the annual meeting of the stockholders each year, shall appoint one or more inspectors of election to act at such annual meeting and at all other meetings of stockholders held during the ensuing year. In the event of the failure of the board to make such appointment or if any inspector of election shall for any reason fail to attend and to act at such meeting, an inspector or inspectors of election, as the case may be, may be appointed by the chairman of the meeting. The inspectors of election shall determine the qualification of voters, the validity of proxies and the results of ballots. SECTION 7. PROPOSALS BY STOCKHOLDERS - --------- ------------------------- No business may be transacted at an annual or special meeting of stockholders other than business that is either (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the board of directors, (b) otherwise properly brought before the meeting by or at the direction of the board of directors or (c) otherwise properly brought before the meeting by a stockholder (i) who is a stockholder on the date of the giving of the notice provided for in this Section 7 and on the record date for the determination of stockholders entitled to vote at such meeting and (ii) who gives to the corporation notice in writing of the proposal, provided that such written notice is received at the principal executive office of the corporation, addressed to the Corporate Secretary, (A) in the case of an annual meeting, not less than ninety (90) nor more than one hundred sixty (160) calendar days prior to the anniversary date of the immediately preceding annual meeting and, (B) in the case of a special meeting, not later than the tenth calendar day next following the date on which notice of the holding of the special meeting is mailed to stockholders or public disclosure of the date PAGE 99 EXHIBIT 3(ii), Page 4 of 11 of the special meeting was made, whichever first occurs. The written notice given to the corporation shall include (i) the specific language on which stockholders will be asked to vote, (ii) the name and address of such stockholder, (iii) the class or series and number of shares of the capital stock of the corporation which are owned beneficially and/or of record by such stockholder, (iv) a representation as to the existence and nature of any agreement or understanding between the proposing stockholder and any other person or persons (including their identities) in connection with bringing the proposal, and (v) a representation as to any material interest of the proposing stockholder (and the other person or persons) in the subject matter of the proposal. The requirements of this Section 7 are in addition to any other applicable requirements. ARTICLE II BOARD OF DIRECTORS SECTION 1. ELECTION, NUMBER AND TERM - --------- ------------------------- The board of directors shall be chosen at the annual meeting of the stockholders. The number of directors shall be eleven, and the directors shall be classified and shall hold office for terms as provided in the articles of incorporation. This number may be increased or decreased at any time by amendment of these bylaws, but shall always be a number of not less than three. Directors need not be stockholders. Directors shall hold office until their successors are elected. SECTION 2. QUORUM - --------- ------ A majority of the number of directors fixed by these bylaws shall constitute a quorum. If less than a quorum is present at a meeting, then a majority of those present may adjourn the meeting to a fixed time and place, no further notice of any adjourned meeting being required. SECTION 3. VACANCIES - --------- --------- Any vacancy arising among the directors, including a vacancy resulting from an increase by not more than thirty percent in the number of directors last elected by the stockholders, may be filled by a majority vote of the remaining directors though less than a quorum unless sooner filled by the stockholders. PAGE 100 EXHIBIT 3(ii), Page 5 of 11 SECTION 4. MEETINGS - --------- -------- Meetings of the board of directors shall be held at times fixed by resolution of the board or upon the call of the chief executive officer or of one-third of the members of the board. Notice of any meeting not held at a time fixed by a resolution of the board shall be given to each director at least two days before the meeting at his residence or business address or by delivering such notice to him or by telephoning or telegraphing it to him at least one day before the meeting. Any such notice shall contain the time and place of the meeting. Meetings may be held without notice if all the directors are present or those not present waive notice before or after the meeting. The chief executive officer, or any director he may designate, shall preside over all meetings. SECTION 5. COMMITTEES - --------- ---------- The board of directors may by resolution designate an executive committee and one or more other committees, each of which shall consist of two or more directors. Any such committee, to the extent provided in the resolution of the board of directors and except as otherwise provided by law, shall have and may exercise the powers and authority of the board of directors in the management of the business and affairs of the corporation. SECTION 6. NOMINATIONS OF DIRECTORS - --------- ------------------------ Except as otherwise provided in the Articles of Incorporation, only persons who are nominated in accordance with the following procedures shall be eligible for election as directors. Nominations of persons for election to the board of directors may be made at any annual meeting of the stockholders (a) by or at the direction of the board of directors or (b) by any stockholder (i) who is a stockholder on the date of the giving of the notice provided for in this Section 6 and on the record date for the determination of stockholders entitled to vote at such meeting and (ii) who gives to the corporation notice in writing of the nomination, provided that such written notice is received at the principal executive office of the corporation, addressed to the Corporate Secretary, not less than ninety (90) nor more than one hundred sixty (160) calendar days prior to the anniversary date of the immediately preceding annual meeting. The written notice given to the corporation shall include all the information about the nominee that would be required by applicable rules and regulations of the Securities and Exchange Commission to be included for nominees listed in the proxy statement for such meeting and shall include (i) the name and address of such stockholder and (ii) the class or series and number of shares of PAGE 101 EXHIBIT 3(ii), Page 6 of 11 the capital stock of the corporation which are owned beneficially and/or of record by such stockholder. Such notice must be accompanied by a written consent of each proposed nominee to being named as a nominee and to serve as a director if elected. ARTICLE III OFFICERS SECTION 1. ELECTION, NUMBER AND TERM - --------- ------------------------- The board of directors, promptly after its election in each year, may elect a chairman of the board and shall elect a president (one of whom shall be designated chief executive officer), a secretary and a treasurer, and may elect one or more vice chairmen and vice presidents and may appoint such other officers as it may deem proper. Any officer may hold more than one office except that the same person shall not be president and secretary. Each officer shall hold office until his successor is elected or until his death or until he resigns or is removed in the manner hereinafter provided. SECTION 2. REMOVAL - --------- ------- Any officer may be removed at any time by the vote of the board of directors and any officer or agent appointed otherwise than by the board of directors may be removed by any officer having authority to appoint that officer or agent. SECTION 3. VACANCIES - --------- --------- Vacancies among the officers elected by the board of directors shall be filled by the directors. SECTION 4. THE CHIEF EXECUTIVE OFFICER - --------- --------------------------- The chief executive officer, subject to the control of the board of directors, shall in general supervise and control all of the business and affairs of the corporation. All officers and agents, other than officers or agents elected or appointed by the board of directors, shall be appointed by the chief executive officer or by the heads of departments, subject to the approval of the chief executive officer. Unless otherwise specifically provided in these bylaws or by direction of the board of directors, PAGE 102 EXHIBIT 3(ii), Page 7 of 11 the chief executive officer or, at his direction, any officer, employee or agent of the corporation designated by him, may sign and execute all representations, securities, conveyances of real and personal property, leases, licenses, releases, contracts and other obligations and instruments in the name of the corporation. SECTION 5. THE VICE CHAIRMEN AND VICE PRESIDENTS - --------- ------------------------------------- The vice chairmen and the vice presidents shall perform such duties as from time to time may be assigned to them by the chief executive officer or by the board of directors. In the absence of the chief executive officer, or in the event of his death, inability or refusal to act, the officer designated by the chief executive officer or the board of directors shall perform the duties of the chief executive officer, and, when so acting, shall have all the powers of and be subject to all the restrictions upon the chief executive officer. Any vice chairman or vice president may sign, with the secretary or an assistant secretary, certificates for shares of the corporation. SECTION 6. THE SECRETARY - --------- ------------- The secretary shall: (a) keep the minutes of the meetings of the stockholders and the board of directors in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these bylaws or as required by law; (c) be custodian of the corporate records and of the seal of the corporation and see that the seal of the corporation is affixed to all documents the execution of which on behalf of the corporation under its seal is duly authorized; (d) keep a register of the post office address of each stockholder which shall be furnished to the secretary by such stockholders; (e) sign with the chairman of the board, a vice chairman, the president, or a vice president, certificates for shares of the corporation, the issuance of which shall have been authorized by resolution of the board of directors; (f) have general charge of the stock transfer books of the corporation; and (g) in general perform all duties incident to the office of secretary and such other duties as from time to time may be assigned to him by the chief executive officer or by the board of directors. PAGE 103 EXHIBIT 3(ii), Page 8 of 11 SECTION 7. THE TREASURER - --------- ------------- If required by the board of directors, the treasurer shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the board of directors shall determine. He shall: (a) have charge and custody of and be responsible for all funds and securities of the corporation; receive and give receipts for moneys due and payable to the corporation from any source whatsoever, and deposit all such moneys in the name of the corporation in such banks, trust companies or other depositories as shall be selected in accordance with the provisions of Article IV of these bylaws; (b) when duly authorized, disperse all moneys belonging or coming to the corporation; and (c) in general perform all the duties incident to the office of treasurer and such other duties as from time to time may be assigned to him by the chief executive officer or by the board of directors. SECTION 8. ASSISTANT SECRETARIES AND ASSISTANT TREASURERS - --------- ---------------------------------------------- The assistant secretaries, when authorized by the board of directors, may sign with the chairman of the board, a vice chairman, the president or a vice president certificates for shares of the corporation the issuance of which shall have been authorized by a resolution of the board of directors. The assistant treasurers shall respectively, if required by the board of directors, give bonds for the faithful discharge of their duties in such sums and with such sureties as the board of directors shall determine. The assistant secretaries and assistant treasurers, in general, shall perform such duties as shall be assigned to them by the secretary or the treasurer, respectively, or by the chief executive officer or the board of directors. SECTION 9. SALARIES - --------- -------- The salaries of the officers elected by the board of directors shall be fixed by the board of directors. The salaries of all other officers shall be fixed by the chief executive officer or by the heads of departments, subject to the approval of the chief executive officer. PAGE 104 EXHIBIT 3(ii), Page 9 of 11 ARTICLE IV CHECKS AND DEPOSITS SECTION 1. CHECKS AND DRAFTS - --------- ----------------- All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the corporation, shall be signed by such officer or officers, agent or agents of the corporation and in such manner as shall from time to time be determined by resolution of the board of directors. SECTION 2. DEPOSITS - --------- -------- All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies or other depositories as may be selected in a manner authorized by the board of directors. ARTICLE V CERTIFICATE OF STOCK Each stockholder shall be entitled to a certificate or certificates of stock in such form as may be approved by the board of directors signed by the chairman of the board, a vice chairman, the president or a vice president and by the secretary or an assistant secretary or the treasurer or any assistant treasurer. All transfers of stock of the corporation shall be made upon its books by surrender of the certificate for the shares transferred accompanied by an assignment in writing by the holder and may be accomplished either by the holder in person or by a duly authorized attorney in fact. In case of the loss, mutilation or destruction of a certificate of stock, a duplicate certificate may be issued upon such terms not in conflict with law as the board of directors may prescribe. The board of directors may also appoint one or more transfer agents and registrars and may require stock certificates to be countersigned by a transfer agent or registered by a registrar or may require stock certificates to be both countersigned by a transfer agent and registered by a registrar. If certificates of capital stock of the corporation are signed by a transfer agent or PAGE 105 EXHIBIT 3(ii), Page 10 of 11 by a registrar (other than the corporation itself or one of its employees), the signature thereon of the officers of the corporation and the seal of the corporation thereon may be facsimiles, engraved or printed. In case any officer or officers who shall have signed, or whose facsimile signature or signatures shall have been used on, any such certificate or certificates shall cease to be such officer or officers of the corporation, whether because of death, resignation or otherwise, such certificate or certificates may nevertheless be issued and delivered as though the person or persons who signed such certificate or certificates or whose facsimile signature or signatures shall have been used thereon had not ceased to be such officer or officers of the corporation. ARTICLE VI SEAL The seal of the corporation shall be a flat-faced circular die, of which there may be any number of counterparts, with the word "SEAL" and the name of the corporation and the state and year of incorporation engraved thereon. ARTICLE VII FISCAL YEAR The fiscal year of the corporation shall begin on the first day of January and end on the thirty-first day of December in each year. ARTICLE VIII VOTING OF STOCK HELD Unless otherwise ordered by the board of directors, the chief executive officer, or his designee, shall have full power and authority in behalf of the corporation to attend and to act and to vote at any meetings of stockholders of any corporation in which the corporation may hold stock, and at any such meeting shall possess and may exercise any and all the rights and powers incident to the ownership of such stock, which, as the owner PAGE 106 EXHIBIT 3(ii), Page 11 of 11 thereof, the corporation might have possessed and exercised if present, and may sign proxies on behalf of the corporation with respect to any such meeting or sign consents on behalf of the corporation with respect to corporate actions permitted without a meeting of stockholders. The board of directors, by resolution, from time to time, may confer like powers upon any other person or persons. ARTICLE IX AMENDMENTS These bylaws may be altered, amended or repealed and new bylaws may be adopted by the board of directors at any regular or special meeting of the board of directors. EX-10.E 3 NSC LONG-TERM INCENTIVE PLAN AS AMENDED EFFECTIVE 11/24/98 PAGE 107 EXHIBIT 10(e), Page 1 of 20 NORFOLK SOUTHERN CORPORATION LONG-TERM INCENTIVE PLAN AS AMENDED EFFECTIVE NOVEMBER 24, 1998 SECTION 1. PURPOSE - --------- ------- The purpose of the Long-Term Incentive Plan, as amended (the "Plan"), is to promote the success of Norfolk Southern Corporation (the "Corporation") and to provide an opportunity for officers and other key employees of the Corporation and its Subsidiary Companies (as hereinafter defined) to acquire or increase a proprietary interest in the Corporation and thereby to provide an additional incentive to officers and other key employees to devote their maximum efforts and skills to the advancement, betterment, and prosperity of the Corporation and its shareholders. The Plan provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, performance share units, performance shares, and shares of the Corporation's common stock (restricted pursuant to the provisions of Section 9 of the Plan), in accordance with the terms and conditions set forth below. SECTION 2. DEFINITIONS - --------- ----------- The terms used herein shall have the following meanings unless otherwise specified or unless a different meaning is clearly required by the context: Award Any one or more of the following: Incentive Stock Option; Non-Qualified Stock Option; Stock Appreciation Right; Restricted Shares; Performance Share Units; and Performance Shares. Beneficiary The person or persons designated in writing by the Participant as his Beneficiary in respect of Awards or, in the absence of such a designation or if the designated person or persons predecease the Participant, the person or persons who shall acquire the Participant's rights in respect of Awards by bequest or inheritance in accordance with the applicable laws of descent and distribution. In order to be effective, a Participant's designation of a Beneficiary must be on file with the Corporation before the Participant's death. Any such designation may be revoked PAGE 108 EXHIBIT 10(e), Page 2 of 20 and a new designation substituted therefor by the Participant at any time before his death without the consent of the previously designated Beneficiary. Board of Directors The Board of Directors of the Corporation. Code The Internal Revenue Code of 1986, as amended from time to time. Committee The Compensation and Nominating Committee of the Board of Directors. Common Stock The Common Stock of the Corporation. Disability A disability that enables the Participant to be eligible for and receive a disability benefit under the Long-Term Disability Plan of the Corporation or a long-term disability plan of a Subsidiary Company (whichever is applicable), as amended from time to time. Exercise Gain With respect to a Stock Appreciation Right, Shares all of the shares of Common Stock received upon exercise of the Stock Appreciation Right. With respect to an Option, the portion of the shares of Common Stock received upon exercise of the Option equal to the excess of the Fair Market Value, as of the exercise date, over the Option price, multiplied by the number of shares purchased under the Option on the exercise date, divided by such Fair Market Value, and rounded down to the nearest whole number of shares. Fair Market Value The value of Common Stock on a particular date as measured by the mean of the high and low prices at which it is traded on such date as reported in the Composite Transactions for such date by "The Wall Street Journal," or, if Common Stock was not traded on such date, on the next preceding day on which Common Stock was traded. Incentive Stock An Option that complies with the terms and Option conditions set forth in Section 422(b) of the Code and is designated by the Committee as an Incentive Stock Option. PAGE 109 EXHIBIT 10(e), Page 3 of 20 Non-Qualified An Option granted under the Plan other than an Stock Option Incentive Stock Option. Option Any option to purchase Common Stock granted pursuant to the provisions of Section 6 or Section 7 of the Plan. Optionee A Participant who is the holder of an Option. Participant Any officer or key employee of the Corporation or a Subsidiary Company selected by the Committee to participate in the Plan. Performance Cycle The period of time, designated by the Committee, over which Performance Shares may be earned. Performance Shares of Common Stock granted pursuant to Shares Section 10 of the Plan, which may be made subject to the restrictions and other terms and conditions prescribed in Section 11 of the Plan. Performance Share Contingent rights to receive Performance Units Shares pursuant to Section 10 of the Plan. Restricted Shares Shares of Common Stock granted pursuant to Section 9 of the Plan and subject to the restrictions and other terms and conditions set forth therein. Restriction Period A period of time not less than twenty-four (24) nor more than sixty (60) months, to be determined within those limits by the Committee in its sole discretion, commencing on the date as of which Restricted Shares are granted, during which the restrictions imposed by paragraph (b) of Section 9 of the Plan shall apply. The Committee shall determine the length of the Restriction Period at the time that the Restricted Shares are granted. Retirement Retirement from the Corporation or a Subsidiary Company pursuant to the provisions of the Retirement Plan of the Corporation or a PAGE 110 EXHIBIT 10(e), Page 4 of 20 retirement plan of a Subsidiary Company (whichever is applicable), as amended from time to time. Share Retention An agreement entered into pursuant to Agreement Section 11 of the Plan. Stock Appreciation The right, granted pursuant to the provisions Right of Section 8 of the Plan, to receive a payment equal to the excess of the Fair Market Value of Common Stock over the Option price of such Common Stock, as specified in Section 8 of the Plan. Subsidiary Company A corporation of which at least eighty percent (80%) of the total combined voting power of all classes of stock entitled to vote is owned, directly or indirectly, by the Corporation. SECTION 3. ADMINISTRATION - --------- -------------- The Plan shall be administered by the Committee, which, subject to the limitations set forth herein, shall have the full and complete authority and sole discretion from time to time to construe and interpret the Plan; to select the officers and other key employees who shall be granted Awards under the Plan; to determine the type, size, terms, and conditions of the Award or Awards to be granted to each such Participant; to authorize the grant of such Awards pursuant to the Plan; to give a Participant an election to surrender an Award in exchange for the grant of a new Award; to adopt, amend and rescind rules and regulations relating to the Plan; and to make all other determinations and take all other action it may deem necessary or advisable for the implementation and administration of the Plan. The Committee may authorize the grant of more than one type of Award, and Awards subject to differing terms and conditions, to any eligible employee. The Committee's decision to authorize the grant of an Award to an employee at any time shall not require the Committee to authorize the grant of an Award to that employee at any other time or to any other employee at any time; nor shall its determination with respect to the size, type, or terms and conditions of the Award to be granted to an employee at any time require it to authorize the grant of an Award of the same type or size or with the same terms and conditions to that employee at any other time or to any other employee at any time. The PAGE 111 EXHIBIT 10(e), Page 5 of 20 Committee shall not be precluded from authorizing the grant of an Award to any eligible employee solely because the employee previously may have been granted an Award of any kind under the Plan. All determinations of the Committee shall be by a majority of its members and shall be final, conclusive and binding. Each member of the Committee, while serving as such, shall be considered to be acting in his capacity as a director of the Corporation, and no member of the Committee shall be liable for any action taken or decision made in good faith with respect to the implementation or administration of the Plan. SECTION 4. ELIGIBILITY - --------- ----------- To be eligible for selection by the Committee to participate in the Plan, an individual must be a full-time salaried officer or key employee of the Corporation, or of a Subsidiary Company, on the date on which the Committee authorizes the grant to such individual of an Award. A director of the Corporation shall not be eligible to participate in the Plan unless he is a full-time salaried officer of the Corporation or a Subsidiary Company. SECTION 5. SHARES AVAILABLE - --------- ---------------- Subject to the provisions of Section 13 of the Plan, no more than an aggregate of 39,878,604 shares of Common Stock may be issued pursuant to the Plan. Such shares shall be provided from shares of Common Stock authorized but not issued. Any shares of Common Stock which were subject to an Option, a Stock Appreciation Right, or a Performance Share Unit, and which were not issued prior to the expiration of the Award shall thereafter again be available for award under the Plan. Upon the forfeiture of any Restricted Shares, the forfeited shares of Common Stock shall thereafter be available for award under the Plan. Notwithstanding any other provision to the contrary, no Participant may be awarded a grant in any one year, which, when added to any other grant of Options, Restricted Shares, and Performance Share Units in the same year, shall exceed 750,000 shares of Common Stock. If an Option is canceled, the canceled Option continues to count against the maximum number of shares for which Options may be granted to a Participant in any year. PAGE 112 EXHIBIT 10(e), Page 6 of 20 SECTION 6. INCENTIVE STOCK OPTIONS - --------- ----------------------- (a) General ------- The Committee may authorize the grant of Incentive Stock Options subject to the terms and conditions set forth in this Section 6. The grant of an Incentive Stock Option shall be evidenced by a written Incentive Stock Option Agreement between the Corporation and the Optionee, setting forth the number of shares of Common Stock subject to the Incentive Stock Option evidenced thereby and the terms, conditions, and restrictions applicable thereto. The issuance of shares of Common Stock pursuant to an Incentive Stock Option also shall be subject to the provisions of any Share Retention Agreement that may be required by the Committee under Section 11 of the Plan. (b) Option Price ------------ The Committee shall determine the Option price for each share of Common Stock purchased under an Option, but, subject to the provisions of Section 13 of the Plan, in no event shall the Option price be less than one-hundred percent (100%) of the Fair Market Value of the Common Stock on the date the Option is granted. (c) Duration of Options ------------------- The Committee shall fix the term or duration of Options, provided that such term shall not exceed ten (10) years from the date the Option is granted, and that such term shall be subject to earlier termination pursuant to the provisions of paragraph (g) of this Section 6 or paragraph (e) of Section 8 of the Plan. (d) Non-Transferability of Options ------------------------------ Options are not transferable other than by will or the applicable laws of descent and distribution following the death of the Optionee. Options may be exercised during the lifetime of the Optionee only by him, and following his death only by his Beneficiary. PAGE 113 EXHIBIT 10(e), Page 7 of 20 (e) Exercise of Options ------------------- The Committee shall determine the time or times at which Options may be exercised; provided that such time or times shall not occur before the latest of: (i) the first anniversary of the date on which the Option was granted; (ii) approval of the Plan, as hereby amended, by the stockholders of the Corporation in the manner provided under Section 15(a) of the Plan; and (iii) the effectiveness of any registration statement required to be filed under the Securities Act of 1933 for the registration of the Common Stock to be issued upon exercise of the Option. (f) Payment of Option Price ----------------------- The purchase price of Common Stock upon exercise of an Option shall be paid in full to the Corporation at the time of the exercise of the Option in cash or, at the discretion of the Committee and subject to any limitations or requirements that the Committee may adopt, by the surrender to the Corporation of shares of previously acquired Common Stock, which have been held by the Optionee for at least twelve (12) months and which shall be valued at Fair Market Value on the date that the Option is exercised, or, at the discretion of the Committee, by a combination of cash and such Common Stock. (g) Termination of Options ---------------------- No Option shall be exercisable after it expires. Each Option shall expire upon the earliest of: (i) the expiration of the term for which the Option was granted; (ii) (A) Except as otherwise provided by the Committee, in the case of an Optionee whose employment with the Corporation or a Subsidiary Company is terminated due to Retirement, Disability or death, the expiration of thirty-six (36) months after such termination of employment, or PAGE 114 EXHIBIT 10(e), Page 8 of 20 (B) in the case of an Optionee whose employment with the Corporation or a Subsidiary Company is terminated for any reason other than Retirement, Disability, or death, at the close of business on the last day of active service by the Optionee with the Corporation or a Subsidiary Company; or (iii) with the Optionee's consent, the grant of a new Award to replace the Option. (h) Limitation on Exercisability ---------------------------- The aggregate Fair Market Value (determined as of the time the Incentive Stock Option is granted) of the Common Stock with respect to which Incentive Stock Options (granted on or after January 1, 1987) are exercisable for the first time by the Optionee during any calendar year shall not exceed $100,000. (i) Order of Exercise ----------------- An Incentive Stock Option granted prior to January 1, 1987, shall not be exercisable while there is outstanding any Incentive Stock Option which was granted to the Optionee before the grant of the first-mentioned Incentive Stock Option. For this purpose, an Incentive Stock Option shall be treated as outstanding until it is exercised in full or expires in accordance with paragraph (c) of this Section 6. As used in paragraphs (h) and (i) of this Section 6, the term Incentive Stock Option shall mean an option to purchase stock which is granted pursuant to the provisions of this Plan or of any other plan of the Corporation or of a parent or subsidiary corporation (as defined by Section 424(f) of the Code) and which complies with the terms and conditions set forth in Section 422(b) of the Code. SECTION 7. NON-QUALIFIED STOCK OPTIONS - --------- --------------------------- The Committee may authorize the grant of Non-Qualified Stock Options subject to the terms and conditions specified in this Section 7. The grant of a Non-Qualified Stock Option shall be evidenced by a written Non-Qualified Stock Option Agreement between the Corporation and the Optionee, setting forth the number of shares of Common Stock subject to the Non-Qualified Stock Option evidenced thereby and the terms, conditions, and restrictions applicable thereto. Non-Qualified Stock Options PAGE 115 EXHIBIT 10(e), Page 9 of 20 granted pursuant to the provisions of this Section 7 shall be subject to the terms, conditions, and restrictions set forth in paragraphs (b) and (d) through (g) of Section 6 of the Plan. The limitations set forth in paragraphs (c), (h) and (i) of Section 6 of the Plan shall not apply to Non-Qualified Stock Options. The issuance of shares of Common Stock pursuant to a Non-Qualified Stock Option also shall be subject to the provisions of any Share Retention Agreement that may be required by the Committee under Section 11 of the Plan. SECTION 8. STOCK APPRECIATION RIGHTS - --------- ------------------------- (a) General ------- The Committee may grant a Stock Appreciation Right to a Participant in connection with an Option, or portion thereof as determined by the Committee, subject to the terms and conditions set forth in this Section 8. The Stock Appreciation Right may be granted at the time of grant of the related Option and shall be subject to the same terms and conditions as the related Option, except as this Section 8 may otherwise provide. The grant of a Stock Appreciation Right shall be evidenced either by provisions in the Option agreement evidencing the related Option or by a written Stock Appreciation Right Agreement between the Corporation and the Optionee, identifying the related Option, specifying the number of shares of Common Stock subject thereto, and setting forth the terms and conditions applicable to the Stock Appreciation Right. (b) Exercise -------- A Stock Appreciation Right shall be exercisable only at such time or times, to such extent, and by such persons, as the Option to which it relates shall be exercisable; provided that: (i) if the Committee determines that all or part of a payment in respect of a Stock Appreciation Right shall be made in cash, the Stock Appreciation Right shall not be exercised before the expiration of one (1) year from the date on which it was granted; provided, however, that this subparagraph (i) shall not apply if the death or Disability of the Optionee occurs within one (1) year after the grant of the Stock Appreciation Right; PAGE 116 EXHIBIT 10(e), Page 10 of 20 (ii) if the Committee determines that all or part of a payment in respect of a Stock Appreciation Right shall be made in cash, such exercise may occur only on a day that is at least three (3) and no more than twelve (12) business days after the date on which the Corporation first made publicly available its most recent regular quarterly or annual financial statements; and (iii) a Stock Appreciation Right granted in connection with an Incentive Stock Option may not be exercised on any date on which the Fair Market Value of a share of Common Stock is less than or equal to the Option price per share under the related Incentive Stock Option. A Stock Appreciation Right shall be exercised by surrendering the related Option, or the portion thereof pertaining to the shares with respect to which the Stock Appreciation Right is exercised, and providing the Corporation with a written notice in such form and containing such information (including the number of shares of Common Stock with respect to which the Stock Appreciation Right is being exercised) as the Committee may specify. The date on which the Corporation receives such notice shall be the date on which the related Option, or portion thereof, shall be deemed surrendered and the Stock Appreciation Right shall be deemed exercised. (c) Payment ------- Upon exercise of a Stock Appreciation Right in the manner provided in paragraph (b) of this Section 8, the Optionee shall be entitled to receive Exercise Gain Shares equal to the number of shares of Common Stock that have an aggregate Fair Market Value on the exercise date equal to the amount by which the Fair Market Value of a share of Common Stock on the exercise date exceeds the Option price per share of the related Option, multiplied by the number of shares covered by the related Option, or portion thereof, surrendered in connection with the exercise of the Stock Appreciation Right. The Exercise Gain Shares shall be subject to the provisions of any Share Retention Agreement that may be required by the Committee under Section 11 of the Plan. In the sole discretion of the Committee, all or part of the payment in respect of a Stock Appreciation Right may be made in cash in lieu of Exercise Gain Shares. (d) Termination of Right -------------------- A Stock Appreciation Right shall expire, unless previously exercised or canceled, upon the expiration of the Option to which it relates. PAGE 117 EXHIBIT 10(e), Page 11 of 20 (e) Effect of Exercise ------------------ A Stock Appreciation Right shall be canceled when, and to the extent that, the related Option is exercised, and an Option shall be canceled when, and to the extent that, the Option is surrendered to the Corporation upon the exercise of a related Stock Appreciation Right. SECTION 9. RESTRICTED SHARES - --------- ----------------- (a) General ------- The Committee, in its sole discretion, may from time to time authorize the grant of Restricted Shares to a Participant. A certificate or certificates representing the number of Restricted Shares granted shall be registered in the name of the Participant. Until the expiration of the Restriction Period or the lapse of restrictions in the manner provided in paragraph (d) or paragraph (e) of this Section 9, the certificate or certificates shall be held by the Corporation for the account of the Participant, and the Participant shall have beneficial ownership of the Restricted Shares, including the right to receive dividends on, and the right to vote, the Restricted Shares. (b) Restrictions ------------ Until the expiration of the Restriction Period or the lapse of restrictions in the manner provided in paragraph (d) or paragraph (e) of this Section 9, Restricted Shares shall be subject to the following restrictions and any additional restrictions that the Committee, in its sole discretion, may from time to time deem desirable in furtherance of the objectives of the Plan: (i) the Participant shall not be entitled to receive the certificate or certificates representing the Restricted Shares; (ii) the Restricted Shares may not be sold, transferred, assigned, pledged, conveyed, hypothecated, or otherwise disposed of; and (iii) the Restricted Shares may be forfeited immediately as provided in paragraph (d) of this Section 9. PAGE 118 EXHIBIT 10(e), Page 12 of 20 (c) Distribution of Restricted Shares --------------------------------- If a Participant to whom Restricted Shares have been granted remains in the continuous employment of the Corporation or a Subsidiary Company during the entire Restriction Period, upon the expiration of the Restriction Period all restrictions applicable to the Restricted Shares shall lapse, and the certificate or certificates representing the shares of Common Stock that were granted to the Participant in the form of Restricted Shares shall be delivered to the Participant. (d) Termination of Employment ------------------------- If the employment of a Participant is terminated for any reason other than the Retirement, Disability, or death of the Participant in service before the expiration of the Restriction Period, the Restricted Shares shall be forfeited immediately and all rights of the Participant to such shares shall terminate immediately without further obligation on the part of the Corporation or any Subsidiary Company. If the Participant's employment is terminated by reason of the Retirement, Disability, or death of the Participant in service before the expiration of the Restriction Period, the number of Restricted Shares held by the Corporation for the Participant's account shall be reduced by the proportion of the Restriction Period remaining after the Participant's termination of employment; the restrictions on the balance of such Restricted Shares shall lapse on the date the Participant's employment terminated; and the certificate or certificates representing the shares of Common Stock upon which the restrictions have lapsed shall be delivered to the Participant (or, in the event of the Participant's death, to his Beneficiary). (e) Waiver of Restrictions ---------------------- The Committee, in its sole discretion, may waive any or all restrictions with respect to Restricted Shares. SECTION 10. PERFORMANCE SHARES - ---------- ------------------ The Committee, in its sole discretion, may from time to time authorize the grant of Performance Share Units to a Participant. Performance Share Units shall entitle the Participant to Performance Shares (or cash in lieu thereof) upon the achievement of such performance goals as may be established by the Committee at the time of grant for three equally weighted performance criteria: (a) the Corporation's total stockholder return as compared to the S&P 500 Index; (b) the Corporation's operating PAGE 119 EXHIBIT 10(e), Page 13 of 20 ratio; and (c) the Corporation's return on average capital invested. At such time as it is certified by the Committee that the performance goals established by the Committee have been attained or otherwise satisfied, the Committee shall authorize the payment of cash in lieu of Performance Shares or the issuance of Performance Shares registered in the name of the Participant, subject to the provisions of any Share Retention Agreement that may be required by the Committee under Section 11 of the Plan, or both. If the Participant's employment with the Corporation or a Subsidiary Company is terminated before the end of a Performance Cycle for any reason other than Retirement, Disability, or death, the Participant shall forfeit all rights with respect to any Performance Shares that were being earned during the Performance Cycle. The Committee, in its sole discretion, may establish guidelines providing that if a Participant's employment is terminated before the end of a Performance Cycle by reason of Disability, or death, the Participant shall be entitled to a prorated payment with respect to any Performance Shares that were being earned during the Performance Cycle. If the Participant's employment is terminated before the end of a Performance Cycle by reason of Retirement, the Participant's rights with respect to any Performance Shares being earned during the Performance Cycle shall, subject to the other provisions of this Section 10, continue as if the Participant's employment had continued through the end of the Performance Cycle. SECTION 11. SHARE RETENTION AGREEMENTS - ---------- -------------------------- (a) General ------- The Committee, in its sole discretion, may require as a condition of an Award of an Option, Stock Appreciation Right, or Performance Share Unit that the Participant and the Corporation enter into a Share Retention Agreement, which shall provide that the certificate or certificates representing any Exercise Gain Shares or Performance Shares, when issued, shall be held by the Secretary of the Corporation for the benefit of the Participant until such time as the retention period specified by the Share Retention Agreement has expired or has been waived by the Committee, whichever occurs first. Each Share Retention Agreement may include some or all of the terms, conditions and restrictions set forth in paragraphs (b) through (g) of this Section 11. PAGE 120 EXHIBIT 10(e), Page 14 of 20 (b) Retention Period ---------------- Exercise Gain Shares and Performance Shares that are subject to the Share Retention Agreement may not be sold, transferred, assigned, pledged, conveyed, hypothecated or otherwise disposed of within such period of time, of not less than twenty-four (24) months and not more than sixty (60) months following the date of exercise (in the case of Exercise Gain Shares) or the date of issuance (in the case of Performance Shares), as shall be prescribed by the Committee. (c) Tax Absorption Payment ---------------------- The Corporation may make a cash payment, either directly to the Participant or on the Participant's behalf, in an amount that the Committee estimates to be equal (after taking into account any Federal and state taxes that the Committee estimates to be applicable to such cash payment) to any additional Federal and state income taxes that are imposed upon the Participant as a result of the issuance of the Exercise Gain Shares or Performance Shares that are subject to the Share Retention Agreement. In determining the amount to be paid pursuant to this paragraph (c), the Committee may adopt such methods and assumptions as it considers appropriate, and it shall not be required to examine the individual tax liability of each Participant who has entered into a Share Retention Agreement. (d) Termination of Employment ------------------------- If a Participant's employment with the Corporation or a Subsidiary Company is terminated for any reason other than Retirement, Disability, or death, Exercise Gain Shares or Performance Shares subject to the Share Retention Agreement shall continue to be held, following the Participant's termination of employment, until the expiration of the retention period specified by the Share Retention Agreement. If the Participant's employment is terminated by reason of Retirement or Disability, Exercise Gain Shares and Performance Shares then held subject to the Share Retention Agreement shall continue to be held until the expiration of the applicable retention period following termination of employment, but any such retention period shall cease upon the earlier of the Participant's attainment of age 65 or the expiration of two (2) years after the Participant's Retirement or Disability, if either of those events occurs before the expiration of the applicable retention period. If the Participant dies while Exercise Gain Shares or Performance Shares are subject to a retention period under the Share Retention Agreement, such retention period shall expire immediately at the time of death. PAGE 121 EXHIBIT 10(e), Page 15 of 20 (e) Change in Control ----------------- Upon a Change in Control, the retention periods specified by all Share Retention Agreements shall immediately expire. A Change in Control shall occur if: (i) any person, other than the Corporation or a Subsidiary Company or any employee benefit plan sponsored by the Corporation or a Subsidiary Company, shall become the beneficial owner of, or obtain voting control over, 20% or more of the Corporation's outstanding Common Stock; (ii) the stockholders of the Corporation shall approve (A) any consolidation or merger of the Corporation in which the Corporation is not the continuing or surviving corporation or pursuant to which shares of Common Stock would be converted into cash, securities, or other property, other than a merger of the Corporation in which holders of Common Stock immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger as immediately before, or (B) any sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all or substantially all the assets of the Corporation; or (iii) there shall have been a change in the composition of the Board of Directors such that within any period of two (2) consecutive years or less individuals who at the beginning of such period constituted such Board, together with any new directors whose election, or nomination for election by the Corporation's stockholders, was approved by a vote of at least two-thirds of the directors then in office who were directors at the beginning of such period, shall for any reason no longer constitute a majority of the directors of the Corporation. If the expiration of a Share Retention Agreement pursuant to this paragraph (e) causes a Participant to be subject to an excise tax under Section 4999 of the Code, or any successor provision thereto (the "Excise Tax"), the Corporation shall make a cash payment, either directly to the Participant or on the Participant's behalf, in an amount that the Committee estimates to be equal (after taking into account any Federal and state taxes, including interest and penalties, that the Committee estimates to be applicable to the additional cash payment) to the additional Excise Tax imposed on the PAGE 122 EXHIBIT 10(e), Page 16 of 20 Participant as a result of the expiration of the Share Retention Agreement. In determining the amount to be paid pursuant to this subparagraph, the Committee may adopt such methods and assumptions as it considers appropriate, and it shall not be required to examine the individual tax liability of each Participant to whom this subparagraph applies. (f) Waiver of Requirements ---------------------- The Committee, in its sole discretion, may waive any or all retention periods or other restrictions in the Share Retention Agreement. (g) Distribution of Shares ---------------------- The Secretary of the Corporation shall promptly distribute the certificate or certificates representing the Exercise Gain Shares or Performance Shares subject to a Share Retention Agreement upon expiration of the retention period or other termination or waiver of the restrictions under this Section 11. SECTION 12. DIVIDEND EQUIVALENT PAYMENTS - ---------- ---------------------------- The Committee may authorize the immediate or deferred payment of dividend equivalents on some or all of the shares of Common Stock covered by Options or Performance Share Units granted after January 1, 1989, in an amount equal to, and commensurate with, dividends declared by the Board of Directors and paid on Common Stock. Dividend equivalents payable on Option shares or on Performance Share Units under this Section 12 may be paid in cash or in Common Stock at the discretion of the Committee. The Committee may authorize the immediate payment of dividend equivalents under this Section 12 with respect to any Option for all or some portion of its term by including a specific provision, authorizing such immediate payment, in the Incentive Stock Option Agreement required under Section 6(a) of the Plan or the Non-Qualified Stock Option Agreement required under Section 7 of the Plan. The Committee may authorize the immediate payment of dividend equivalents under this Section 12 with respect to any Performance Share Unit for all or some portion of its term as a term and condition of the Performance Share Unit grant. The Committee also may authorize the deferred payment of dividend equivalents under this Section 12 with respect to any Option for all or some portion of its term by including a specific provision authorizing such deferred payment (including the manner in which such payment will be credited to Optionees and subsequently paid) in the Incentive Stock Option Agreement required under Section 6(a) of the Plan or the Non-Qualified Stock Option PAGE 123 EXHIBIT 10(e), Page 17 of 20 Agreement required under Section 7 of the Plan. The Committee may authorize the deferred payment of dividend equivalents under this Section 12 with respect to any Performance Share Unit for all or some portion of its term by including a specific provision authorizing such deferred payment (including the manner in which such deferred payment will be credited to Optionees and subsequently paid) as a term and condition of the Performance Share Unit grant. SECTION 13. CAPITAL ADJUSTMENTS - ---------- ------------------- In the event of a recapitalization, stock split, stock dividend, exchange, combination, or reclassification of shares, merger, consolidation, reorganization, or other change in or affecting the capital structure or capital stock of the Corporation, the Board of Directors, upon the recommendation of the Committee, may make appropriate adjustments in the number of shares of Common Stock authorized for the Plan and in the annual limitation imposed by Section 5 of this Plan; and the Committee may make appropriate adjustments in the number of shares subject to outstanding Options, Stock Appreciation Rights, Restricted Stock, or Performance Share Unit grants, and in the Option price of any then outstanding Options, as it deems equitable, in its absolute discretion, to prevent dilution or enlargement of the rights of Participants. SECTION 14. REGULATORY APPROVALS - ---------- -------------------- The exercise of each Option and Stock Appreciation Right, and the grant or distribution of Restricted Shares and Performance Shares, shall be subject to the condition that if at any time the Corporation shall determine in its discretion that the satisfaction of withholding tax or other tax liabilities, or the listing, registration, or qualification of any shares of Common Stock upon any securities exchange or under any Federal or state law, or the consent or approval of any regulatory body, is necessary or desirable as a condition of, or in connection with, such exercise, grant, or distribution, then in any such event such exercise, grant, or distribution shall not be effective unless such liabilities have been satisfied or such listing, registration qualification, consent, or approval shall have been effected or obtained free of any conditions not acceptable to the Corporation. PAGE 124 EXHIBIT 10(e), Page 18 of 20 SECTION 15. EFFECTIVE DATE AND TERM OF THE PLAN - ---------- ----------------------------------- (a) Effective Date -------------- The Plan, as hereby amended, shall be effective when approved by the Board of Directors, and Options, Stock Appreciation Rights, and Performance Share Units may be granted immediately thereafter; provided, that no Option or Stock Appreciation Right may be exercised and no Restricted Shares or Performance Shares may be granted under the Plan unless and until the Plan, as hereby amended, is approved by the vote of the holders of a majority of the shares of Common Stock present or represented and entitled to vote at a meeting of the stockholders of the Corporation, at which a quorum is present, held within twelve (12) months after the date of adoption of the Plan, as hereby amended, by the Board of Directors. (b) Term of the Plan ---------------- Awards may be granted from time to time under the terms and conditions of the Plan, but no Incentive Stock Option may be granted after the expiration of ten (10) years from the date of adoption of the Plan, as hereby amended, by the Board of Directors; provided, that any future amendment to the Plan that is approved by the stockholders of the Corporation in the manner provided under paragraph (a) of this Section 15 shall be regarded as creating a new Plan, and an Incentive Stock Option may be granted under such new Plan until the expiration of ten (10) years from the earlier of the approval by the Board of Directors, or the approval by the stockholders of the Corporation, of such new Plan. Incentive Stock Options theretofore granted may extend beyond the expiration of that ten-year period, and the terms and conditions of the Plan shall continue to apply thereto and to shares of Common Stock acquired upon the subsequent exercise of an Incentive Stock Option or related Stock Appreciation Right. SECTION 16. AMENDMENT OR TERMINATION OF THE PLAN - ---------- ------------------------------------ The Board of Directors may at any time and from time to time alter or amend, in whole or in part, any or all of the provisions of the Plan, or may at any time suspend or terminate the Plan, provided that no change in any Awards theretofore granted to any Participant may be made which would impair or diminish the rights of the Participant without the Participant's consent, and provided further, that no alteration or amendment may be made without the approval of the holders of a majority of the Common PAGE 125 EXHIBIT 10(e), Page 19 of 20 Stock then outstanding and entitled to vote if such stockholder approval is necessary to comply with the requirements of any rules promulgated under Section 16 of the Securities Exchange Act of 1934 or such other Federal or state laws or regulations as may be applicable. SECTION 17. MISCELLANEOUS - ---------- ------------- (a) Fractional Shares ----------------- The Corporation shall not be required to issue or deliver any fractional share of Common Stock upon the exercise of an Option or Stock Appreciation Right, the award of Performance Shares, or the payment of a dividend equivalent in Common Stock pursuant to Section 12 of the Plan, but may pay, in lieu thereof, an amount in cash equal to the Fair Market Value of such fractional share. (b) Withholding ----------- The Corporation and its Subsidiary Companies shall have the right, to the extent permitted by law, to deduct from any payment of any kind otherwise due to a Participant any Federal, state or local taxes of any kind required by law to be withheld with respect to Awards under the Plan, and to the extent any such withholding requirements are not satisfied, each Participant shall pay to the Corporation any Federal, state or local taxes of any kind required by law to be withheld with respect to Awards under the Plan. (c) Stockholder Rights ------------------ No person shall have any rights of a stockholder by virtue of an Option, Stock Appreciation Right, or Performance Share Unit except with respect to shares of Common Stock actually issued to him, and the issuance of shares of Common Stock shall confer no retroactive right to dividends. (d) No Contract of Employment ------------------------- This Plan shall not be deemed to be an employment contract between the Corporation or any Subsidiary Company and any Participant or other employee. Nothing contained herein, or in any agreement, certificate or other document evidencing, providing for, or setting forth the terms and conditions applicable to any Awards shall be deemed to confer upon any Participant or other employee a right to continue in the employment of the Corporation or any Subsidiary Company, or to interfere with the right of the Corporation or any Subsidiary Company to terminate the employment of such Participant or employee at any time. PAGE 126 EXHIBIT 10(e), Page 20 of 20 (e) Unfunded Plan ------------- Except as may otherwise be provided in the Plan, the Plan shall be unfunded. Neither the Corporation nor any Subsidiary Company shall be required to segregate any assets that may be represented by Options, Stock Appreciation Rights, or Performance Share Units, and neither the Corporation nor any Subsidiary Company shall be deemed to be a trustee of any amounts to be paid under an Option, Stock Appreciation Right, or Performance Share Unit. Any liability of the Corporation to pay any Participant or Beneficiary with respect to an Option, Stock Appreciation Right, or Performance Share Unit shall be based solely upon any contractual obligations created pursuant to the provisions of the Plan; no such obligation shall be deemed to be secured by any pledge or encumbrance on any property of the Corporation or a Subsidiary Company. (f) Applicable Law -------------- The Plan, its validity, interpretation, and administration, and the rights and obligations of all persons having an interest therein, shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia, except to the extent that such laws may be preempted by Federal law. (g) Gender and Number ----------------- Wherever used in the Plan, words in the masculine form shall be deemed to refer to females as well as to males, and words in the singular or plural shall be deemed to refer also to the plural or singular, respectively, as the context may require. EX-10.F 4 NSC OFFICERS' DEFERRED COMPENSATION PLAN PAGE 127 EXHIBIT 10(f), Page 1 of 8 NORFOLK SOUTHERN CORPORATION OFFICERS' DEFERRED COMPENSATION PLAN ARTICLE I. NAME AND PURPOSE OF THE PLAN - --------- ---------------------------- The name of the plan is the Norfolk Southern Corporation Officers' Deferred Compensation Plan (the "Plan"). The purpose of the Plan is to provide retirement and death benefits to those officers of Norfolk Southern Corporation (the "Corporation") or a Participating Subsidiary who elect to participate in the Plan. ARTICLE II. DEFINITIONS - ---------- ----------- Account The total of the amount of Deferrals by a Participant together with Interest as provided in Article V. Agreement The "Deferral Agreement" between each Participant and the Corporation. Beneficiary The person or persons designated as Beneficiary pursuant to Article XII. Board of The Board of Directors of the Corporation. Directors Committee The Compensation and Nominating Committee of the Board of Directors. Compensation The fixed salary payable in the form of cash (including vacation pay) of the Participant before any reduction for contributions to the Thrift and Investment Plan of Norfolk Southern Corporation and Participating Subsidiary Companies, as amended from time to time, and before any deferrals under this Plan. Deferral A Deferred Bonus and/or a Monthly Deferred Amount. Deferred That amount set forth in the Agreement which shall be Bonus deferred from a Participant's MIP incentive award (and any other annual cash incentive award payable to participants in MIP) or EMIP incentive award (and any other annual cash incentive award approved by the Board of Directors and payable to participants in EMIP), or the bonus program of a Participating Subsidiary, if the deferral of such incentive award or bonus under the Plan is authorized by the Corporation. PAGE 128 EXHIBIT 10(f), Page 2 of 8 Disability A disability that enables the Participant to be eligible for a disability benefit under the Long-Term Disability Plan of Norfolk Southern Corporation and Participating Subsidiaries, as amended from time to time, or under any such similar plan of a Participating Subsidiary. EMIP Norfolk Southern Corporation Executive Management Incentive Plan. MIP Norfolk Southern Corporation Management Incentive Plan. Monthly That amount set forth in the Agreement which shall be Deferred deferred monthly from a Participant's salary pursuant Amount to the Plan. Participant Any employee of the Corporation or a Participating Subsidiary eligible to participate under Article IV of the Plan. Participating Each subsidiary or affiliated company of the Subsidiary Corporation which adopts the Plan and is approved for participation in the Plan as provided in Article XVIII. Plan The Executive Vice President-Administration of the Administrator Corporation or the successor officer who performs substantially similar duties. Plan Year Any calendar year during which deferrals under this Plan are made. Retirement Retirement from the Corporation or a Participating Subsidiary pursuant to the provisions of the retirement plan of the Corporation or of a Participating Subsidiary (whichever is applicable), as amended from time to time. ARTICLE III. ADMINISTRATION - ----------- -------------- The Plan Administrator shall administer, construe, and interpret this Plan and, from time to time, adopt such rules and regulations and make such recommendations to the Committee concerning Plan changes as are deemed necessary to ensure effective implementation of this Plan. The administration, construction, and interpretation by the Plan Administrator may be appealed to the Committee, and the decision of the Committee shall be final and conclusive, except that any claim for benefits with respect to a Participant shall be subject to the claims procedure set forth in Section 503 of the Employee Retirement Income Security Act of 1974. The Plan Administrator may correct errors and, so far as practicable, may PAGE 129 EXHIBIT 10(f), Page 3 of 8 adjust any benefit or payment or credit accordingly. Neither the Plan Administrator nor any member of the Committee shall be liable for any act done or determination made in good faith. ARTICLE IV. ELIGIBILITY AND PARTICIPATION - ---------- ----------------------------- Any nonagreement employee with at least 830 salary administration points assigned to his position shall be eligible to participate in the Plan. However, only those Participants with annual Compensation in excess of ninety thousand dollars ($90,000) shall be eligible to defer Compensation under this Plan, and only 20% of monthly Compensation in excess of seven thousand five hundred dollars ($7,500) shall qualify for deferral hereunder. A nonagreement employee who elects to become a Participant in the Plan and defer a portion of his monthly Compensation thereby consents to the reduction in his monthly Compensation by the Monthly Deferred Amount as specified in the Agreement. An election to participate in the Plan must be made annually by December 22 of the year prior to each Plan Year. Benefits payable hereunder shall be in addition to any other compensation or benefits to which a Participant may be entitled from the Corporation or a Participating Subsidiary. A Participant may elect to defer a portion of any incentive bonus which may be awarded to him pursuant to MIP or EMIP or the authorized bonus program of a Participating Subsidiary. A Participant who elects to defer any of his incentive bonus thereby consents to a reduction in his bonus by the Deferred Bonus as specified in the Agreement, commencing with the incentive bonus award earned after December 31, 1986. By December 22 of the year prior to each Plan Year, a Participant may elect to defer any incentive bonus which may be earned by him during that Plan Year, either in whole or in part, in increments of twenty-five percent (25%). ARTICLE V. INTEREST EQUIVALENT - --------- ------------------- Unless otherwise stated herein or determined by the Board of Directors, an amount equivalent to interest ("Interest") shall accrue and be compounded annually on all Deferrals. For purposes of calculating the appropriate Interest only, the Deferred Bonus is deemed to occur on the date on which the incentive bonus is paid. Interest shall accrue and be compounded annually at rates in accordance with the schedule below on the basis of the Participant's age attained during the Plan Year for which the Deferral is made: Age Rate --- ---- Up to 45 7% 45 - 54 10% 55 - 60 11% Over 60 12% PAGE 130 EXHIBIT 10(f), Page 4 of 8 Interest on each Deferral shall continue to accrue at the rate determined by the Participant's age attained during the Plan Year for which the Deferral is made until all benefits payable hereunder have been distributed to, or with respect to, the Participant. ARTICLE VI. BENEFITS - ---------- -------- (a) Retirement ---------- When a Participant ceases active service due to his Retirement, he shall be paid a monthly annuity commencing in January of the first calendar year following such Retirement for a period of years in accordance with the schedule below: Age at Time of Distribution Deferral Period -------- ------------ Up to 50 5 Years 50 or Over 10 Years The amount of the monthly annuity payable under this Article VI(a), shall be an amount sufficient to amortize the Participant's Account together with Interest over the applicable period. (b) Disability ---------- When a Participant ceases active service due to Disability, he shall be paid a monthly annuity commencing in January of the first calendar year following such Disability for a period of fifteen (15) years in an amount sufficient to amortize the Participant's Account together with Interest over that period. (c) Death ----- If a Participant dies while in active service, the Corporation shall pay the amount of the Participant's Account to the Participant's Beneficiary in a single payment as soon as practicable after the date of death. If a Participant dies after Retirement or Disability but prior to receiving all benefits payable thereunder, the monthly payments shall be paid to the Participant's Beneficiary for the scheduled annuity period. (d) Termination of Employment ------------------------- If a Participant ceases active service other than by reason of leave of absence granted pursuant to the Family and Medical Leave Act, Retirement, Disability or Death, he shall be paid the balance of his Account as of the date of his separation from service as soon as practicable after such separation from service. PAGE 131 EXHIBIT 10(f), Page 5 of 8 (e) Lump Sum or Other Settlement ---------------------------- Notwithstanding the foregoing provisions of this Article VI, the Committee, in its sole discretion, may authorize and direct the Corporation to make payments after termination of employment of a Participant to such Participant or his Beneficiary in a lump sum or over a period other than that provided for in this Article VI, and to charge such payments against the Participant's Account. Such accelerated distribution may be made only (1) in the event of a financial emergency which is beyond the control of the Participant if disallowance of the accelerated distribution would result in severe financial hardship to the Participant or Beneficiary, and only in an amount necessary to satisfy the financial emergency, or (2) if in the written opinion of counsel, payment in accordance with this Article VI could create a conflict of interest for the Participant or Beneficiary; provided, that all amounts due to a Participant or Beneficiary under this Plan shall in all events be paid to the Participant or Beneficiary by the end of the appropriate period referred to in this Article VI. No Participant or Beneficiary who is also a member of the Committee shall participate in any decision of the Committee to make accelerated payments under this Article VI. (f) Change in Mandatory Distribution Schedule ----------------------------------------- Notwithstanding the foregoing provisions of this Article VI, the Committee may, without the consent of any Participant or Beneficiary, direct that all benefits payable thereafter pursuant to paragraph (a), (b), or (c) above (including benefits that accrued prior to the issuance of the direction) shall be paid under a schedule that differs from that prescribed by paragraph (a), (b), or (c). Any such direction shall apply to all Participants, without differentiating among individual Participants, except to the extent otherwise provided by paragraph (e), above. No Participant or Beneficiary who is also a member of the Committee shall participate in any decision of the Committee to make a change in the distribution schedule. ARTICLE VII. NATURE AND SOURCE OF PAYMENTS - ----------- ----------------------------- The obligation to pay benefits under Article VI with respect to each Participant shall constitute a liability of the Corporation to the Participant and any death Beneficiaries in accordance with the terms of the Plan. All benefits payable hereunder shall be made from the general funds of the Corporation, and nothing herein shall be deemed to create a trust of any kind or a fiduciary relationship between the Corporation and any Participant or other person. No special or separate fund need be established or other segregation of assets made to assure payments hereunder, and no Participant or Beneficiary shall have any interest in any particular asset of the PAGE 132 EXHIBIT 10(f), Page 6 of 8 Corporation by virtue of the existence of the Plan or an Agreement. Participants and Beneficiaries shall stand in the position of unsecured creditors of the Corporation, and all rights hereunder are subject to the claims of creditors of the Corporation. ARTICLE VIII. EXPENSES OF ADMINISTRATION - ------------ -------------------------- All expenses of administering the Plan shall be borne by the Corporation, and no part thereof shall be charged against the benefit of any Participant. ARTICLE IX. AMENDMENT TO AND TERMINATION OF PLAN - ---------- ------------------------------------ The Corporation reserves the right at any time by a resolution duly adopted by its Board of Directors to amend this Plan in any manner or to terminate it at any time, except that no such amendment or termination shall deprive a Participant or his Beneficiary of any rights hereunder theretofore legally accrued, and no such termination shall be effective for the year in which such resolution is adopted. ARTICLE X. RECALCULATION EVENTS - ---------- -------------------- The Corporation's commitment to accrue and pay Interest as provided in Article V is facilitated by the purchase of corporate-owned life insurance purchased on the lives of eligible Participants. If the Board of Directors, in its sole discretion, determines that any change whatsoever in Federal, State or local law, or in its application or interpretation, has materially affected, or will materially affect, the ability of the Corporation to recover the cost of providing the benefits otherwise payable under the Plan, then, if the Board of Directors so elects, a Recalculation Event shall be deemed to have occurred. If a Recalculation Event occurs, then Interest shall be recalculated and restated using a lower rate of Interest determined by the Board of Directors, but which shall be not less than one-half (1/2) the rate of Interest provided for in Article V. ARTICLE XI. GOVERNING LAW - ---------- ------------- This Plan and the Agreements are subject to the laws of the Commonwealth of Virginia. ARTICLE XII. DESIGNATION OF BENEFICIARY - ----------- -------------------------- For the purpose of this Plan, a beneficiary shall be either (1) the named Beneficiary or Beneficiaries designated as hereinafter provided for by the Participant, or (2) in the absence of any such designation, his estate. A Participant may designate both primary PAGE 133 EXHIBIT 10(f), Page 7 of 8 and contingent Beneficiaries. A Participant may revoke or change any designation. To be effective, the designation of a named Beneficiary or Beneficiaries, or any change in or revocation of any designation, must be on a form provided by the Corporation, signed by the Participant and filed with the Office of the Plan Administrator prior to the death of such Participant. Any such designation, change or revocation shall not invalidate any cash payment made or other action taken by the Corporation pursuant to the Plan prior to its receipt by the Corporation. The determination by the Corporation of a Beneficiary or Beneficiaries, or the identity thereof, or evidence satisfactory to the Corporation shall be conclusive as to the liability of the Corporation and any payment made in accordance therewith shall discharge the Corporation of all its obligations under the Plan for such payment. ARTICLE XIII. SUCCESSORS, MERGERS, CONSOLIDATIONS - ------------ ----------------------------------- The terms and conditions of this Plan and each Agreement shall inure to the benefit of and bind the Corporation, the Participants, their successors, assigns, and personal representatives. If substantially all the assets of the Corporation are acquired by another corporation or entity or if the Corporation is merged into, or consolidated with, another corporation or entity, then the obligations created hereunder and as a result of the Corporation's acceptance of Agreements shall be obligations of the successor corporation or entity. ARTICLE XIV. WITHHOLDING FOR TAXES - ----------- --------------------- The Participant agrees as a condition of participation hereunder that the Corporation may withhold applicable Federal, State, and local income taxes and Social Security or Railroad Retirement taxes from any distribution or benefit paid hereunder. ARTICLE XV. NON-ALIENATION OF BENEFITS - ---------- -------------------------- No benefit under the Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, and any attempt at such shall be void; nor shall any such benefit be in any way subject to the debts, contracts, liabilities, engagements, or torts of the person who shall be entitled to such benefit; nor shall it be subject to attachment or legal process for or against such person. ARTICLE XVI. FACILITY OF PAYMENT - ----------- ------------------- If the Plan Administrator shall find that any individual to whom any amount is payable under the Plan is unable to care for his affairs because of illness or accident, or is a minor or other person under legal disability, any payment due such individual PAGE 134 EXHIBIT 10(f), Page 8 of 8 (unless a prior claim therefore shall have been made by a duly appointed guardian, committee, or other legal representative) may be paid to the spouse, a child, a parent, or a brother or sister of such individual or to any other person deemed by the Plan Administrator to have incurred expenses of such individual, in such manner and proportions as the Plan Administrator may determine. Any such payment shall be a complete discharge of the liabilities of the Corporation with respect thereto under the Plan or the Agreement. ARTICLE XVII. CONTINUED EMPLOYMENT - ------------ -------------------- Nothing contained herein or in an Agreement shall be construed as conferring upon any Participant the right nor imposing upon him the obligation to continue in the employment of the Corporation or a Participating Subsidiary in any capacity. ARTICLE XVIII. PARTICIPATION BY SUBSIDIARY COMPANIES - ------------- ------------------------------------- Conditional upon prior approval by the Corporation, any company which is a subsidiary of or affiliated with the Corporation may adopt and participate in this Plan as a Participating Subsidiary. Each Participating Subsidiary shall make, execute and deliver such instruments as the Corporation and/or the Plan Administrator shall deem necessary or desirable, and shall constitute the Corporation and/or the Plan Administrators as its agents to act for it in all transactions in which the Corporation and/or the Plan Administrators believe such agency will facilitate the administration of this Plan. ARTICLE XIX. MISCELLANEOUS - ----------- ------------- Whenever used in the Plan, words in the masculine form shall be deemed to refer to females as well as to males, and words in the singular or plural shall be deemed to refer also to the plural or singular, respectively, as the context may require. ARTICLE XX. EFFECTIVE DATE - ---------- -------------- The effective date of the Plan is January 1, 1987, as amended effective November 24, 1998. EX-10.H 5 NSC DIRECTORS' RESTRICTED STOCK PLAN PAGE 135 EXHIBIT 10(h), Page 1 of 2 NORFOLK SOUTHERN CORPORATION DIRECTORS' RESTRICTED STOCK PLAN I. Effective January 1, 1994, as restated November 24, Date: 1998. II. Purpose: To increase the ownership of common stock of Norfolk Southern Corporation ("Corporation") by nonemployee directors so as to align further their ownership interest in the Corporation with that of the stockholders. III. Eligibility: Any nonemployee director of the Corporation as of the Effective Date and any nonemployee director of the Corporation who begins his or her term as director on or after the Effective Date ("Eligible Director"). A "nonemployee director" is a director who is not an officer of the Corporation or any of its subsidiaries. IV. Benefits: (1) An Eligible Director shall be granted three thousand (3,000) shares of Corporation common stock ("Restricted Shares") on the later of the Effective Date of the Registration Statement registering the grant of common stock under this Plan or the date a person becomes an Eligible Director. (2) Restricted Shares shall be restricted as hereinafter provided for a period ("Restriction Period") commencing on the date of grant and ending on the date that is the earlier of the death of the Eligible Director or 6 months after the Eligible Director ceases to be a director by reason of disability or retirement. During the Restriction Period, the Eligible Director shall have the entire beneficial interest in and all rights and privileges of a stockholder as to the Restricted Shares, including the right to receive dividends and the right to vote such shares, subject to the following conditions: (a) the Eligible Director shall not be entitled to delivery of the stock certificate until expiration of the Restriction Period; (b) none of the Restricted Shares may be sold, transferred, assigned, pledged or otherwise encumbered or disposed of PAGE 136 EXHIBIT 10(h), Page 2 of 2 during the Restriction Period; and (c) all Restricted Shares shall be forfeited and all rights of the Eligible Director in and to such shares shall terminate unless the Eligible Director remains a director of the Corporation until death, disability or retirement. (3) For purposes of this Plan, "retirement" of an Eligible Director means termination of service as a director of the Corporation, if (a) the Eligible Director at the time of termination was ineligible to continue serving as a director under the Corporation's Retirement Policy for Directors or (b) the Eligible Director had served as a director of the Corporation for at least two consecutive years, and such termination is (i) due to the Eligible Director's taking a position with or providing services to a governmental, charitable or educational institution whose policies prohibit continued service as a director of the Corporation, or (ii) due to the fact that continued service as a director would be a violation of law, or (iii) not due to the voluntary resignation or refusal to stand for reelection by the Eligible Director. (4) The Board of Directors of the Corporation may make such adjustments in the number and kind of shares authorized by the Plan and the number and kind of shares or other securities or property covered by outstanding awards as are required by any change in the corporate structure or shares of the Corporation, including, but not limited to, recapitalization, stock splits, stock dividends, combination or exchange of shares, mergers, consolidations, rights, offerings, separations, reorganizations, and liquidations. V. Miscellaneous: A maximum of 66,000 shares of Corporation common stock may be granted under this Plan. This Plan may be amended (but not more than once every six months, other than to comply with changes in the Internal Revenue Code) or terminated by the Board of Directors of the Corporation. EX-10.O 6 NSC DESCRIPTION OF 1999 SPECIAL INCENTIVE BONUS PROGRAM PAGE 137 EXHIBIT 10(o), Page 1 of 1 NORFOLK SOUTHERN CORPORATION DESCRIPTION OF 1999 SPECIAL INCENTIVE BONUS PROGRAM At its meeting on November 24, 1998, the Board of Directors of Norfolk Southern Corporation (NS) adopted the 1999 Special Incentive Bonus Program (Program) to provide cash incentives to a large number of NS nonagreement employees (including the persons named in the Summary Compensation Table of the Proxy Statement for the 1999 Annual Meeting of Stockholders and other executive officers [collectively Executive Officers]) based on the 1999 NS Operating Ratio. Payment of Special Incentive Bonus awards to participants, including the Executive Officers, is authorized only if the 1999 NS Operating Ratio meets a designated threshold; if the 1999 NS Operating Ratio is better than the designated threshold, the Program authorizes payments of increasing Special Incentive Bonus awards, based on a predetermined sliding scale, to all participants, including the Executive Officers. Specifically, if the threshold is met exactly, the Program authorizes payment to each Executive Officer of a Special Incentive Bonus award that is equal to 1/12th of that individual's maximum 1999 opportunity under the NS Executive Management Incentive Plan; the largest Special Incentive Bonus award that may be paid to each Executive Officer under this Program is an amount equal to 1/2 of that individual's maximum 1999 opportunity under the NS Executive Management Incentive Plan. As a general rule, each participant, including an Executive Officer, must be in active service on December 31, 1999, to receive a payment. Exceptions -- and related provision for pro-rata payment of earned Special Incentive Bonus awards -- are made in the cases of an otherwise-eligible participant's death, retirement or total disability, and in other specified circumstances. As in the case of other NS incentive programs, authority exists under this Program to reduce or eliminate a special incentive bonus award to any employee, including an Executive Officer, for work performance that is inconsistent with the Program's purposes and objectives. EX-12 7 NSC COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES PAGE 138 EXHIBIT 12, Page 1 of 1 NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Millions of Dollars)
Year ended December 31 --------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- EARNINGS Income from continuing operations before income taxes as reported $ 845 $ 998 $1,166 $1,089 $1,028 Add: Total interest expenses (as detailed below) 688 530 182 173 156 Amortization of capitalized interest 3 3 3 2 2 Income (loss) of partially owned entities (1) 165 113 1 -- 1 Subsidiaries' preferred dividend requirement 2 2 2 3 3 ------ ------ ------ ------ ------ Income before income taxes, as adjusted $1,703 $1,646 $1,354 $1,267 $1,190 ====== ====== ====== ====== ====== FIXED CHARGES Interest expense on debt $ 516 $ 385 $ 116 $ 113 $ 101 Other interest expense 27 32 36 31 30 Calculated interest portion of rent expense 31 30 30 29 25 NS' share of Conrail interest 114 83 -- -- -- ------ ------ ------ ------ ------ Total interest expenses 688 530 182 173 156 Capitalized interest 21 17 12 14 18 Subsidiaries' preferred dividend requirement on a pretax basis 4 4 4 4 4 ------ ------ ------ ------ ------ Total fixed charges $ 713 $ 551 $ 198 $ 191 $ 178 ====== ====== ====== ====== ====== RATIO OF EARNINGS TO FIXED CHARGES 2.39 2.99 6.84 6.63 6.69
(1) Includes: (a) the distributed income of 20%-49% owned entities, net of equity recorded in undistributed income and the minority income of consolidated entities which have fixed charges; and (b) NS' share of Conrail's income before income taxes, net of equity in earnings of Conrail included in NS' income from continuing operations before taxes as reported. The computations do not include $0.3 million of interest expense related to $7.8 million of debt guaranteed for a less than 50% owned entity. EX-21 8 NSC SUBSIDIARIES AS OF 03/01/99 PAGE 139 EXHIBIT 21, Page 1 of 2 NAME AND STATE OF INCORPORATION OF SUBSIDIARIES OF NORFOLK SOUTHERN CORPORATION AS OF MARCH 1, 1999 Agency Media Services, Inc., Indiana Atlantic Acquisition Corporation, Pennsylvania Atlantic Investment Company, Delaware Norfolk Southern Properties, Inc., Virginia Norfolk Southern Railway Company, Virginia Northmont Limited Partnership, Georgia NS Crown Services, Inc., Virginia NS Fiber Optics, Inc., Virginia NS Transportation Brokerage Corporation, Virginia Pocahontas Development Corporation, Kentucky Pocahontas Land Corporation, Virginia TCS Leasing, Inc., Oklahoma Norfolk Southern Railway Company subsidiaries: Airforce Pipeline, Inc., North Carolina Alabama Great Southern Railroad Company, The; Alabama Atlantic and East Carolina Railway Company, North Carolina Camp Lejeune Railroad Company, North Carolina Central of Georgia Railroad Company, Georgia Chesapeake Western Railway, Virginia Cincinnati, New Orleans and Texas Pacific Railway Company, The; Ohio Citico Realty Company, Virginia Georgia Southern and Florida Railway Company, Georgia High Point, Randleman, Asheboro and Southern Railroad Company, North Carolina Interstate Railroad Company, Virginia Lamberts Point Barge Company, Inc., Virginia Memphis and Charleston Railway Company, Mississippi Mobile and Birmingham Railroad Company, Alabama Norfolk and Portsmouth Belt Line Railroad Company, Virginia North Carolina Midland Railroad Company, The; North Carolina Rail Investment Company, Delaware Shenandoah-Virginia Corporation, Virginia South Western Rail Road Company, The; Georgia Southern Rail Terminals, Inc., Georgia Southern Rail Terminals of North Carolina, Inc., North Carolina Southern Region Coal Transport, Inc., Alabama Southern Region Materials Supply, Inc., Georgia Southern Region Motor Transport, Inc., Georgia State University Railroad Company, North Carolina Tennessee, Alabama & Georgia Railway Company, Delaware Tennessee Railway Company, Tennessee Virginia and Southwestern Railway Company, Virginia Yadkin Railroad Company, North Carolina PAGE 140 EXHIBIT 21, Page 2 of 2 Norfolk Southern Properties, Inc. subsidiaries: Alexandria-Southern Properties, Inc., Virginia Arrowood-Southern Company, North Carolina Arrowood Southern Executive Park, Inc., North Carolina Carlyle CA Corporation, Virginia Carlyle Development Corporation, Virginia Charlotte-Southern Corporation, North Carolina Charlotte-Southern Hotel Corporation, North Carolina Lambert's Point Docks, Incorporated, Virginia Nickel Plate Improvement Company, Inc., The; Indiana NKPI Management, Inc., Indiana Norfolk Southern Industrial Development Corp., Virginia Norfolk Southern Tower, LLC, Washington, D.C. NS-Charlotte Tower Corporation, North Carolina NS Gas Properties, Inc., Virginia NS Gas Properties, II, Inc., Virginia Sandusky Dock Corporation, Virginia Southern Region Industrial Realty, Inc., Georgia Virginia Holding Corporation, Virginia NOTE: Of the above subsidiaries, each of which is more than 50% owned, only Norfolk Southern Railway Company meets the Commission's "significant subsidiary" test. This list does not include CRR Holdings, LLC, in which Norfolk Southern Corporation has 50% voting control; Conrail Inc. and Consolidated Rail Corporation are subsidiaries of CRR Holdings, LLC. EX-23.A 9 CONSENT OF INDEPENDENT AUDITORS PAGE 141 EXHIBIT 23(a), Page 1 of 1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Norfolk Southern Corporation: We consent to incorporation by reference in Registration Statement No. 333-67937 on Form S-3 and Registration Statements Nos. 33-61317, 33-52031, 333-40993, 33-57417, and 333-71321 on Form S-8 of Norfolk Southern Corporation of our report dated January 26, 1999, relating to the consolidated balance sheets of Norfolk Southern Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity, and cash flows and the related consolidated financial statement schedule for each of the years in the three-year period ended December 31, 1998, which report appears in the December 31, 1998, Annual Report on Form 10-K405 of Norfolk Southern Corporation. /s/ KPMG LLP Norfolk, Virginia March 23, 1999 EX-23.B 10 CONSENT OF INDEPENDENT ACCOUNTANTS PAGE 142 EXHIBIT 23(b), Page 1 of 1 CONSENT OF PRICEWATERHOUSECOOPERS LLP INDEPENDENT ACCOUNTANTS The Board of Directors Norfolk Southern Corporation: We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-67937), and in the Registration Statements on Form S-8 (Nos. 33-61317, 33-52031, 333-40993, 33-57417, and 333-71321) of Norfolk Southern Corporation of our report dated January 19, 1999 on the consolidated financial statements of Conrail Inc. and subsidiaries for the year ended December 31, 1998, which appears in the Annual Report on Form 10-K of Norfolk Southern Corporation for the year ended December 31, 1998. /s/ PricewaterhouseCoopers LLP PRICEWATERHOUSECOOPERS LLP Philadelphia, PA March 23, 1999 EX-27 11 YEAR END 1998 EX-27 NSC FINANCIAL DATA SCHEDULE
5 1,000,000 YEAR DEC-31-1998 DEC-31-1998 5 58 523 4 59 913 15,063 4,586 18,180 1,117 7,483 0 0 401 5,520 18,180 0 4,221 0 3,169 (309) 0 516 845 215 630 104 0 0 734 1.94 1.93
EX-99 12 1998 CONRAIL INC. ANNUAL REPORT PAGE 144 EXHIBIT 99, Page 1 of 30 TITLE PAGE CONRAIL INC. 1998 ANNUAL REPORT TO STOCKHOLDERS Page 145 EXHIBIT 99, Page 2 of 30 REPORT OF MANAGEMENT The Stockholders Conrail Inc. Management is responsible for the preparation, integrity and objectivity of the Company's financial statements. The financial statements are prepared in conformity with generally accepted accounting principles and include amounts based on management's best estimates and judgment. The Company maintains a system of internal accounting controls and procedures which is continually reviewed and supported by written policies and guidelines and supplemented by a corporate staff of internal auditors. The system provides reasonable assurance that assets are safeguarded against loss from unauthorized use and that the books and records reflect the transactions of the Company and are reliable for the preparation of financial statements. The concept of reasonable assurance recognizes that the cost of a system of internal accounting controls should not exceed the benefits derived and also recognizes that the evaluation of these factors necessarily requires estimates and judgments by management. The Company's financial statements are audited by its independent accountants. Their audit is conducted in accordance with generally accepted auditing standards and includes a study and evaluation of the Company's system of internal accounting controls to determine the nature, timing and extent of the auditing procedures required for expressing an opinion on the Company's financial statements. The Company's Board of Directors was reconstituted on August 22, 1998, the effective date of the Surface Transportation Board's written decision approving the acquisition of the Company by Norfolk Southern Corporation ("NSC") and CSX Corporation ("CSX"). The new Board of Directors, which is comprised of an equal number of directors from NSC and CSX, pursues its oversight responsibilities for the financial statements and corporate conduct through periodic meetings with and written reports from the Company's management. /s/ Timothy T. O'Toole Timothy T. O'Toole President and Chief Executive Officer /s/ John A. McKelvey John A. McKelvey Senior Vice President- Finance & Administration January 19, 1999 Page 146 EXHIBIT 99, Page 3 of 30 REPORT OF INDEPENDENT ACCOUNTANTS The Stockholders and Board of Directors Conrail Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Conrail Inc. and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Our audits of the consolidated financial statements of Conrail Inc. and subsidiaries also included an audit of the Financial Statement Schedule, Schedule II - Valuation and Qualifying Accounts. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 January 19, 1999 Page 147 EXHIBIT 99, Page 4 of 30 CONRAIL INC. CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, ------------------------ ($ In Millions Except Per Share Data) 1998 1997 1996 ---- ---- ---- Revenues $ 3,863 $ 3,765 $ 3,714 ------- ------- ------- Operating Expenses Way and structures 467 458 462 Equipment 776 776 803 Transportation 1,342 1,388 1,385 General and administrative (Note 3) 444 313 312 Transition and acquisition-related compensation costs (Note 3) 251 222 Transition and merger costs (Note 3) 68 65 16 ESOP termination charge (Note 3) 221 Voluntary separation programs (Note 10) 135 ------- ------- ------- Total operating expenses 3,348 3,443 3,113 ------- ------- ------- Income from operations 515 322 601 Interest expense (153) (170) (182) Other income, net (Note 11) 72 83 112 ------- ------- ------- Income before income taxes 434 235 531 Income taxes (Note 7) 167 228 189 ------- ------- ------- Net income $ 267 $ 7 $ 342 ======= ======= ======= Net income per common share (Note 1) Basic $ -- $ -- $ 4.29 Diluted -- -- 3.91 Ratio of earnings to fixed charges (Note 1) 3.11x 1.98x 3.19x
See accompanying notes. Page 148 EXHIBIT 99, Page 5 of 30 CONRAIL INC. CONSOLIDATED BALANCE SHEETS
December 31, ------------ ($ In Millions) 1998 1997 ---- ---- ASSETS Current assets Cash and cash equivalents $ 138 $ 97 Accounts receivable 580 623 Deferred tax assets (Note 7) 182 115 Material and supplies 92 104 Other current assets 13 15 ------ ------ Total current assets 1,005 954 Property and equipment, net (Note 4) 7,151 6,830 Other assets 744 700 ------ ------ Total assets $8,900 $8,484 ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current maturities of long-term debt (Note 6) 113 112 Accounts payable 130 113 Wages and employee benefits 403 366 Casualty reserves 139 141 Accrued and other current liabilities (Note 5) 422 476 ------ ------ Total current liabilities 1,207 1,208 Long-term debt (Note 6) 1,609 1,732 Casualty reserves 215 198 Deferred income taxes (Note 7) 1,564 1,453 Special income tax obligation (Note 7) 223 283 Other liabilities 426 445 ------ ------ Total liabilities 5,244 5,319 ------ ------ Commitments and contingencies (Note 12) Stockholders' equity (Notes 2, 3 and 9) Common stock ($1 par value; 100 and 250,000,000 shares authorized, respectively; 100 and 6,320,349 shares issued, respectively; 100 shares outstanding) -- 6 Additional paid-in capital 2,291 3,006 Unearned ESOP compensation (75) (155) Employee benefits trust (144) (274) Retained earnings 1,584 1,324 ------ ------ 3,656 3,907 Treasury stock, at cost -- (742) ------ ------ Total stockholders' equity 3,656 3,165 ------ ------ Total liabilities and stockholders' equity $8,900 $8,484 ====== ======
See accompanying notes. Page 149 EXHIBIT 99, Page 6 of 30 CONRAIL INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Addi- Series A Unearned tional Employee ($ in Millions Preferred ESOP Com- Common Paid-in Benefits Retained Treasury Except Per Share Data) Stock pensation Stock Capital Trust Earnings Stock - ---------------------- --------- --------- ------ ------- -------- -------- -------- Balance, January 1, 1996 $ 282 $ (233) $ 85 $2,187 $ (329) $1,176 $ (191) Amortization 11 Net income 342 Common dividends, $1.80 per share (146) Preferred dividends, $2.165 per share (20) Common shares acquired (156) Exercise of stock options 29 53 Employee benefits trust transactions, net 128 (116) Effects of voluntary separation programs (8) 8 Effects of CSX tender offer (63) 3 60 Other 5 ------ ------ ------ ------ ------ ------ ------ Balance, December 31, 1996 211 (222) 88 2,404 (384) 1,357 (347) Amortization 2 Net income 7 Common dividends, $.475 per share (40) Preferred dividends, $.541 per share (3) Exercise of stock options 2 11 Employee benefits trust transactions, net (5) 9 Effects of Conrail acquisition, net (Notes 2 and 3) (209) (82) 594 90 (393) Allocation of unearned ESOP compensation 65 Other (2) 11 3 (2) ------ ------ ------ ------ ------ ------ ------ Balance, December 31, 1997 -- (155) 6 3,006 (274) 1,324 (742) Net income 267 Common dividends (7) Employee benefits trust transactions, net 21 (21) Payments as a result of Conrail acquisition (Notes 3 and 9) 151 Allocation of unearned ESOP compensation 80 Common shares reclassified as unissued (Note 9) (6) (736) 742 ------ ------ ------ ------ ------ ------ ------ Balance, December 31, 1998 $ -- $ (75) $ -- $2,291 $ (144) $1,584 $ -- ====== ====== ====== ====== ====== ====== ======
Page 150 EXHIBIT 99, Page 7 of 30 CONRAIL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, ------------------------ ($ In Millions) 1998 1997 1996 ---- ---- ---- Cash flows from operating activities Net income $ 267 $ 7 $ 342 Adjustments to reconcile net income to net cash provided by operating activities: Transition and acquisition-related charges (Note 3) 302 -- -- Transition and acquisition-related compensation costs 66 159 -- ESOP termination charge -- 221 -- Voluntary separation programs -- -- 135 Depreciation and amortization 310 293 283 Deferred income taxes 30 152 183 Special income tax obligation (60) (63) (94) Gains from sales of property (21) (23) (24) Pension credit (63) (61) (46) Changes in (net of effect of transition, acquisition and merger-related items): Accounts receivable 33 7 (16) Accounts and wages payable (33) 42 (18) Deferred tax assets (67) 178 40 Settlement of tax audit -- 6 (39) Other (37) (34) (77) ------ ------ ------ Net cash provided by operating activities 727 884 669 ------ ------ ------ Cash flows from investing activities Property and equipment acquisitions (537) (439) (387) Proceeds from disposals of properties 19 25 34 Other (32) (31) (46) ------ ------ ------ Net cash used in investing activities (550) (445) (399) ------ ------ ------ Cash flows from financing activities Payment of long-term debt (119) (238) (184) Payment of debt consent fees (10) -- -- Repurchase of common stock -- -- (156) Net proceeds from (repayments of) short-term borrowings -- (99) 10 Proceeds from long-term debt -- -- 26 Loans from and redemptions of insurance policies -- -- 95 Dividends on common stock (7) (40) (146) Dividends on Series A preferred stock -- (3) (25) Proceeds from stock options and other -- 8 67 ------ ------ ------ Net cash used in financing activities (136) (372) (313) ------ ------ ------ Increase(decrease) in cash and cash equivalents 41 67 (43) Cash and cash equivalents Beginning of year 97 30 73 ------ ------ ------ End of year $ 138 $ 97 $ 30 ====== ====== ======
See accompanying notes. Page 151 EXHIBIT 99, Page 8 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies ------------------------------------------ Industry -------- Conrail Inc. ("Conrail") is a holding company of which the principal subsidiary is Consolidated Rail Corporation ("CRC"), a freight railroad which operates within the northeast and midwest United States and the Province of Quebec. Conrail has been acquired by CSX Corporation ("CSX") and Norfolk Southern Corporation ("NSC"). The operations of CRC will substantially change after NSC and CSX begin operating the Conrail properties under operating agreements (the "Closing Date") (Notes 2 and 3). Principles of Consolidation --------------------------- The consolidated financial statements include Conrail and majority-owned subsidiaries. Investments in 20% to 50% owned companies are accounted for by the equity method. Cash Equivalents ---------------- Cash equivalents consist of commercial paper, certificates of deposit and other liquid securities purchased with a maturity of three months or less, and are stated at cost which approximates market value. Material and Supplies --------------------- Material and supplies consist mainly of fuel oil and items for maintenance of property and equipment, and are valued at the lower of cost, principally weighted average, or market. Property and Equipment ---------------------- Property and equipment are recorded at cost. Depreciation is provided using the composite straight-line method. The cost (net of salvage) of depreciable property retired or replaced in the ordinary course of business is charged to accumulated depreciation and no gain or loss is recognized. Asset Impairment ---------------- Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Expected future cash flows from the use and disposition of long-lived assets are compared to the current carrying amounts to determine the potential impairment loss. Page 152 EXHIBIT 99, Page 9 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Revenue Recognition ------------------- Revenue is recognized proportionally as a shipment moves on the Conrail system from origin to destination. Earnings Per Share ------------------ Earnings per share are not presented for 1998 and 1997 as a result of the joint acquisition of the Company's common stock by NSC and CSX which was completed on May 23, 1997 (Notes 2 and 3). Following that acquisition, the Company's common stock was delisted from the New York Stock Exchange ("NYSE") and deregistered with the Securities and Exchange Commission ("SEC"). The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" (SFAS 128) to be effective for periods ending after December 15, 1997. SFAS 128 requires all prior- period earnings per share data presented to be restated to conform with the provisions of this pronouncement. SFAS 128 replaces primary earnings per share with the presentation of basic earnings per share and fully diluted earnings per share with diluted earnings per share. The earnings per share amounts resulting from the application of SFAS 128 were not materially different than those previously presented by the Company for 1996. For 1996, basic earnings per share were based on net income adjusted for the effects of preferred dividends net of income tax benefits, divided by the weighted average number of shares outstanding during the period. Diluted earnings per share assumed conversion of the previously outstanding Series A ESOP Convertible Junior Preferred Stock ("ESOP Stock") to Conrail common stock and the dilutive effects of stock options. Net income amounts applicable to diluted earnings per share were adjusted by the increase, net of income tax benefits, in ESOP- related expenses assuming conversion of all ESOP Stock to common stock. Shares in the Conrail Employee Benefits Trust were not considered outstanding for computing earnings per share. The weighted average number of shares of common stock outstanding during the year ended December 31, 1996 were as follows:
1996 ---- Basic weighted average shares 76,903,665 Diluted weighted average shares 87,022,413
Page 153 EXHIBIT 99, Page 10 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ratio of Earnings to Fixed Charges ---------------------------------- Earnings used in computing the ratio of earnings to fixed charges represent income before income taxes plus fixed charges, less equity in undistributed earnings of 20% to 50% owned companies. Fixed charges represent interest expense together with interest capitalized and a portion of rent under long-term operating leases representative of an interest factor. New Accounting Standards ------------------------ During 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pension and Other Postretirement Benefits" ("SFAS 132") which revises and standardizes disclosures previously required by other pronouncements related to these two types of employee benefit programs. SFAS 132 is effective during 1998 and therefore the Company has incorporated the disclosure requirements of this pronouncement into its employee benefits disclosures (Note 8). The Company had no material items required to be disclosed by SFAS 130, "Reporting Comprehensive Income", which also became effective during 1998. Also, in 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), which is effective for all fiscal quarters for all fiscal years beginning after June 15, 1999. The Company has determined that adoption of SFAS 133 will not have a material impact on its consolidated financial position, results of operations or cash flows. 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 and 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. 2. Acquisition of Conrail Inc. --------------------------- On May 23, 1997, the CSX-NSC joint tender offer for the remaining outstanding shares of Conrail's common and ESOP Stock was concluded, and on June 2, 1997, Conrail became the surviving corporation in a merger with Green Merger Corp. and remained the only subsidiary of Green Acquisition Corp., an entity jointly- owned by CSX and NSC. As a result, the remaining outstanding capital stock of Conrail was acquired by NSC and CSX. Simultaneous with the merger, Conrail's common stock was delisted Page 154 EXHIBIT 99, Page 11 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS from the NYSE and, through the filing of a Form 15, deregistered with the SEC. The Conrail stock acquired by NSC and CSX was held in a voting trust pending approval of the joint acquisition by the Surface Transportation Board ("STB"). On June 8, 1998, the STB approved the application of CSX and NSC to control Conrail. On July 23, 1998, the STB issued a written opinion that permitted those companies to exercise operating control of Conrail beginning August 22, 1998. NSC and CSX will not formally begin to exercise operating control until Closing Date, which is expected to occur on June 1, 1999. Subsequent to the Closing Date, the majority of CRC's routes and assets will be segregated into separate subsidiaries of CRC, and NSC and CSX will operate their respective portions under operating arrangements requiring payments which represent the fair market rental values of the assets being operated. Other CRC routes and assets will be operated by CRC for the benefit of NSC and CSX. After the Closing Date, the Company's major sources of revenue will be operating income and lease rentals from NSC and CSX instead of freight line haul revenues. The nature of the Company's operating expenses will also reflect this change in operations. Therefore, the Company's future operating results will be significantly different than those currently reported. In the course of normal business, the Company currently interchanges freight with both NSC and CSX for transport to destinations both within and outside of Conrail's service region. The Company shares ownership interests with either one or both railroads in various transportation-related entities, all of which are immaterial to the Company's operating results and financial position. 3. Transition, Acquisition and Merger-Related Costs ------------------------------------------------ In connection with its joint acquisition by NSC and CSX, the Company has incurred pre-tax transition, acquisition and merger- related costs totaling $68 million ($42 million after income taxes) and $65 million ($41 million after income taxes) during 1998 and 1997, respectively. Merger costs of $16 million ($10 million after income taxes) were incurred during 1996 related to the previously proposed merger of Conrail with CSX. In 1997 and 1996, these amounts primarily included costs for investment banking, legal and consulting services related to the acquisition of Conrail, and in 1998, included costs to facilitate the integration of the Company's activities into those of CSX and NSC. Page 155 EXHIBIT 99, Page 12 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During the third quarter of 1998, the Company recorded charges totaling $302 million ($187 million after income taxes), primarily for separation benefits of $170 million covering certain non-union employees, included in "transition and acquisition-related compensation costs", and $132 million of other costs, such as the effects of changing to an actuarial method of valuing certain components of the Company's casualty reserves, included in "general and administrative" expenses. The charge for non-union separation benefits represents termination payments to be made to approximately 1,300 non-union employees whose non-executive positions will be eliminated as a result of the joint acquisition of Conrail. It is anticipated that most of these termination payments will be made in the form of supplemental retirement benefits from the Company's overfunded pension plan. During 1998 and 1997, the Company recorded charges totaling $66 million ($41 million after income taxes) and $49 million ($31 million after income taxes), respectively, representing amounts to be paid to certain non-union employees as incentive to continue their employment with the Company through August 22, 1998, the effective date of the STB approval of the joint acquisition of Conrail ("Control Date"), and the subsequent transition period. At December 31, 1998, the remaining liability for these incentive payments, included in "wages and employee benefits" in the balance sheet, is $31 million, however, such liability is being funded from the Conrail employee benefits trust ("EBT") and therefore does not require use of the Company's cash. The Company has also recorded $15 million ($9 million after income taxes) for payments made to certain middle management employees as provided in the amended merger agreement. During 1997, the Company recorded a charge of $221 million (no related income tax effect) for 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 and related accrued interest to the Company. The Company recorded a long- term liability of $221 million related to the ESOP termination charge, which is not expected to require future use of the Company's cash for settlement. Such liability, the balance of which is $75 million at December 31, 1998, is being reduced as the cash proceeds, held by the ESOP as a result of selling its ESOP Stock in the joint tender offer, are allocated to eligible ESOP participants. Page 156 EXHIBIT 99, Page 13 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During 1997, the Company recorded a charge of $110 million ($103 million after income taxes) in connection with employment "change in control" agreements with certain executives, which became operative as a result of the joint acquisition of Conrail. A portion of the benefits under these agreements, $68 million, has been paid in 1998 from the EBT. Also, as a result of the joint acquisition of Conrail, all outstanding performance shares and all outstanding unvested stock options, restricted shares and phantom shares vested during 1997. The Company paid all of the amounts due employees under these arrangements and recorded a $63 million charge ($39 million after income taxes). 4. Property and Equipment ----------------------
December 31, 1998 1997 ---- ---- (In Millions) Roadway $ 7,255 $ 7,167 Equipment 1,593 1,398 Less: Accumulated depreciation (2,029) (2,128) ------- ------- 6,819 6,437 ------- ------- Capital leases (primarily equipment) 793 869 Accumulated amortization (461) (476) ------- ------- 332 393 ------- ------- $ 7,151 $ 6,830 ======= =======
Conrail acquired equipment and incurred related long-term debt under various capital leases of $79 million in 1997 and $82 million in 1996. In 1995 and 1991, the Company recorded allowances for disposition for the sale or abandonment of certain under-utilized rail lines and other facilities. However, subsequent to Control Date, NSC and CSX determined that all such assets will initially continue to be used in operations. Therefore, amounts related to these allowances have been reclassified to accumulated depreciation. Page 157 EXHIBIT 99, Page 14 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Accrued and Other Current Liabilities -------------------------------------
December 31, 1998 1997 ---- ---- (In Millions) Freight settlements due others $ 42 $ 43 Equipment rents (primarily car hire) 78 74 Unearned freight revenue 59 77 Property and corporate taxes 33 55 Other 210 227 ------ ------ $ 422 $ 476 ====== ======
6. Long-Term Debt -------------- Long-term debt outstanding, including the weighted average interest rates at December 31, 1998, is composed of the following:
December 31, 1998 1997 ---- ---- (In Millions) Capital leases $ 391 $ 465 Medium-term notes payable, 6.27%, due 1999 30 60 Notes payable, 9.75%, due 2000 250 250 Debentures payable, 7.88%, due 2043 250 250 Debentures payable, 9.75%, due 2020 544 544 Equipment and other obligations, 6.79% 257 275 ------- ------- 1,722 1,844 Less current portion (113) (112) ------- ------- $ 1,609 $ 1,732 ======= =======
Using current market prices when available, or a valuation based on the yield to maturity of comparable debt instruments having similar characteristics, credit rating and maturity, the total fair value of the Company's long-term debt, including the current portion, but excluding capital leases, is $1,637 million and $1,607 million at December 31, 1998 and 1997, respectively, compared with carrying values of $1,331 million and $1,379 million at December 31, 1998 and 1997, respectively. Page 158 EXHIBIT 99, Page 15 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's noncancelable long-term leases generally include options to purchase at fair value and to extend the terms. Capital leases have been discounted at rates ranging from 3.09% to 14.26% and are collateralized by assets with a net book value of $332 million at December 31, 1998. Minimum commitments, exclusive of executory costs borne by the Company, are:
Capital Operating Leases Leases ------- --------- (In Millions) 1999 $ 92 $ 111 2000 76 85 2001 60 76 2002 57 72 2003 52 70 2004 - 2018 194 417 ----- ----- Total 531 $ 831 ===== Less interest portion (140) ----- Present value $ 391 =====
Operating lease rent expense was $121 million in 1998, $122 million in 1997 and $127 million in 1996. Equipment and other obligations mature in 1999 through 2043 and are collateralized by assets with a net book value of $249 million at December 31, 1998. Maturities of long-term debt other than capital leases are $48 million in 1999, $268 million in 2000, $19 million in 2001, $18 million in 2002, $18 million in 2003 and $960 million in total from 2004 through 2043. The shelf registration established in 1993, which enabled CRC to issue up to $500 million in debt securities or the Company to issue up to $500 million in convertible debt and equity securities, is no longer available as a financing source at December 31, 1998. CRC and the Company have each filed a Form 15 with the SEC, terminating their status as SEC registrants and their ability to issue any securities under a shelf registration. Page 159 EXHIBIT 99, Page 16 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Effective December 31, 1998, at the request of NSC and CSX, CRC terminated its $440 million uncollateralized bank credit agreement with a group of banks which was used for general corporate purposes and to support CRC's commercial paper program, which is no longer in effect. Interest payments were $153 million in 1998, $163 million in 1997 and $170 million in 1996. 7. Income Taxes ------------ The provisions for income taxes are composed of the following:
1998 1997 1996 ---- ---- ---- (In Millions) Current Federal $ 173 $ 122 $ 90 State 24 17 10 ----- ----- ----- 197 139 100 ----- ----- ----- Deferred Federal 24 115 151 State 6 37 32 ----- ----- ----- 30 152 183 ----- ----- ----- Special income tax obligation Federal (51) (54) (80) State (9) (9) (14) ----- ----- ----- (60) (63) (94) ----- ----- ----- $ 167 $ 228 $ 189 ===== ===== =====
In conjunction with the public sale in 1987 of the 85% of the Company's common stock then owned by the U.S. Government, federal legislation was enacted which resulted in a reduction of the tax basis of certain of the Company's assets, particularly property and equipment, thereby substantially decreasing tax depreciation deductions and increasing future federal income tax payments. Also, net operating loss and investment tax credit carryforwards were canceled. As a result of the sale-related transactions, a special income tax obligation was recorded in 1987 based on the estimated effective federal and state income tax rates at that time. Page 160 EXHIBIT 99, Page 17 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The nondeductibility of the ESOP termination charge and certain transition and acquisition-related compensation costs for federal and state income tax purposes, has resulted in a significant difference between the Company's statutory and effective tax rates for 1997 (Note 3). A tax law was enacted during the third quarter of 1997 by a state in which CRC operates which changed the Company's method of computing taxes and resulted in a tax rate increase. Income tax expense for 1997 was increased by $22 million representing the effects of adjusting deferred income taxes and the special income tax obligation for the rate increase as required by SFAS 109, "Accounting for Income Taxes" ("SFAS 109"). Reconciliations of the U.S. statutory tax rates with the effective tax rates are as follows:
1998 1997 1996 ---- ---- ---- Statutory tax rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 3.2 3.2 3.4 ESOP termination charge 36.3 Nondeductible transition and acquisition-related compensation costs 14.9 Effect of state tax increase on deferred taxes 9.3 Other .3 (1.7) (2.8) ----- ----- ----- Effective tax rate 38.5% 97.0% 35.6% ===== ===== =====
In 1996, the Company reached a settlement with the Internal Revenue Service ("IRS") related to the audit of the Company's consolidated federal income tax returns for the fiscal years 1990 through 1992. The Company made a payment of $39 million pending resolution of the final interest determination related to the settlement, of which $6 million was refunded to the Company in 1997. The Company's consolidated federal income tax returns for fiscal years 1993 through 1995 are currently being examined by the IRS. Federal and state income tax payments were $196 million in 1998, $120 million in 1997 and $145 million in 1996 (excluding tax settlement). Page 161 EXHIBIT 99, Page 18 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Significant components of the Company's special income tax obligation and deferred income tax liabilities (assets) are as follows:
December 31, ------------ 1998 1997 ---- ---- (In Millions) Current assets $ (22) $ (10) Current liabilities (152) (97) Miscellaneous (8) (8) ------- ------- Current deferred tax asset, net $ (182) $ (115) ======= ======= Noncurrent liabilities: Property and equipment 1,839 1,877 Other long-term assets (primarily prepaid pension asset) 106 90 Miscellaneous 117 130 ------- ------ 2,062 2,097 ------- ------ Noncurrent assets: Nondeductible reserves and other liabilities (239) (200) Tax benefit transfer receivable (36) (36) Miscellaneous -- (125) ------- ------ (275) (361) ------- ------ Special income tax obligation and deferred income tax liabilities, net $ 1,787 $ 1,736 ======= =======
8. Employee and Postretirement Benefits ------------------------------------ Postretirement Benefits ----------------------- The Company and its subsidiaries sponsor several qualified and nonqualified pension plans and other postretirement benefit plans for its employees. The following tables provide a reconciliation of the changes in the plans' benefit obligations and fair value of assets over the two-year period ending December 31, 1998, and a statement of the funded status as of December 31 of both years: Page 162 EXHIBIT 99, Page 19 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Postretirement Pension Benefits Benefits ---------------- -------------------- (In Millions) 1998 1997 1998 1997 ---- ---- ---- ---- Change in benefit obligation Net benefit obligation at beginning of year $ 699 $ 734 $ 57 $ 64 Service cost 13 8 -- -- Interest cost 52 50 4 4 Plan amendments 59 -- -- -- Actuarial (gains)losses 65 (11) 1 (6) Gross benefits paid (64) (82) (6) (5) ------ ------ ------ ------ Net benefit obligation at end of year $ 824 $ 699 $ 56 $ 57 Change in plan assets Fair value of plan assets at beginning of year $1,308 $1,187 $ 10 $ 10 Actual return on plan assets 211 205 -- 1 Gross benefit payments (78) (84) (1) (1) ------ ------ ------ ------ Fair value of plan assets at end of year $1,441 $1,308 $ 9 $ 10 Funded status at end of year $ 617 $ 609 $ (47) $ (47) Unrecognized transition asset (54) (72) -- -- Unrecognized prior service cost 88 33 -- -- Unrecognized actuarial (gains)losses (373) (343) -- (7) ------ ------ ------ ------ Net amount recognized at year end $ 278 $ 227 $ (47) $ (54) ====== ====== ====== ======
The following amounts have been recognized in the balance sheets as of December 31:
Other Postretirement Pension Benefits Benefits ---------------- -------------------- (In Millions) 1998 1997 1998 1997 ---- ---- ---- ---- Prepaid pension cost $ 278 $ 227 -- -- Accrued benefit cost -- -- $ (47) $ (54)
Page 163 EXHIBIT 99, Page 20 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All of the Company's plans for postretirement benefits other than pensions have no plan assets except for the retiree life insurance plan which has $9 million of assets. The aggregate benefit obligation for the postretirement plans other than pensions is $56 million and $57 million at December 31, 1998 and 1997, respectively. The assumptions used in the measurement of the Company's benefit obligation are as follows:
Other Postretirement Pension Benefits Benefits ----------------- -------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Discount rate 6.50% 7.00% 6.50% 7.00% Expected return on plan assets 9.00% 9.00% 8.00% 8.00% Rate of compensation increase 5.00% 6.00% 5.00% 6.00%
The Company's pension plan was amended during 1998 to include certain enhanced benefits for qualifying Conrail employees. The effect of the amendment was to increase the Conrail plan's projected benefit obligation by $59 million. The Company's pension plan was also amended during 1998 to allow for payment of non-union supplemental retirement benefits to the extent consistent with applicable Internal Revenue Service Tax Code provisions. Both of these liabilities are accrued in "wages and employee benefits" in the balance sheet (Note 3). A 7% annual rate of increase in the per capital cost of covered health care benefits was assumed for 1999, gradually decreasing to 6% by the year 2007. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. The effect of a one percentage point increase and (decrease) in the assumed health care cost trend rate on accumulated postretirement benefit obligation is $2 million and $(2) million, respectively, and would have an immaterial effect on the net periodic postretirement benefit cost for 1998. Page 164 EXHIBIT 99, Page 21 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of the Company's net periodic benefit cost for the plans are as follows:
Other Postretirement Pension Benefits Benefits ---------------- ------------------- (In Millions) 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Service cost $ 13 $ 8 $ 9 $ -- $ -- $ -- Interest cost 52 50 51 4 4 5 Expected return on assets (109) (98) (91) (1) (1) (1) Amortization of: Transition asset (18) (18) (18) -- -- -- Prior service cost 4 3 4 -- -- -- Actuarial gain (5) (6) (1) (1) (1) -- ----- ----- ----- ----- ----- ----- $ (63) $ (61) $ (46) $ 2 $ 2 $ 4 ===== ===== ===== ===== ===== =====
Savings Plans ------------- The Company and certain subsidiaries provide 401(k) savings plans for union and non-union employees. However, in connection with the close of the CSX-NSC joint tender offer for Conrail, the Company's Non-union ESOP was terminated with the repayment of the ESOP note payable of $291 million and related accrued interest in the second quarter of 1997, resulting in a charge of $221 million (no related income tax effect) (Notes 2 and 3). Under the Non- union ESOP, 100% of employee contributions were matched in the form of ESOP Stock for the first 6% of a participating employee's base pay. There is no Company match provision under the union employee plan except for three unions which negotiated a Company match as part of their contract provisions. Savings plan expense was $1 million in 1997 and $4 million in 1996. In connection with the formation of the Non-union ESOP in 1990, the Company issued 9,979,562 of the authorized 10 million shares of its ESOP Stock to the Non-union ESOP in exchange for a 20 year promissory note from the Non-union ESOP in the principal amount of approximately $290 million. In addition, unearned ESOP compensation in the same amount was recognized as a charge to stockholders' equity coincident with the Non-union ESOP's issuance of its promissory note to the Company. The debt of the Non-union ESOP was recorded by the Company and offset against the promissory note from the Non-union ESOP. The Company received debt service payments from the Non-union ESOP of $11 million in 1997 and $40 million in 1996. Page 165 EXHIBIT 99, Page 22 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Prior to the close of the joint tender offer (Notes 2 and 3), unearned ESOP compensation was charged to expense as shares of ESOP Stock were allocated to participants. An amount equivalent to the preferred dividends declared on the ESOP Stock had partially offset compensation and interest expense related to the Non-union ESOP through the close of the joint tender offer. Interest expense incurred by the Non-union ESOP on its debt to the Company was $9 million in 1997 and $24 million in 1996. Compensation expense related to the Non-union ESOP was $2 million in 1997 and $11 million in 1996. Prior to its acquisition, the Company made dividend payments at a rate of 7.51% on the ESOP Stock and additional contributions in an aggregate amount sufficient to enable the Non-union ESOP to make the required interest and principal payments on its note to the Company. Preferred dividends declared were $3 million in 1997 and $20 million in 1996. Preferred dividend payments of $3 million and $25 million were made in 1997 and 1996, respectively. 9. Capital Stock ------------- Employee Benefits Trust ----------------------- In 1995, the Company issued approximately 4.7 million shares of its common stock to the Conrail Employee Benefits Trust (the "Trust") in exchange for a promissory note of $250 million at an interest rate of 6.9%. As a result of the joint tender offer (Notes 2 and 3) for the Company's common stock, the Trust repaid $90 million of the promissory loan with a portion of the proceeds it received from the sale of the common stock it held. The Trust currently funds, and is expected to continue to fund, the payment of employee benefits with the remaining proceeds it currently holds. The Trust was intended to fund certain employee benefits and other forms of compensation over its fifteen-year term. The amount representing unearned employee benefits is recorded as a deduction from stockholders' equity and is reduced as benefits and compensation, including future transition and acquisition- related compensation, are paid from the Trust. Before the close of the joint tender offer for the Company's common stock, the shares owned by the Trust were valued at the closing market price as of the end of each reporting period, with corresponding changes in the balance of the Trust reflected in additional paid- in capital. Currently, interest earned on the proceeds received from the joint tender offer increases both the Trust balance and Page 166 EXHIBIT 99, Page 23 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS additional paid-in capital. Shares held by the Trust were not considered outstanding for earnings per share computations until released by the Trust, but did have voting and dividend rights. Treasury Stock -------------- As a result of the acquisition of Conrail, the Company's common stock repurchase program was terminated in the fourth quarter of 1996. The activity for 1997 is related to the repurchase of common stock in connection with the repayment of $90 million of the Trust promissory loan described above. The remaining shares of treasury stock at December 31, 1997, were recorded as canceled and retired during 1998. The activity and status of treasury stock follow:
1998 1997 1996 ---- ---- ---- Shares, beginning of year 6,320,249 5,523,455 3,297,717 Acquired 2,225,738 Effects of Conrail acquisition (6,320,249) 796,794 ---------- --------- --------- Shares, end of year -- 6,320,249 5,523,455 ========= ========= =========
Stock Plans ----------- The Company has applied APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for the Conrail plans. Accordingly, no compensation cost was recognized for the Conrail fixed stock option plans prior to Conrail's acquisition. However, in connection with the acquisition of Conrail, all outstanding performance shares and all outstanding unvested stock options, restricted shares and phantom shares vested during 1997. The Company paid all of the amounts due under these arrangements and recorded a $63 million charge ($39 million after income taxes) for the related compensation expense (Notes 2 and 3). The Company's 1987 and 1991 Long-Term Incentive Plans authorized the granting to officers and other key employees of up to 4 million and 6.6 million shares of common stock, respectively, through stock options, stock appreciation rights, phantom stock and awards of restricted or performance shares. A stock option was exercisable for a specified term commencing after grant at a price not less than the fair market value of the stock on the date Page 167 EXHIBIT 99, Page 24 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of grant. The vesting of awards made pursuant to these plans was contingent upon one or more of the following: continued employment, passage of time or financial and other performance goals. The activity and status of stock options under the incentive plans follow:
Non-qualified Stock Options ------------------------------------ Option Price Shares Per Share Under Option ------------------ ------------ Balance, January 1, 1996 $14.000 - $ 68.563 1,556,212 Granted $68.563 - $ 96.063 551,038 Exercised $14.000 - $ 73.250 (1,268,085) Canceled $42.625 - $ 70.031 (3,984) ------------ Balance, December 31, 1996 $14.000 - $ 96.063 835,181 Granted $42.625 - $104.438 416,190 Exercised $14.000 - $104.438 (267,294) Canceled $42.625 - $ 50.688 (6,625) Purchased due to Conrail acquisition $14.000 - $104.438 (977,452) ------------ Balance, December 31, 1997 -- ============ Available for future grants December 31, 1998 and 1997 -- ============
The weighted average exercise prices of options granted during 1996 was $70.130 per share. The weighted average exercise price of options exercised during 1996 was $48.32 per share. Pro forma disclosures of net income and earnings per share as if the Company had adopted the cost recognition requirements under SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123) in 1996 are presented below ($ in millions except per share data):
1996 ---- Net income as reported $ 342 Net income pro forma 335 Basic earnings per share $4.29 Basic earnings per share pro forma 4.20 Diluted earnings per share $3.91 Diluted earnings per share pro forma 3.82
Page 168 EXHIBIT 99, Page 25 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value of each option granted during 1996 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: (1) dividend yield of 2.43%, (2) expected volatility of 25.25%, (3) risk-free interest rate of 5.51%, and (4) expected life of 4 years. The weighted average fair value of options granted during 1996 was $16.00 per share. Prior to its acquisition, the Company had granted phantom shares and restricted stock under its non-union employee bonus plans to eligible employees who elected to defer all or a portion of their annual bonus in a given year. The number of shares granted depended on the length of the deferral period. Grants were made at the market price of the Company's common stock at the date of grant. The Company had granted 148,749 shares and 337,329 shares of phantom and restricted stock, respectively, under its non- union employee bonus plans through its acquisition date of May 23, 1997. The Company had also granted 201,945 performance shares under its 1991 Long-Term Incentive Plan through its acquisition date. Compensation expense related to these plans was $2 million in 1996. The weighted-average fair value for the phantom shares and restricted stock granted during 1996 was $68.02 per share. As a result of its acquisition, the Company paid all of the amounts due to employees under stock-related compensation arrangements during 1997 (Note 3). 10. Voluntary Separation Programs ----------------------------- During 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 reduction in the Company's workforce. Over 840 applications were accepted from eligible employees under the voluntary separation programs. Approximately $90 million in benefits are being paid from the Company's overfunded pension plan. Page 169 EXHIBIT 99, Page 26 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. Other Income, Net -----------------
1998 1997 1996 ---- ---- ---- (In Millions) Interest income $ 7 $ 13 $ 29 Rental income 42 41 50 Property sales 21 23 23 Other, net 2 6 10 ---- ---- ---- $ 72 $ 83 $112 ==== ==== ====
12. Commitments and Contingencies ----------------------------- Environmental ------------- The Company is subject to various federal, state and local laws and regulations regarding environmental matters. CRC is a party to various proceedings brought by both regulatory agencies and private parties under federal, state and local laws, including Superfund laws, and has also received inquiries from governmental agencies with respect to other potential environmental issues. At December 31, 1998, CRC has received, together with other companies, notices of its involvement as a potentially responsible party or requests for information under the Superfund laws with respect to cleanup and/or removal costs due to its status as an alleged transporter, generator or property owner at 138 locations. However, based on currently available information, the Company believes CRC may have some potential responsibility at only 45 of these sites. Due to the number of parties involved at many of these sites, the wide range of costs of possible remediation alternatives, the changing technology and the length of time over which these matters develop, it is often not possible to estimate CRC's liability for the costs associated with the assessment and remediation of contaminated sites. Although the Company's operating results and liquidity could be significantly affected in any quarterly or annual reporting period if CRC were held principally liable in certain of these actions, at December 31, 1998, the Company had accrued $81 million, an amount it believes is sufficient to cover the probable liability and remediation costs that will be incurred at Superfund sites and other sites based on known information and using various estimating techniques. The Company believes the ultimate liability for these matters will not materially affect its consolidated financial condition. Page 170 EXHIBIT 99, Page 27 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company spent $10 million in 1998, $9 million in 1997 and $11 million in 1996 for environmental remediation and related costs. In addition, the Company's capital expenditures for environmental control and abatement projects were approximately $8 million in 1998, $7 million in 1997 and $6 million in 1996. The Environmental Quality Department is charged with promoting the Company's compliance with laws and regulations affecting the environment and instituting environmentally sound operating practices. The department monitors the status of the sites where the Company is alleged to have liability and continually reviews the information available and assesses the adequacy of the recorded liability. Other ----- The Company is involved in various legal actions, principally relating to occupational health claims, personal injuries, casualties, property damage and damage to lading. The Company has recorded liabilities for amounts sufficient to cover the expected payments for such actions. CRC had an average of 19,808 employees in 1998, approximately 88% of whom are represented by 14 different labor organizations and are covered by 21 separate collective bargaining agreements. The Company was not engaged in any collective bargaining at December 31, 1998. CRC currently guarantees the principal and interest payments in the amount of $42 million on Equipment Trust Certificates for Locomotive Management Services, a general partnership of which CRC holds a fifty percent interest. The Company has taken actions to resolve anticipated year 2000 issues related to certain of its computer systems. Conrail believes that all of its year 2000 issues will be resolved either by the certain actions taken by the Company or by the integration of its systems with those of CSX and NSC on or following the Closing Date. The Company believes that failure to integrate its systems with those of CSX and NSC could result in a material financial risk and serious disruption in its operations. The Company has developed contingency plans related to the year 2000 in the event the integration does not occur. While it is not possible, at this time, to quantify the overall cost of implementing such contingency plans, the Company believes that it would be material to its results of operations during the implementation period. Page 171 EXHIBIT 99, Page 28 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. Condensed Quarterly Data (Unaudited) ------------------------------------
First Second Third Fourth --------- --------- --------- --------- 1998 1997 1998 1997 1998 1997 1998 1997 ---- ---- ---- ---- ---- ---- ---- ---- ($ In Millions Except Per Share) Revenues $927 $906 $983 $937 $976 $944 $977 $978 Income (loss) from operations 160 116 206 (231) (82) 218 231 219 Net income (loss) 85 61 115 (273) (65) 101 132 118 Net income (loss) per common share: Basic -- .74 -- -- -- -- -- -- Diluted -- .70 -- -- -- -- -- -- Ratio of earnings to fixed charges 3.44x 2.52x 4.53x -- -- 4.82x 6.02x 4.76x Dividends per common share -- .475 -- -- -- -- -- -- Market prices per common share (New York Stock Exchange) High -- 113-1/4 -- -- -- -- -- -- Low -- 98-1/2 -- -- -- -- -- --
Due to the acquisition of Conrail (Notes 2 and 3), per share data are not presented for periods subsequent to the first quarter of 1997. The Company recorded pre-tax transition and acquisition-related costs of $29 million ($18 million after income taxes), $43 million ($27 million after income taxes), $215 million ($133 million after income taxes) and $32 million ($19 million after income taxes) during the first, second, third and fourth quarters of 1998, respectively. During the third quarter of 1998, the Company recorded charges totaling $302 million ($187 million after income taxes), primarily for separation benefits of $170 million covering certain non-union employees, included in the third quarter of 1998 transition and acquisition-related costs, and $132 million of other costs included in general and administrative expense (Note 3). After the transition and acquisition-related costs were recognized during the third quarter of 1998, earnings available for fixed charges were inadequate by $109 million. The Company recorded pre-tax transition, acquisition and merger- related costs of $22 million ($14 million after income taxes), $440 million ($390 million after income taxes), $23 million ($16 million after income taxes) and $23 million ($15 million after income taxes) during the first, second, third and fourth quarters of 1997, respectively. A $221 million ESOP termination charge (no income tax effect) is included in the second quarter of 1997 transition, acquisition and merger-related costs (Note 3). Page 172 EXHIBIT 99, Page 29 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS After the transition, acquisition and merger-related costs were recognized during the second quarter of 1997, earnings available for fixed charges were inadequate by $259 million. 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 was increased by $22 million representing the effects of adjusting deferred income taxes and the special income tax obligation for the rate increase as required by SFAS 109 (Note 7). Page 173 EXHIBIT 99, Page 30 of 30 Schedule II CONRAIL INC. VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, (In Millions)
Additions Balance Charged Charged Balance at Begin- to Costs to Other at End ning of and Accounts Deduc- of Description Period Expenses (1) tions Period - ----------- ------- -------- -------- ------ ------- 1996 Casualty reserves Current.............. $ 110 $(31)(2) $ 141 Noncurrent........... 217 $ 165 $ 11 203 (3) 190 Allowance for disposition of property and equipment (4)....... 439 31 408 1997 Casualty reserves Current.............. 141 1 1(2) 141 Noncurrent........... 190 127 14 133(3) 198 Allowance for disposi- tion of property and equipment (4)........... 408 16 392 1998 Casualty reserves Current.............. 141 17 19(2) 139 Noncurrent........... 198 140 11 134(3) 215 Allowance for disposi- tion of property and equipment (4)(5)......... 392 392 --
(1) Includes charges to property accounts in connection with construction projects and the recording of receivables from third parties. (2) Includes net transfers from noncurrent. (3) Includes net transfers to current. (4) Deductions of $31 million, $16 million and $25 million in 1996, 1997 and 1998, respectively, represent net losses on asset dispositions. (5) At December 31, 1998, the Company reclassified the remaining balance of $367 million from the allowance for disposition to accumulated depreciation since subsequent to Control Date, Norfolk Southern Corporation and CSX Corporation determined that all assets included in the reserve will initially continue to be used in operations. -----END PRIVACY-ENHANCED MESSAGE-----