-----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, ED87c8KrWFcDE1cihXnssp9Q5vxQtvcV6DZSrClEwYYYbzWOksXaqmPzWF8m9bjC pWRk+Iy75ML6fpbk7Liuxw== 0000702165-98-000016.txt : 19980327 0000702165-98-000016.hdr.sgml : 19980327 ACCESSION NUMBER: 0000702165-98-000016 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980325 SROS: NYSE 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: 98573447 BUSINESS ADDRESS: STREET 1: THREE COMMERCIAL PL CITY: NORFOLK STATE: VA ZIP: 23510-2191 BUSINESS PHONE: 8046292680 10-K405 1 NORFOLK SOUTHERN CORPORATION 10-K405 FYE 12/31/97 PAGE 1 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, 1997. OR ( )TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------------- --------------- Commission file number 1-8339 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 28, 1998: $13,018,725,432 The number of shares outstanding of each of the registrant's classes of common stock, as of February 28, 1998: 378,039,214 (excluding 21,757,902 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, 1998), to be filed electronically pursuant to Regulation 14A not later than 120 days after the end of the fiscal year, are incorporated by reference in Part III. PAGE 3 TABLE OF CONTENTS ----------------- Item Page ---- ---- Part I 1. Business 4 2. Properties 4 3. Legal Proceedings 21 4. Submission of Matters to a Vote of Security Holders 21 Executive Officers of the Registrant 22 Part II 5. Market for Registrant's Common Stock and Related Stockholder Matters 26 6. Selected Financial Data 27 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 34 8. Financial Statements and Supplementary Data 52 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 81 Part III 10. Directors and Executive Officers of the Registrant 81 11. Executive Compensation 81 12. Security Ownership of Certain Beneficial Owners and Management 81 13. Certain Relationships and Related Transactions 81 Part IV 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 82 Index to Consolidated Financial Statement Schedule 82 Power of Attorney 87 Signatures 87 Exhibit Index 91 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). As of Dec. 31, 1997, all the common stock of NW (100 percent voting control) was owned by Norfolk Southern Railway, and 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 June 21, 1985, Norfolk Southern acquired control of North American Van Lines, Inc. and its subsidiaries (NAVL), a diversified motor carrier. In accordance with an Acquisition Agreement dated May 2, 1984, and with the approval of the transaction by the ICC, Norfolk Southern acquired all the issued and outstanding common stock of NAVL. During 1993, NAVL underwent a restructuring (see discussion on page 17) designed to enhance its opportunities to return to profitability. On Jan. 12, 1998, NS announced that it signed an agreement to sell all the common stock of NAVL. The transaction is subject to customary closing conditions and is expected to be consummated before May 31, 1998; NS expects to report a gain on this sale. NAVL's results of operation, 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. equity (see "Joint Acquisition of Conrail" on page 47). CONTINUING OPERATIONS: RAILROAD OPERATIONS - As of Dec. 31, 1997, 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 PAGE 5 Virginia, and in the Province of Ontario, Canada. Of this total, 12,101 miles are owned with the balance operated under lease or trackage rights; most of this total is main line track. In addition, its railroads operate 10,838 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) and by the stockholders of NCRR, the U.S. District Court in Raleigh ruled that there was no quorum at the stockholders' meeting and enjoined the parties from performing under the extension agreement. NCRR has suits pending against 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. Also, certain NCRR stockholders earlier had filed four separate, and still pending, derivative actions challenging the adequacy of the rental terms in the extension agreement. NS' 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' lines carry raw materials, intermediate products and finished goods primarily in the Southeast and Midwest and to and from the rest of the United States and parts of Canada. These lines also transport overseas freight through several Atlantic and Gulf Coast ports. Atlantic ports served by NS include: Norfolk, Virginia; Morehead City, North Carolina; Charleston, South Carolina; Savannah and Brunswick, Georgia; and Jacksonville, Florida. Gulf Coast ports served include: Mobile, Alabama, and New Orleans, Louisiana. 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 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 PAGE 6 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. Implementation of the Conrail transaction should expand NS' service area considerably, giving it access to most of the major ports on the East Coast, to New York City and the Northeast, and to the Midwest. Additional information is provided in "Management's Discussion and Analysis," beginning on page 34, and in Note 2 to the Consolidated Financial Statements. 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, Norfolk Southern's 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 Norfolk Southern and Conrail are equal partners. RoadRailer(RT) equipment owned or leased by TCS (which was renamed TCS Leasing, Inc.) is operated by TCSC. Because NS indirectly owns only 50 percent of TCSC, the revenues of TCSC are not consolidated with the results of NS. 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. NS expects to succeed to Conrail's interest in TCSC, if its joint control application with CSX is approved. PAGE 7 RAILWAY OPERATING REVENUES - NS' total railway operating revenues were $4.2 billion in 1997. Revenue, shipments and revenue yield by principal railway operating revenue sources for the past five years are set forth in the following table:
Year Ended December 31, Principal Sources of ----------------------------------------------- Railway Operating Revenues 1997 1996 1995 1994 1993 - -------------------- ---- ---- ---- ---- ---- (Revenues in millions, shipments in thousands, revenue yield in dollars per shipments) COAL Revenues $1,301 $1,305 $1,268 $1,290 $1,239 % of total revenues 31% 32% 32% 33% 33% Shipments 1,324 1,310 1,267 1,274 1,209 % of total shipments 28% 29% 29% 30% 30% Revenue Yield $ 983 $ 996 $1,001 $1,013 $1,025 CHEMICALS Revenues $ 585 $ 560 $ 541 $ 538 $ 501 % of total revenues 14% 14% 14% 14% 14% Shipments 405 385 374 376 343 % of total shipments 8% 8% 8% 9% 8% Revenue Yield $1,446 $1,456 $1,447 $1,433 $1,459 PAPER/CLAY/FOREST Revenues $ 539 $ 513 $ 537 $ 522 $ 522 % of total revenues 13% 12% 13% 13% 14% Shipments 457 438 459 464 466 % of total shipments 9% 10% 10% 11% 12% Revenue Yield $1,178 $1,171 $1,170 $1,124 $1,120 AUTOMOTIVE Revenues $ 492 $ 489 $ 449 $ 429 $ 426 % of total revenues 11% 12% 11% 11% 11% Shipments 361 354 328 317 318 % of total shipments 8% 8% 7% 7% 8% Revenue Yield $1,364 $1,379 $1,368 $1,352 $1,340 AGRI./GOVT./CONSUMER Revenues $ 391 $ 393 $ 394 $ 380 $ 357 % of total revenues 9% 9% 10% 10% 10% Shipments 366 376 391 383 359 % of total shipments 8% 8% 9% 9% 9% Revenue Yield $1,065 $1,045 $1,007 $ 992 $ 994 METALS/CONSTRUCTION Revenues $ 368 $ 354 $ 349 $ 330 $ 309 % of total revenues 9% 9% 8% 8% 8% Shipments 374 359 367 366 338 % of total shipments 8% 8% 8% 8% 8% Revenue Yield $ 985 $ 986 951 $ 902 $ 915
PAGE 8
Year Ended December 31, Principal Sources of ----------------------------------------------- Railway Operating Revenues 1997 1996 1995 1994 1993 - -------------------- ---- ---- ---- ---- ---- (Revenues in millions, shipments in thousands, revenue yield in dollars per shipments) INTERMODAL (Trailers, Containers and RoadRailers) Revenues $ 547 $ 487 $ 474 $ 429 $ 374 % of total revenues 13% 12% 12% 11% 10% Shipments 1,472 1,331 1,263 1,127 995 % of total shipments 31% 29% 29% 26% 25% Revenue Yield $ 372 $ 366 $ 376 $ 380 $ 376 OTHER INTERMODAL RELATED* Revenues $ -- $ -- $ -- $ -- $ 18 % of total revenues -- -- -- -- -- ------ ------ ------ ------ ------ Total Railway Operating Revenues $4,223 $4,101 $4,012 $3,918 $3,746 Total Railway Shipments 4,759 4,553 4,449 4,307 4,028 Railway Revenue Yield $ 887 $ 901 $ 902 $ 910 $ 930 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. * See discussion on page 6 regarding TCSC revenues.
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 1997 and handled a total of 134 million tons. Originated tonnage increased 2 percent from 117 million tons in 1996, and total tons handled increased 3 percent from 130 million tons in 1996. Revenues from coal, coke and iron ore account for about 31 percent of NS' total railway operating revenues. The following table shows total coal, coke and iron ore tonnage originated on line, received from connections and handled for the past five years:
Tons of Coal, Coke and Iron Ore (Millions) -------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Originated 119 117 114 115 112 Received 15 13 11 11 6 ---- ---- ---- ---- ---- Handled 134 130 125 126 118
Of the 119 million tons of coal, coke and iron ore originated on NS' railroads' lines in 1997, the approximate breakdown by origin state was as follows:
Origin State Millions of Tons ------------ ---------------- West Virginia 43 Virginia 35 Kentucky 28 Alabama 5 Indiana 3 Illinois 2 Tennessee 2 Other 1 --- Total 119 ===
Of this 119 million tons, approximately 28 million moved for export, principally through NS' pier facilities at Norfolk (Lamberts Point), Virginia; 19 million moved to domestic and Canadian steel industries; 64 million of steam coal moved to electric utilities; and 8 million moved to other industrial and miscellaneous users. NS' railroads moved 9 million tons of originated coal, coke and iron ore to various docks on the Ohio River, and 5 million tons to various Lake Erie ports. Other than coal for export, virtually all coal handled by NS' railroads was terminated in states situated east of the Mississippi River. PAGE 10 Total coal handled through all system ports in 1997 was 45 million tons. Of this total, 71 percent, or 32 million tons (including coastwise traffic), moved through Lamberts Point, a 7 percent increase, compared with the 30 million tons handled in 1996. 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) ----------------------------------
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- 28 26 25 24 25
See the discussion of coal traffic, by type of coal, in Part II, Item 7, "Management's Discussion and Analysis," on page 34. MERCHANDISE TRAFFIC - The merchandise traffic group consists of Intermodal and five major commodity groupings: Paper, Clay, and Forest Products; Chemicals; Automotive; Agriculture, Government, and Consumer Products; and Metals and Construction. Total merchandise revenues in 1997 were $2.92 billion, a 5 percent increase, compared with 1996. Merchandise carloads handled in 1997 were 3.43 million, compared with 3.24 million handled in 1996, an increase of 6 percent. Intermodal results, for 1993 and later, reflect the effect of the formation, in April 1993, of TCSC, a partnership between subsidiaries of NS and Conrail (see also page 6). This partnership provides RoadRailer(RT) service previously offered by a wholly owned subsidiary of NS. Because NS currently owns only 50 percent of TCSC, its revenues are not consolidated. NS' intermodal revenues include only revenues for rail service NS provides the partnership. In 1997, 111 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 five of the six market groups comprising merchandise traffic improved in 1997. The largest gains were in Intermodal, up $60 million; Paper, Clay, and Forest Products, up $26 million; and Chemicals, up $25 million. See the discussion of merchandise rail traffic by commodity group in Part II, Item 7, "Management's Discussion and Analysis," on page 34. PAGE 11 RAIL OPERATING STATISTICS - The following table sets forth certain statistics relating to NS' railroads' operations for the past five years:
Year Ended December 31, ------------------------------------------- 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Revenue ton miles (billions) 136 130 127 122 112 Freight train miles traveled (millions) 49.7 49.4 48.5 46.0 43.3 Revenue per ton mile $0.0311 $0.0316 $0.0317 $0.0320 $0.0336 Revenue tons per train 2,732 2,625 2,611 2,655 2,577 Revenue ton miles per man-hour worked 2,905 2,764 2,679 2,579 2,304 Percentage ratio of railway operating expenses to railway operating revenues 71.3 71.6 73.5 73.4 75.6
FREIGHT RATES - In 1997, 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 economically regulated by the government. In general, market forces have been substituted for government regulation and now are the primary determinant of rail service prices. In 1997, NS' railroads were found by the STB to be "revenue adequate" based on results for the year 1996. A railroad is "revenue adequate" under the applicable law when its return on net investment exceeds the rail industry's composite cost of capital. The revenue adequacy measure is one of several factors considered by the STB when it is called upon to rule on the reasonableness of regulated rates. PASSENGER OPERATIONS - Regularly scheduled passenger operations on NS' 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. Should the Conrail transaction become effective as proposed, NS will accommodate substantially increased Amtrak and commuter passenger mileage and will conduct significant freight operations over trackage owned by Amtrak or by commuter entities. PAGE 12 NONCARRIER OPERATIONS - Norfolk Southern's 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 1997, 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. 14. RAILWAY PROPERTY: EQUIPMENT - As of Dec. 31, 1997, 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 2,027 0 2,027 6,472,600 Switching 112 0 112 163,950 Auxiliary units 61 0 61 0 --------- ------- -------- ------------ Total locomotives 2,200 0 2,200 6,636,550 ========= ======= ======== ============ Freight Cars: (Tons) Hopper 22,639 331 22,970 2,425,379 Box 18,789 666 19,455 1,520,443 Covered Hopper 12,400 1,890 14,290 1,550,683 Gondola 26,140 0 26,140 2,797,632 Flat 3,967 825 4,792 346,931 Caboose 207 0 207 0 Other 1,438 0 1,438 95,840 --------- ------- -------- ------------ Total freight cars 85,580 3,712 89,292 8,736,908 ========= ======= ======== ============ Other: Work equipment 6,745 3 6,748 Vehicles 3,649 0 3,649 Highway trailers and containers 2,043 2,785 4,828 RoadRailers(RT) 922 0 922 Miscellaneous 1,498 1,799 3,297 --------- ------- -------- Total other 14,857 4,587 19,444 ========= ======= ======== * 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, 1997:
Year Built --------------------------------------------------------- 1987- 1981- 1980 & 1997 1996 1995 1994 1993 1992 1986 Before Total ---- ---- ---- ---- ---- ---- ---- ------ ----- Locomotives: Number of units 120 120 125 25 31 292 420 1,067 2,200 Percent of fleet 5 5 6 1 1 13 19 50 100 Freight cars: Number of units 499 787 1,034 779 931 6,122 6,632 68,796 85,580 Percent of fleet 1 1 1 1 1 7 8 80 100
The average age of the freight car fleet at Dec. 31, 1997, was 23.0 years. During 1997, 2,250 freight cars were retired. As of Dec. 31, 1997, the average age of the locomotive fleet was 15.3 years. During 1997, 78 locomotives, the average age of which was 23.3 years, were retired. Since 1988, more than 25,100 coal cars have been rebodied. As a result, the remaining serviceability of the freight car fleet is greater than may be inferred from the high percentage of freight cars built in earlier years. Ongoing freight car and locomotive maintenance programs are intended to ensure the highest standards of safety, reliability, customer satisfaction and equipment marketability. In past years, the freight car bad order ratio reflected the storage of certain types of cars which were not in high demand. The ratio has declined more recently as a result of a disposition program for underutilized, unserviceable and over-age revenue cars. In this connection, an orderly disposition of 17,000 freight cars, begun in October 1994, was completed in 1997. The locomotive bad order ratio rose in 1997, particularly in the early months of the year as older units required additional servicing and some new units were out-of-service related to warranty work. By year-end, the locomotive bad order ratio had returned to a more historic level.
Annual Average Bad Order Ratio ------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Freight Cars (excluding cabooses): NS Rail 4.6% 4.8% 5.8% 6.7% 7.3% Locomotives: NS Rail 5.0% 4.5% 4.7% 4.7% 4.3%
PAGE 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 22,427 miles of track maintained as of Dec. 31, 1997, 15,878 were laid with welded rail. The density of traffic on running tracks (main line trackage plus passing tracks) during 1997 was as follows:
Gross tons of freight carried per track mile Track miles Percent (Millions) of running tracks* of total ---------------- ----------------- -------- 0-4 4,470 28 5-19 4,708 29 20 and over 6,893 43 ------ --- 16,071 100 * Excludes trackage rights.
The following table summarizes certain information about NS' track roadway additions and replacements during the past five years:
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Track miles of rail installed 451 401 403 480 574 Miles of track surfaced 4,703 4,686 4,668 4,760 5,048 New crossties installed (millions) 2.2 1.9 2.0 1.7 1.6
MICROWAVE SYSTEM - The NS 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, Ga. Operating and traffic data are compiled and stored to provide customers with information on their shipments throughout the system. Data processing facilities are capable of providing current information on the location of every train and each car on line, as PAGE 15 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 underway a project to review, and modify as necessary, computer and other systems for Year-2000 compliance. As of December 1997, most of NS' mainframe computer programs have been reviewed. This mainframe project is expected to be completed by the end of 1998. Failure to achieve Year-2000 compliance -- by NS, other railroads, its suppliers, and its customers -- could negatively affect NS' ability to conduct business for an extended period. Management believes that NS' project will be completed on time and that the chance of failure is remote. 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 $601 million as of Dec. 31, 1997, and $594 million at Dec. 31, 1996. In addition, a portion of NS' properties is subject to liens securing, as of Dec. 31, 1997, and 1996, approximately $1 million and $51 million of mortgage debt, respectively. CAPITAL EXPENDITURES - Capital expenditures for road, equipment and other property for the past five years were as follows:
Capital Expenditures ----------------------------------------- 1997 1996 1995 1994 1993 ----- ----- ----- ----- ----- (In millions of dollars) Road $ 599 $ 438 $ 386 $ 385 $ 418 Equipment 306 326 338 240 217 Other property 24 25 33 82 4 ----- ----- ----- ----- ----- Total $ 929 789 $ 757 $ 707 $ 639 ===== ===== ===== ===== =====
Capital spending and maintenance programs are and have been designed to assure the ability to provide safe, efficient and reliable transportation services. For 1998, NS has budgeted $903 million of capital spending, of which $149 million are initial outlays for facilities and equipment related to the Conrail transaction. Capital spending is expected to be affected significantly by Conrail-related expenditures, which are anticipated to add approximately $500 million (net of predicted savings) over the next three years. PAGE 16 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 49 in Part II, Item 7, "Management's Discussion and Analysis" beginning on page 34, and in Note 17 to the Consolidated Financial Statements on page 78. EMPLOYEES - NS employed an average of 25,817 employees in 1997, compared with an average of 25,830 in 1996. The approximate average cost per employee during 1997 was $46,604 in wages and $17,279 in employee benefits. Approximately 74 percent of these employees are represented by various labor organizations. As of the end of 1997, NS had negotiated labor agreements with all of its unions. The accords with the 13 union organizations, which include compensation settlements in line with other major industries, will not be due for change until after January 1, 2000. GOVERNMENT REGULATION - In addition to environmental, safety, securities and other regulations generally applicable to all businesses, NS' 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, which no longer require regulatory approval, 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 1998 to re-subject the rail industry to unwarranted federal economic regulation. The Staggers Rail Act of 1980, which substantially reduced such regulation, encouraged and enabled rail carriers to innovate and to compete for business, thereby contributing to the economic health of the nation and to the revitalization of the industry. Accordingly, NS and other rail carriers vigorously will oppose these counterproductive efforts to re- impose or to authorize re-imposing such economic regulation. PAGE 17 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. 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. DISCONTINUED OPERATIONS - MOTOR CARRIER: DOMESTIC OPERATIONS - NAVL's principal transportation activity is the domestic, irregular route common and contract carriage of used household goods and special commodities between points in the United States. NAVL also operates as an intrastate carrier of property in 33 states. Prior to its restructuring in 1993, NAVL's domestic motor carrier business was organized into three primary divisions: Relocation Services (RS) specializing in residential relocation of used household goods; High Value Products (HVP) specializing in office and industrial relocations and transporting exhibits; and Commercial Transport (CT) specializing in the transportation of truckload shipments of general commodities. In 1993, NAVL underwent a restructuring involving termination of the CT Division and sale of the operations of Tran-Star, Inc. (Tran-Star), NAVL's refrigerated trucking subsidiary. In 1993, NAVL discontinued CT's operations, transferred some parts of CT's business to other divisions and began selling CT's assets that were not needed in NAVL's other operations. The sale of Tran-Star's operations was completed on Dec. 31, 1993. During 1997, the RS and HVP divisions conducted operations through a network of approximately 380 agents with over 600 locations in the United States. Agents are local moving and storage companies that provide NAVL with such services as solicitation, packing and warehousing in connection with the movement of household goods and specialized products. NAVL's future domestic operations are expected to be conducted principally through the RS and HVP divisions. Customized Logistics Services (CLS) was established in 1993 as an operating unit of the HVP Division. CLS' business is to focus NAVL's resources to respond to a variety of customer needs for integrated logistics services. The services include emergency parts order fulfillment, time-definite transportation and in-transit merge programs (delivering an entire order, merged from multiple manufacturing points, to a customer at one time). PAGE 18 FOREIGN OPERATIONS - NAVL's foreign operations are conducted through the RS and HVP Divisions and through foreign subsidiaries, including North American Van Lines Canada, Ltd. The Canadian subsidiary provides motor carrier service for the transportation of used household goods and specialized commodities between most points in Canada through a network of approximately 138 agent locations. During 1996, certain administrative functions related to the Canadian operations were transferred to NAVL's Fort Wayne, Indiana, headquarters. NAVL's international operations consist primarily of forwarding used household goods to and from the United States and between foreign countries through a network of approximately 350 foreign agents and representatives. NAVL's international operations are structurally aligned with the services provided by its domestic operating divisions. All international household goods operations and related subsidiaries in Alaska and Canada are assigned to the RS Division. The remaining international operations, which include subsidiaries in the United States, Germany and the United Kingdom, are involved in the transportation of selected general and specialized commodities and are assigned to the HVP Division. As a result of the agreement to sell NAVL, motor carrier results are presented, net of taxes, as "Discontinued operations," in the Consolidated Financial Statements; see also Note 3 on page 64. The following table presents a five-year comparison of revenues.
Year ended December 31, ---------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- MOTOR CARRIER * (Revenues in millions, shipments in thousands, revenue yield in dollars per shipment) Revenues * $ 942 $ 930 $ 896 $ 891 $ 952 Shipments (domestic) 392 383 381 379 550 Revenue Yield $2,403 $2,428 $2,352 $2,351 $1,731 * Certain motor carrier expenses previously reported net in revenues have been reclassified to motor carrier expenses. Income from motor carrier operations is not affected by this change in presentation.
MOTOR CARRIER TRAFFIC - Motor carrier revenues increased 1 percent to $942 million in 1997, due to gains in all segments of the HVP Division. These HVP gains were partly offset by shortfalls in RS attributable to volume declines. In 1996, motor carrier revenues were $930 million, up 4 percent from 1995, attributable to gains in both divisions. DOMESTIC OPERATIONS are conducted through NAVL's RS and HVP divisions. In 1997, total domestic shipments for these divisions were 392,455, up 2 percent from 1996. RS - Domestic shipments of used household goods transported by the RS Division fall into three market categories. Approximately 53 percent of the domestic shipment volume comes from the sale of moving services to individual consumers. Another 37 percent comes PAGE 19 from corporations and other businesses that pay for the relocation of their employees. The remaining 10 percent is derived from military, government and other sources. Total domestic RS Division shipments in 1997 represented 25 percent of the NAVL domestic motor carrier shipments transported by the two primary divisions. Total domestic revenues from this division were down 2 percent, compared with 1996, and represented 52 percent of total revenues from operations. HVP - The HVP Division specializes in providing transportation services in less-than-truckload (LTL) and truckload (TL) quantities of sensitive products. These products are divided into the following categories: office furniture and equipment, exhibits and displays, electronic equipment, industrial machinery, commercial relocation, LTL furniture and selected general commodities. Total HVP Division shipments transported in 1997, including TL and LTL, represented 75 percent of the NAVL domestic motor carrier shipments transported by the two primary divisions. Revenues from this division were up 6 percent from 1996 levels and represented 40 percent of total revenues from operations. FOREIGN OPERATIONS include NAVL's Canadian subsidiary, North American Van Lines Canada, Ltd., as well as operating subsidiaries in England and Germany. Foreign operations involving the transportation of used household goods and selected general and specialized commodities generated revenues of $77 million in 1997, down 2 percent from 1996. Revenues from foreign operations represented 8 percent of NAVL's total revenues. FREIGHT RATES - Pricing and service flexibility afforded by the Motor Carrier Act of 1980 and the Household Goods Transportation Act of 1980 has resulted in NAVL's increased emphasis on innovative pricing action in order to remain competitive. Since 1980, NAVL has increasingly operated as a contract carrier. As of Dec. 31, 1997, domestic contract carriage agreements accounted for 33 percent of RS Division shipments and 68 percent of HVP Division shipments. MOTOR CARRIER PROPERTY: REAL ESTATE - NAVL owns and leases real estate in support of its operations. Principal real estate holdings include NAVL's headquarters complex and warehouse and vehicle maintenance facilities in Fort Wayne, Indiana, vehicle maintenance facilities in Fontana, California, and terminal facilities in Grand Rapids, Michigan, and Great Falls, Montana. NAVL also leases facilities throughout the United States for sales offices, maintenance facilities and for warehouse, terminal and distribution center operations. EQUIPMENT - NAVL relies extensively on independent contractors (owner-operators) who supply the power equipment (tractors) used to pull NAVL trailers. Agents also provide a substantial portion of NAVL's equipment needs, particularly for the transportation of household goods, by furnishing tractors and trailers on either a permanent or an intermittent lease basis. PAGE 20 As of Dec. 31, 1997, agents and owner-operators together supplied 3,352 tractors, representing 98 percent of the U.S. power equipment operated in NAVL service. Also as of Dec. 31, 1997, NAVL owned 2,915 trailer units, representing 54 percent of the U.S. trailer fleet in NAVL service. The remaining 46 percent was provided mainly by agents and owner-operators. Agents and owner-operators also provided 997 straight trucks, or 97 percent of such units in NAVL service. NAVL has an extensive program for the repair and maintenance of its trailer equipment. In 1997, approximately 24,000 work orders were completed at NAVL's facility in Fort Wayne. As of Dec. 31, 1997, the average age of trailer equipment in the NAVL fleet was 8.5 years. ENCUMBRANCES - Many of the tractors utilized in NAVL service are purchased by NAVL from manufacturers and resold to agents and owner-operators under a NAVL-sponsored financing program. At Dec. 31, 1997, NAVL had $19 million in such tractor contracts receivable. This program allows NAVL to generate the funds necessary to purchase the tractors and to resell them under favorable financing terms. The equipment is sold under conditional sales contracts with the agents and owner-operators. COMPUTERS - NAVL relies extensively on data processing facilities for shipment planning and dispatch functions as well as shipment tracing. Data processing capabilities are also utilized in revenue processing functions, driver and agent account settlement activity, and internal accounting and record keeping service. GOVERNMENT REGULATION - For motor carrier operations conducted by NAVL, the Department of Transportation and the STB are the principal regulatory entities. The STB exercises jurisdiction over the relationship between carriers and owner-operators, and carrier practices and common carrier rates relating to the transportation of household goods. The primary focus of the Department of Transportation is on driver qualification and safety standards, including maximum trailer length and width. COMPETITION - NAVL continues to face strong competition due to deregulation and overcapacity in the industry that will keep profits at a modest level. While service remains a key issue, many shippers now place greater emphasis on price. For the RS Division, contract carriage and volume discount programs dominate the corporate relocation segment, and guaranteed price options are common to the individual consumer segment. Contract carriage agreements are also utilized extensively by the HVP Division to meet the service and price requirements of its customers. PAGE 21 Item 3. Legal Proceedings. - ------ ----------------- The Conrail-related litigation (and related negotiations) reported previously by NS in Part II, Item 1, of its Form 10-Q Report for the quarter ending Sept. 30, 1996, and in Part I, Item 3, of its Form 10-K Report for the year ending Dec. 31, 1996, either have been terminated or are believed to have been rendered moot by the various agreements reached with CSX during the year concerning the operation of certain Conrail assets and routes. Item 4. Submission of Matters to a Vote of Security Holders. - ------ --------------------------------------------------- There were no matters submitted to a vote of security holders during the fourth quarter of 1997. PAGE 22 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, 1998, relating to these officers: Business Experience during Name, Age, Present Position past 5 Years - --------------------------- ----------------------------------- David R. Goode, 57, Present position since September Chairman, President and 1992. Chief Executive Officer James C. Bishop, Jr., 61, Present position since March Executive Vice President-Law 1996; prior thereto was Vice President-Law. R. Alan Brogan, 57, Present position since December Executive Vice President- 1992. Transportation Logistics (and President-North American Van Lines, Inc.) L. I. Prillaman, 54, Present position since October Executive Vice President- 1995; prior thereto was Vice Marketing President-Properties. Stephen C. Tobias, 53, Present position since July 1994. Executive Vice President- Served as Senior Vice President- Operations Operations from October 1993 to July 1994, and prior thereto was Vice President-Strategic Planning. Henry C. Wolf, 55, Present position since June 1993; Executive Vice President- prior thereto was Vice President- Finance Taxation. John F. Corcoran, 57, Present position since August 1, Senior Vice President- 1997; prior thereto was Vice Public Affairs President-Public Affairs. PAGE 23 Business Experience during Name, Age, Present Position past 5 Years - --------------------------- ----------------------------------- Paul N. Austin, 54, Present position since June 1994. Vice President-Personnel Served as Assistant Vice President-Personnel from February 1993 to June 1994, and prior thereto was Director- Compensation. David A. Cox, 61, Present position since December Vice President-Properties 1995; prior thereto was Assistant Vice President- Industrial Development. Thomas L. Finkbiner, 45, Present position since August 1993. Vice President-Intermodal Served as Senior Assistant Vice President-International and Intermodal from April to August 1993, and prior thereto was Assistant Vice President- International and Intermodal. Nancy S. Fleischman, 50, Present position since August Vice President 1997. Served as Assistant Vice President-Strategic Planning from November 1993 to August 1997, and prior thereto was Senior General Attorney. Robert C. Fort, 53, Present position since December Vice President- 1996; prior thereto was Assistant Public Relations Vice President-Public Relations. John W. Fox, Jr., 50, Present position since October Vice President- 1995. Served as Assistant Vice Coal Marketing President-Coal Marketing from August 1993 to October 1995, and prior thereto was General Manager- Eastern Region. Thomas J. Golian, 64, Present position since October Vice President 1995. Served as Executive Assistant to the Chairman, President and CEO from April 1993 to October 1995, and prior thereto was Special Assistant to the President. James L. Granum, 61, Present position since March 1992. Vice President- Public Affairs PAGE 24 Business Experience during Name, Age, Present Position past 5 Years - --------------------------- ----------------------------------- James A. Hixon, 44, Present position since June 1993; Vice President-Taxation prior thereto was Assistant Vice President-Tax Counsel. Jon L. Manetta, 59, Present position since December Vice President- 1995. Served as Vice President- Transportation & Mechanical Transportation from June 1994 to December 1995, Assistant Vice President-Transportation from October 1993 to June 1994, Assistant Vice President- Strategic Planning from January to October 1993, and prior thereto was Director-Joint Facilities and Budget. Harold C. Mauney, Jr., 59, Present position since August 1, Vice President- 1997. Served as Vice President- Public Affairs Operations Planning and Budget from December 1996 to August 1997, and prior thereto was Vice President-Quality Management. Donald W. Mayberry, 54, Present position since December Vice President- 1995; prior thereto was Vice Research and Tests President-Mechanical. James W. McClellan, 58, Present position since October Vice President- 1993; prior thereto was Assistant Strategic Planning Vice President-Corporate Planning. Kathryn B. McQuade, 41, Present position since December Vice President-Internal Audit 1992. Charles W. Moorman, 46, Present position since October Vice President- 1993; prior thereto was Vice Information Technology President-Employee Relations. Phillip R. Ogden, 57, Present position since December Vice President-Engineering 1992. John P. Rathbone, 46, Present position since December Vice President and 1992. Controller William J. Romig, 53, Present position since April 1992. Vice President and Treasurer PAGE 25 Business Experience during Name, Age, Present Position past 5 Years - --------------------------- ----------------------------------- John M. Samuels, 54, Present position since January 16, Vice President-Operations 1998. Served as Vice President- Planning and Budget Operating Assets of Conrail from January 1996 to January 1998, Vice President-Mechanical of Conrail from November 1994 to January 1996, and prior thereto was Vice President-Engineering of Conrail. Donald W. Seale, 45, Present position since August 1993; Vice President- prior thereto was Assistant Vice Merchandise Marketing President-Sales and Service. Robert S. Spenski, 63, Present position since June 1994; Vice President- prior thereto was Senior Labor Relations Assistant Vice President-Labor Relations. Rashe W. Stephens, Jr., 56, Present position since December Vice President- 1996. Served as Assistant Vice Quality Management President-Public Affairs from February 1993 to December 1996, and prior thereto was Director, EEO and Manpower Planning. William C. Wooldridge, 54, Present position since March 1996; Vice President-Law prior thereto was General Counsel-Corporate. Dezora M. Martin, 50, Present position since April 1995. Corporate Secretary Served as Assistant Corporate Secretary-NS from October 1993 to April 1995, and prior thereto was Assistant Corporate Secretary-Planning. PAGE 26 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 50,938 stockholders of record as of Dec. 31, 1997, 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 1997 and 1996, after restatement for the Sept. 5, 1997, three-for-one stock split.
Quarter ---------------------------------------------- 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 1996 1st 2nd 3rd 4th ---- --- --- --- --- Market price High $ 29-5/16 $29-15/16 $ 30-9/16 $ 32-3/16 Low 25-7/16 26-11/16 26-1/8 28-3/16 Dividends per share $0.18-2/3 $0.18-2/3 $0.18-2/3 $0.18-2/3
PAGE 27 Item 6. Selected Financial Data. - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1994 - 1997 Page One
1997 1996 1995 1994 -------- -------- -------- -------- ($ in millions, except per share amounts) RESULTS OF OPERATIONS: Railway operating revenues $ 4,223 $ 4,101 $ 4,012 $ 3,918 Railway operating expenses 3,010 2,936 2,950 2,875 -------- -------- -------- -------- Income from railway operations 1,213 1,165 1,062 1,043 Other income - net 170 117 140 86 Interest expense on debt 385 116 113 101 -------- -------- -------- -------- Income from continuing operations before income taxes 998 1,166 1,089 1,028 Provision for income taxes 299 413 391 372 -------- -------- -------- -------- Income from continuing operations before accounting changes 699 753 698 656 Discontinued operations 22 17 15 12 Cumulative effect of accounting changes -- -- -- -- -------- -------- -------- -------- Net income $ 721 $ 770 $ 713 $ 668 ======== ======== ======== ======== PER SHARE DATA: Income from continuing operations before accounting changes - basic $ 1.85 $ 1.98 $ 1.78 $ 1.60 Income from continuing operations before accounting changes - diluted $ 1.84 $ 1.96 $ 1.77 $ 1.59 Net income - basic $ 1.91 $ 2.03 $ 1.81 $ 1.63 Net income - diluted $ 1.90 $ 2.01 $ 1.80 $ 1.62 Dividends $ 0.80 $0.74-2/3 $0.69-1/3 $ 0.64 Stockholders' equity at year-end $ 14.44 $ 13.26 $ 12.47 $ 11.73
PAGE 28 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1994 - 1997 Page Two
1997 1996 1995 1994 -------- -------- -------- -------- ($ in millions, except per share amounts) FINANCIAL POSITION: Total assets $ 17,350 $ 11,234 $ 10,718 $ 10,403 Total long-term debt, including current maturities $ 7,459 $ 1,856 $ 1,638 $ 1,619 Stockholders' equity $ 5,445 $ 4,977 $ 4,829 $ 4,685 OTHER: Capital expenditures $ 929 $ 789 $ 757 $ 707 Average number of shares outstanding (thousands) 376,593 379,372 392,987 408,904 Number of stockholders at year-end 50,938 50,748 53,401 52,442 Average number of employees: Rail 23,323 23,361 24,488 24,710 Nonrail 2,494 2,469 2,456 2,458 -------- -------- -------- -------- Total 25,817 25,830 26,944 27,168 ======== ======== ======== ======== All share and per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. NOTES 1997 results include several Conrail-related items. These principally consist of: (1) $264 million of interest expense on debt issued to finance NS' share of the NS/CSX joint acquisition of Conrail stock, (2) $117 million for the equity in earnings of Conrail net of amortization, (3) credit facility costs including a $77 million charge incurred in conjunction with certain now-terminated commitments that provided financing for NS' then-proposed acquisition of all Conrail stock, and (4) $3 million of identified integration costs. These items reduced net income by $107 million, or 29 cents per diluted share. On Jan. 12, 1998, NS announced that it signed an agreement to sell all the common stock of its motor carrier subsidiary, NAVL. Accordingly, NAVL's results of operation, financial position, and cash flows are presented as "Discontinued operations."
PAGE 29 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1990 - 1993 Page One
1993 1992 1991 1990 -------- -------- -------- -------- ($ in millions, except per share amounts) RESULTS OF OPERATIONS: Railway operating revenues $ 3,746 $ 3,777 $ 3,654 $ 3,786 Railway operating expenses 2,831 2,851 3,345 2,969 -------- -------- -------- -------- Income from railway operations 915 926 309 817 Other income - net 135 97 131 142 Interest expense on debt 98 109 99 78 -------- -------- -------- -------- Income from continuing operations before income taxes 952 914 341 881 Provision for income taxes 370 328 112 316 -------- -------- -------- -------- Income from continuing operations before accounting changes 582 586 229 565 Discontinued operations (33) (28) (199) (9) Cumulative effect of accounting changes 223 -- -- -- -------- -------- -------- -------- Net income $ 772 $ 558 $ 30 $ 556 ======== ======== ======== ======== PER SHARE DATA: Income from continuing operations before accounting changes - basic $ 1.39 $ 1.38 $ 0.52 $ 1.16 Income from continuing operations before accounting changes - diluted $ 1.37 $ 1.37 $ 0.52 $ 1.16 Net income - basic $ 1.85 $ 1.31 $ 0.07 $ 1.14 Net income - diluted $ 1.83 $ 1.30 $ 0.07 $ 1.14 Dividends $ 0.62 $ 0.60 $0.53-1/3 $0.50-2/3 Stockholders' equity at year-end $ 11.12 $ 10.05 $ 9.55 $ 10.52
PAGE 30 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1990 - 1993 Page Two
1993 1992 1991 1990 -------- -------- -------- -------- ($ in millions, except per share amounts) FINANCIAL POSITION: Total assets $ 10,301 $ 10,188 $ 9,959 $ 10,326 Total long-term debt, including current maturities $ 1,594 $ 1,648 $ 1,387 $ 1,122 Stockholders' equity $ 4,621 $ 4,233 $ 4,093 $ 4,912 OTHER: Capital expenditures $ 639 $ 628 $ 688 $ 605 Average number of shares outstanding (thousands) 418,243 424,378 443,276 486,284 Number of stockholders at year-end 51,884 51,200 53,725 56,187 Average number of employees: Rail 25,531 25,650 27,366 28,697 Nonrail 3,773 4,485 4,586 4,584 -------- -------- -------- -------- Total 29,304 30,135 31,952 33,281 ======== ======== ======== ======== All share and per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. NOTES 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. 1993 "Discontinued operations" includes a $50 million pretax restructuring charge for the disposition of two NAVL businesses. 1993 also includes two accounting changes; the cumulative effect of accounting changes increased 1993 net income by $223 million, or 53 cents per diluted share. The change in accounting for income taxes increased net income by $467 million, with a corresponding reduction in deferred taxes. The changes in accounting for postretirement and postemployment benefits decreased net income by $244 million. 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 $1.12 per diluted share.
PAGE 31 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1987 - 1989 Page One
1989 1988 1987 -------- -------- -------- ($ in millions, except per share amounts) RESULTS OF OPERATIONS Railway operating revenues $ 3,694 $ 3,617 $ 3,336 Railway operating expenses 2,864 2,680 3,269 -------- -------- -------- Income from railway operations 830 937 67 Other income - net 155 103 228 Interest expense on debt 50 53 58 -------- -------- -------- Income from continuing operations before income taxes 935 987 237 Provision for income taxes 323 358 87 -------- -------- -------- Income from continuing operations before accounting changes 612 629 150 Discontinued operations (6) 6 22 Cumulative effect of accounting changes -- -- -- -------- -------- -------- Net income $ 606 $ 635 $ 172 ======== ======== ======== PER SHARE DATA: Income from continuing operations before accounting changes - basic $ 1.17 $ 1.16 $ 0.26 Income from continuing operations before accounting changes - diluted $ 1.16 $ 1.16 $ 0.26 Net income - basic $ 1.16 $ 1.17 $ 0.30 Net income - diluted $ 1.15 $ 1.17 $ 0.30 Dividends $ 0.46 $ 0.42 $ 0.40 Stockholders' equity at year-end $ 10.15 $ 9.58 $ 8.83
PAGE 32 Item 6. Selected Financial Data. (continued) - ------ ----------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES ELEVEN-YEAR FINANCIAL REVIEW 1987 - 1989 Page Two
1989 1988 1987 -------- -------- -------- ($ in millions, except per share amounts) FINANCIAL POSITION: Total assets $ 10,049 $ 9,845 $ 9,622 Total long-term debt, including current maturities $ 838 $ 778 $ 791 Stockholders' equity $ 5,169 $ 5,153 $ 4,979 OTHER: Capital expenditures $ 620 $ 482 $ 521 Average number of shares outstanding (thousands) 523,109 543,113 568,391 Number of stockholders at year-end 61,630 64,974 68,121 Average number of employees: Rail 29,667 30,330 32,563 Nonrail 4,645 4,209 3,539 -------- -------- -------- Total 34,312 34,539 36,102 ======== ======== ======== All share and per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split. NOTES 1987 operating expenses include a $616 million special charge principally related to railroad restructuring costs and a $4 million restructuring charge in "Discontinued operations." These charges reduced net income by $352 million, or 62 cents per diluted share.
PAGE 33 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 three (3) separate graphs with the Eleven-Year Financial Review in the 1997 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.
1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- RETURN ON AVERAGE STOCKHOLDERS' EQUITY 15.7%* 15.7% 15.4%** 14.4% 13.7%*** 13.4% 1997's return on average stockholders' equity equaled 1996's record, which marked the sixth consecutive year of year-over-year improvement. *Excludes effect of Conrail-related items. Return on average stockholders' equity including the effect of Conrail-related items was 13.8%. **Excludes $33.6 million ($20.4 million after-tax) charge for early retirement program. ***Excludes the cumulative effects of required accounting changes and the prior years' effect of the federal income tax increase.
1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- DIVIDENDS PER SHARE (dollars) $0.80 $0.74-2/3 $0.69-1/3 $0.64 $0.62 $0.60 Since 1983, NS' first full year after consolidation, the annual dividend has grown at a compound annual rate of 7%. Stockholders received a dividend yield of 2.6% in 1997, compared with less than 1.6% for all S&P 500 stocks.
PAGE 34 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 (beginning on page 54) and Notes (beginning on page 60) and the Eleven-Year Financial Review (beginning on page 27). SUMMARIZED RESULTS OF OPERATIONS 1997 Compared With 1996 - ----------------------- Net income in 1997 was $721 million, a decrease of 6%. However, 1997's results reflect several Conrail-related items, primarily interest expense on the $5.8 billion of debt incurred to finance the acquisition, which reduced net income by $107 million (see Note 2 on page 62). Excluding the effects of these items, net income was up 8% over 1996's record result. Income from railway operations increased 4%. Increased nonoperating income (see Note 4 on page 64) and a lower effective income tax rate (see Note 5 on page 65) also contributed to the improvement in net income. As required by a new accounting pronouncement, NS is reporting two earnings per share amounts on the face of the income statement: basic and diluted. "Basic" earnings per share is calculated by dividing net income by the average number of shares outstanding during the period. "Diluted" earnings per share reflects the dilutive effect of all unexercised stock options and projected performance awards under the Long-Term Incentive Plan. Diluted earnings per share of $1.90 were down 5%. Excluding the effects of the Conrail-related items, diluted earnings per share were up 9% over 1996's record result. On Jan. 12, 1998, NS announced that it had reached an agreement to sell all the common stock of its motor carrier subsidiary, North American Van Lines, Inc. (NAVL) (see Note 3 on page 64). Accordingly, NAVL's results are presented, net of taxes, as "Discontinued operations," and all prior period amounts have been reclassified to conform to this presentation. NS expects to report a gain upon consummation of the NAVL sale in 1998. 1996 Compared With 1995 - ----------------------- Net income in 1996 was a record $770 million, an increase of 8%. However, 1995's results included a $34 million early retirement charge that reduced net income by $20 million. Excluding the effects of that charge, 1996 net income was up 5%. The improvement was due to increased income from railway operations, reflecting a 2% increase in railway operating revenues and a less than 1% increase in railway operating expenses (excluding the early retirement charge), which more than compensated for decreased nonoperating income. Included in 1995 nonoperating income was a $31 million gain from the partial redemption of a real estate partnership interest. Interest expense on debt was up 2%, a result of interest expense on $200 million of debt issued in September 1996. Record diluted earnings per share of $2.01 for 1996 were up 12% (8%, excluding the effects of the early retirement charge). The greater improvement in earnings per share compared with net income was the result of the stock purchase program, which was suspended on Oct. 23, 1996, and to date has not been resumed (see Note 15 on page 77). PAGE 35 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- INCOME FROM RAILWAY OPERATIONS (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995* 1994 1993 1992 --------- --------- --------- --------- --------- --------- $1,213 $1,165 $1,095 $1,043 $ 915 $ 926 Income from railway operations increased 4% in 1997, marking the fourth consecutive year of record-breaking results. Income from railway operations has increased 31% above 1992's results. * 1995 excludes a $34 million charge for an early retirement program.
DETAILED RESULTS OF CONTINUING OPERATIONS Railway Operating Revenues - -------------------------- Railway operating revenues were $4.2 billion in 1997, compared with $4.1 billion in 1996, and $4.0 billion in 1995. The following table presents a three-year comparison of revenues by market group. RAILWAY OPERATING REVENUES BY MARKET GROUP ($ in millions)
1997 1996 1995 ------- ------- ------- Coal $1,301 $1,305 $1,268 Chemicals 585 560 541 Paper/clay/forest 539 513 537 Automotive 492 489 449 Agriculture/government/consumer 391 393 394 Metals/construction 368 354 349 Intermodal 547 487 474 ------ ------ ------ Total $4,223 $4,101 $4,012 ====== ====== ======
In 1997, revenues increased or remained steady for all market groups. In 1996, revenues increased in all market groups except in the paper, clay, and forest products group, and the agriculture, government, and consumer products group. As shown in the following table, volume gains produced all of the revenue improvement in 1997 and most of the improvement in 1996. RAILWAY OPERATING REVENUE VARIANCE ANALYSIS Increases (Decreases) ($ in millions)
1997 vs. 1996 1996 vs. 1995 ------------- ------------- Volume $ 130 $ 73 Revenue per unit (8) 16 ----- ----- Total $ 122 $ 89 ===== =====
PAGE 36 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Coal tonnage increased 3% in 1997, primarily due to increased export and utility tonnage; however, revenues decreased slightly as a result of a shorter length of haul. Coal revenues represented 31% of total railway operating revenues in 1997, and 89% of coal shipments originated on NS' lines. In 1996, coal tonnage increased 4%, and revenues increased 3%, principally due to increased utility and export tonnage. TOTAL COAL, COKE, AND IRON ORE TONNAGE (In millions of tons)
1997 1996 1995 ---- ---- ---- Utility 76 75 70 Export 29 27 26 Steel 21 20 22 Other 8 8 7 --- --- --- Total 134 130 125 === === ===
Utility coal traffic increased 2% in 1997, despite the unusually cool weather in late spring and early summer that moderated demand for domestic steam coal. Several utility customers in the NS service region shifted more generation to coal-fired plants, as some nuclear power plants experienced downtime. New business resulting from innovative marketing efforts also contributed to the increase. In 1996, utility coal traffic volume increased 6%, primarily due to nuclear generator downtime and market share gains in the Southeast. The near-term outlook for utility coal remains positive, as coal- fired generation continues to be the cheapest marginal source of electricity. Normalized U.S. electricity demand continues to increase at a rate greater than generation capacity is being added. Increased electricity price competition expected from utility deregulation could cause utilities to seek to reduce costs and increase plant utilization. These factors, coupled with excess capacity at low-cost, coal-fired generation plants, could provide an opportunity for coal volume growth. However, competitive pressures on utilities to reduce costs also could transfer price pressure to generation source fuels, including NS- delivered coal. Moreover, a significant number of the mines served by NS produce coals that satisfy both the Phase I and Phase II requirements of the Clean Air Act Amendments. Adoption of tighter restrictions on the emission of nitrous oxides, as proposed by the Environmental Protection Agency, however, could impose added cost burdens on some coal-fired plants. Furthermore, if implemented, the greenhouse gas emission targets proposed for the United States at the Global Climate Summit in Kyoto, Japan, in December 1997 also could increase the cost of coal-fired generation and adversely affect coal traffic. The portion of Conrail's properties that NS proposes to operate serves 27 coal-fired utility plants and mines with an abundant supply of low-cost, high-quality steam coal. Export coal tonnage increased 6% in 1997, reaching the highest level since 1992. Higher metallurgical coal demand and increased sales from NS-served producers caused growth in shipments to Japan. Increased metallurgical coal exports to Holland and Romania and increased shipments to Brazil early in the year also contributed to the improvement. Export coal tonnage increased 5% in 1996, as NS benefited from increases in steam coal exports to Italy and metallurgical shipments to Germany, a result of reduced subsidies to German coal producers that enhanced the competitiveness of U.S. coal. Increased exports of U.S. coal to Brazil also contributed to the improvement. PAGE 37 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Metallurgical coal exports are expected to remain stable through 2000. The high-quality coking coals from mines on NS should keep its export metallurgical coal competitive. However, the current relative strength of the U.S. dollar vs. the currencies of several other major coal-producing nations has put U.S. coal at a price disadvantage. A gradual decline in export metallurgical coal tonnage is projected over the long term, as new steel-making technologies take market share from traditional coke-based producers. Export demand for steam coal is expected to increase over the long term, and NS is working to increase its participation in this market. Conrail and its coal-producing customers are well established in the export steam coal market, which, assuming approval of the Conrail transaction, should help NS achieve greater levels of participation. Furthermore, current NS and Conrail coal exporters should benefit from being able to ship their coal single-line through Baltimore, Md., and Norfolk, Va. Steel coal domestic traffic increased 4% in 1997, due to growth in coke and iron ore shipments. Metallurgical coal traffic declined, primarily due to prolonged aggressive producer pricing of higher volatile metallurgical coals not located on NS' lines. In 1996, traffic decreased 7%, a result of the aggressive high-volatile coal pricing. With the reduction in U.S. blast-furnace capacity, coke production in the United States continues to decline. Advanced technologies that allow production of steel using little or no coke could cause this market to decline slowly over the long term. However, NS is working to participate in the movement of non-coking coal used by technologies such as pulverized coal injection and coal-based, direct-reduced iron, in order to mitigate the potential decline in traditional metallurgical shipments. The Conrail transaction, if approved, should increase NS' participation in shipments of raw materials for the steel industry by means of new single-line routes with access to most domestic integrated steel plants and merchant coke plants. Other coal traffic, primarily steam coal shipped to manufacturing plants, decreased 3% in 1997, principally due to the unusually cool late spring and early summer weather and to allocation of equipment to other markets. Other coal traffic increased 14% in 1996, mostly reflecting gains from other modes of transportation. This market is expected to remain stable in coming years. COAL (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 ------- ------- ------- ------- ------- ------- Export $ 380 $ 374 $ 353 $ 340 $ 366 $ 478 Domestic 921 931 915 950 873 846 ------- ------- ------- ------- ------- ------- $ 1,301 $ 1,305 $ 1,268 $ 1,290 $ 1,239 $ 1,324 ======= ======= ======= ======= ======= ======= Revenues decreased slightly in 1997. Since 1992, revenues have decreased $23 million, or 2%, mostly due to lower export coal traffic. Total tonnage handled in 1997 was 7% above 1992's volume. This group includes utility coal, export coal, domestic metallurgical coal, industrial coal, coke, and iron ore.
PAGE 38 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- MERCHANDISE traffic volume and revenues each increased 3% in 1997, as all market groups, except the agriculture, government, and consumer products group, posted gains. In 1996, merchandise volume decreased slightly, as gains in automotive, intermodal, and chemicals traffic were more than offset by declines in the remaining market groups. However, higher average revenues in 1996 resulted in a 2% revenue improvement. CHEMICALS traffic increased 5%, and revenues increased 4% in 1997. Plastics, chlor-alkali, and nonhazardous waste markets strengthened during 1997. Petroleum and industrial chemicals volume also increased. In 1996, chemicals traffic volume grew 3%, and revenues increased 4%, as fertilizer and plastics markets strengthened. In addition, the harsh winter resulted in increased movements of liquid petroleum gas, and industrial chemicals remained strong throughout the year. The chemicals market group should continue to show moderate growth through 1998, based on industrial expansion projects and expected increases in national chemical production. If approved, the Conrail transaction should give NS a competitive route from the southwest to northern New Jersey, where Conrail currently originates or terminates annually about 40,000 carloads of chemicals. CHEMICALS (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $ 585 $ 560 $ 541 $ 538 $ 501 $ 500 Revenues increased $25 million, or 4%, in 1997. Since 1992, revenues have increased $85 million, or 17%. This group includes fertilizers, sulfur and related chemicals, petroleum products, chlorine, and bleaching compounds, plastics, industrial chemicals, chemical wastes, and municipal wastes.
PAPER, CLAY, AND FOREST products traffic rose 4%, and revenues increased 5% in 1997. Shipments of wood chips led the growth, as three major on-line wood-chip plants began full production. Lumber traffic also increased as Southern yellow pine from NS' service territory continued to replace timber from Pacific Northwest sources. Kaolin clay traffic increased, and shipments of paper products were up slightly in a mature industry where strong competition continues between rail and truck transportation. In 1996, paper, clay, and forest products revenues and traffic each declined 5%, due to the overall downturn in the paper and forest products industry. The paper, clay, and forest products market group is expected to experience modest growth in 1998, bolstered by increased printing paper production in the Southeast and increased wood-chip volume when two additional plants come on line. The Conrail transaction, if approved, will give NS access to 35 additional paper mills and 39 additional lumber reload centers. PAGE 39 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- PAPER, CLAY, AND FOREST PRODUCTS (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $ 539 $ 513 $ 537 $ 522 $ 522 $ 517 Revenues increased $26 million, or 5%, in 1997. Since 1992, revenues have increased $22 million, or 4%. This group includes lumber and wood products, pulpboard and paper products, wood fibers, woodpulp, scrap paper, and clay. NS serves 50 paper mills, 20 paper distribution centers, and more than 30 lumber reload centers.
AUTOMOTIVE traffic increased 2%, and revenues rose 1% in 1997, both reaching the highest levels in this group's history. Auto parts drove the growth as volume increased 12%. Vehicle traffic decreased 3%, due to industrywide railcar shortages, service disruptions in the West, unexpected downtime at certain plants and modest sales for some of the models transported by NS. In 1996, automotive traffic rose 8%, and revenues increased 9%. Auto parts traffic increased 21% and vehicle traffic increased 3%, largely a result of new just-in-time rail centers and all NS-served assembly plants being on-line. The automotive group is expected to experience growth in 1998. When fully operational, the Ford mixing centers are expected to increase NS' vehicle business with Ford. Full production at the Mercedes-Benz plant in Vance, Ala., and Toyota's new minivan line at Georgetown, Ky., also should support growth. Parts traffic is expected to continue to grow, supported by increased volumes on NS' just-in-time network, specifically less-than-truckload traffic moving from Detroit to Mexico. If approved, the Conrail transaction will provide NS access to 13 additional assembly plants with an annual production of more than 2.6 million vehicles, and NS' network of automobile distribution facilities will increase from 22 to 39. AUTOMOTIVE (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $ 492 $ 489 $ 449 $ 429 $ 426 $ 392 Revenues increased $3 million, or 1%, in 1997. Since 1992, revenues have increased $100 million, or 26%. This group includes finished vehicles for BMW, Chrysler, Ford, General Motors, Honda, Isuzu, Jaguar, Land Rover, Mazda, Mercedes, Mitsubishi, Nissan, Saab, Subaru, Suzuki, Toyota, and Volkswagen, and auto parts for Ford, General Motors, Mercedes, and Toyota. In the past 10 years, eight of 11 major automotive plants in the East have located on NS lines.
AGRICULTURE, GOVERNMENT, AND CONSUMER products traffic decreased 3%, and revenues decreased 1% in 1997. Most of the decline resulted from decreases in the bulk agriculture commodities. Weak export markets, declines in corn shipments to processors, and an unfavorable soybean market resulting from higher prices led to traffic declines that began early in the year. In 1996, agriculture, government, and consumer products traffic declined 4%, and revenues were flat. Despite strong demand for feed grains in the Southeast, grain traffic was affected PAGE 40 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- adversely by poor crops and strong export demand that left NS receivers competing for limited supplies. Slight average revenue growth occurred, resulting primarily from longer hauls, as receivers obtained grain supplies from the West. The agriculture, government, and consumer products group is expected to experience moderate growth in 1998 due to improved soybean and corn crops. NS also should benefit from the on-line location of one new feed mill and three new wheat mills during the year. The Conrail transaction, if approved, is expected to increase NS- accessed grain elevator capacity by about 10%. AGRICULTURE, GOVERNMENT, AND CONSUMER PRODUCTS (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $ 391 $ 393 $ 394 $ 380 $ 357 $ 344 Revenues decreased $2 million, or 1%, in 1997. Since 1992, revenues have increased $47 million, or 14%. This group includes soybeans, wheat, corn, animal and poultry feed, food oils, flour, beverages, canned goods, sweeteners, consumer products, and items for the military.
METALS AND CONSTRUCTION traffic and revenues each increased 4% in 1997. Construction traffic on NS experienced strong gains in 1997, primarily due to increased highway building activity in the Southeast. Metals traffic increased due to gains in domestic sheet steel movements resulting from record steel production and increased pipe shipments. In 1996, metals and construction traffic declined 2%, but revenues were up 1%. Construction carloads fell behind in early 1996 due to inclement weather and were flat the rest of the year; however, higher average revenues more than offset the volume decline. In the metals market, NS' shipments remained strong due to a healthy domestic steel market, which has added capacity, as efficiency at integrated mills and new steel processing facilities has improved. Moderate growth is expected in 1998, supported by several new metals projects coming on-line, and continued growth in construction traffic. If approved, the Conrail transaction will give NS access to 11 additional steel mills. METALS AND CONSTRUCTION (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $ 368 $ 354 $ 349 $ 330 $ 309 $ 289 Revenues increased $14 million, or 4%, in 1997. Since 1992, revenues have increased $79 million, or 27%. This group includes steel, aluminum products, machinery, scrap metals, cement, aggregates, bricks, and minerals.
PAGE 41 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- INTERMODAL traffic volume increased 11%, and revenues increased 12% in 1997, each exceeding the records set in 1996. Capacity expansions on major terminals and trains, combined with a healthy domestic and international economy, enabled NS to achieve the third year of double- digit growth in four years. Volume increases were balanced, allowing NS to outperform the market in all traffic segments. Container traffic volume increased 12%, supported by strength in new steamship business under contract. In 1996, driven by increased domestic container and Triple Crown Services Company (TCSC) volume, intermodal traffic volume increased 5%, and revenues increased 3%, each reaching a record level. EMP, the container equipment-sharing arrangement with Union Pacific and Conrail, contributed significantly to the domestic growth. International container volume declined only slightly, despite an industry slowdown that began in the spring and lasted until the fall. NS' overall market share improved slightly due to new international business and the continued domestic container and TCSC growth. NS' intermodal volume is expected to remain strong, although growth in 1998 is not expected to equal the double-digit performance of 1997. New train services between Greensboro and Chicago, and St. Louis and Atlanta are expected to attract less-than-truckload and other premium service customers. Rate actions to improve balance and margin are expected to be implemented throughout the year and to contribute to traffic moderation. The Conrail transaction, if approved, should result in significant growth in intermodal revenues, as NS will benefit from direct access to most major East Coast ports. INTERMODAL (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $ 547 $ 487 $ 474 $ 429 $ 392 $ 411 Revenues increased $60 million, or 12%, in 1997. Since 1992, revenues have increased $136 million, or 33%. 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 3% in 1997, despite a 5% increase in traffic volume. In 1996, railway operating expenses decreased slightly; however, 1995's expenses included a $34 million charge for an early retirement program (see Note 12 on page 71). Excluding that charge, 1996 railway operating expenses increased 1% on a 2% increase in traffic volume. As a result, the railway operating ratio, which measures the percentage of railway revenues consumed by railway expenses, was a record 71.3 in 1997, compared with 71.6 in 1996, and 73.5 (72.7 excluding the early retirement charge) in 1995. NS' railway operating ratio continues to be the best among the major railroads in the United States. Even before the Conrail transaction is approved, NS expects to incur expenses related to integration efforts, and, as a result, the railway operating ratio is anticipated to be higher in 1998. PAGE 42 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- The following table shows the changes in railway operating expenses summarized by major classifications. RAILWAY OPERATING EXPENSES Increases (Decreases) ($ in millions)
1997 vs. 1996 1996 vs. 1995 ------------- ------------- Compensation and benefits $ 5 $(80)* Materials, services and rents 61 5 Depreciation 13 19 Diesel fuel (6) 43 Casualties and other claims -- 2 Other 1 (3) ---- ---- Total $ 74 $(14) ==== ==== *Reflects the $34 million early retirement charge in 1995.
COMPENSATION AND BENEFITS, which represents about half of total railway operating expenses, increased slightly in 1997, but decreased 5% (3% excluding the effect of the early retirement charge) in 1996. In 1997, higher wages resulting from contract wage increases and additional train and engine employees were offset by lower fringe benefit and incentive compensation costs. The decline in fringe benefit costs was largely due to favorable investment experience on pension plan assets. Productivity improvements and train efficiencies offset the effects of the higher traffic volume to a large extent. The 1996 decrease (excluding the effect of the 1995 early retirement charge) was principally attributable to: (1) reduced employment resulting from the 1995 early retirement program and productivity improvements due to ongoing reductions in train-crew sizes and train efficiencies and (2) reduced costs for fringe benefits, principally medical costs for salaried employees. These decreases were somewhat offset by increases attributable to higher volume and increased wage rates resulting from new labor agreements. MATERIALS, SERVICES, AND RENTS includes items used for the maintenance of the railroads' lines, structures, and equipment; the costs of services purchased from outside contractors, including the net costs of operating joint (or leased) facilities with other railroads; and the net cost of equipment rentals. This category of expenses increased 10% in 1997 and 1% in 1996. The 1997 increase resulted principally from higher volume-related intermodal expenses, as well as higher equipment rent costs, partially a result of a change in the mix of received vs. forwarded traffic. Higher locomotive repair expenses and costs for contract programmers to make computer processes Year-2000 compliant (discussed below) also contributed to the increase. The 1996 increase also resulted from higher volume- related intermodal expenses, as well as higher equipment rent costs that more than offset lower locomotive and car-repair costs. Equipment rents, which represent the cost to NS 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 11% in 1997 and 10% in 1996. The 1997 increase was due to a 5% increase in overall traffic and a shift in traffic mix. Carloadings in other railroads' and privately owned freight cars were up 7%, due to growth in traffic received from other railroads. Trailer and container loadings, moving mostly on privately owned flatcars, were up 11%. These increased costs PAGE 43 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- were mitigated somewhat by higher receipts from short-term leases of locomotives to various railroads. The 1996 increase resulted from higher container traffic, lower receipts from short-term leases of locomotives, and more freight car leases necessary to meet customer requirements. These increased costs were somewhat offset by lower net costs for multilevel equipment. Locomotive repair costs increased in 1997, a result of higher traffic levels and an increase in the average number of locomotives in service throughout the year. In October 1995, NS initiated a project to review, and modify as necessary, computer and other systems for Year-2000 compliance. As of December 1997, most of NS' mainframe computer programs have been reviewed. This mainframe project is expected to be completed by the end of 1998. NS has redeployed existing information technology resources and has incurred incremental costs, mostly for contract programmers. Incremental costs through 1997, which were expensed, were less than $10 million, and the total incremental costs of the entire project are expected to be less than $25 million. Failure to achieve Year-2000 compliance -- by NS, other railroads, its suppliers, and its customers -- could negatively affect NS' ability to conduct business for an extended period. Management believes that NS' project will be completed on time and that the chance of failure is remote. DEPRECIATION expense (see Note 1, "Properties," on page 61 for NS' depreciation policy) was up 3% in 1997 and 5% in 1996. Increases in both years were due to property additions, reflecting recent substantial levels of capital spending. DIESEL FUEL costs declined 3% in 1997, but increased 23% in 1996. The 1997 decrease was due to a 5% drop in the average price per gallon, somewhat offset by a 3% rise in consumption. The 1996 increase was due to a 20% rise in the average price per gallon, as prices reached levels unseen since the Persian Gulf Crisis in 1991, and to a 3% increase in consumption. CASUALTIES AND OTHER CLAIMS (including estimates of costs related to personal injury, property damage, and environmental matters) were unchanged in 1997, but increased 2% in 1996. In 1997, a reduction in personal injury expenses was offset by higher freight damage costs. In 1996, higher accruals for environmental remediation costs more than offset reduced accruals for personal injury liabilities and the effects of a nonrecurring liability insurance premium refund. The largest component of casualties and other claims expense is personal injury costs. NS experienced another reduction in the number of reportable injuries in 1997, with a consequent reduction in the cost of personal injury claims. NS continues to work actively to reduce all accidents and to control the associated costs. The rail industry remains uniquely susceptible to litigation involving job-related accidental injury and occupational claims because of an outmoded law, the Federal Employers' Liability Act (FELA), originally passed in 1908 and applicable only to railroads. This law, which covers employee claims for job-related injuries, promotes an adversarial claim settlement environment and produces results that are unpredictable and inconsistent, at a far greater cost to the rail industry than the no-fault workers' compensation system to which non-rail competitors are universally subject. The railroads have been unsuccessful so far in efforts to persuade Congress to replace FELA with a no-fault workers' compensation system. NS maintains substantial amounts of commercial insurance for potential third-party liability and property damage losses. However, it also retains reasonable levels of risk through self-insurance. OTHER expenses increased 1% in 1997, but decreased 2% in 1996. PAGE 44 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Income Taxes - ------------ Income tax expense in 1997 was $299 million for an effective rate of 30%, compared with an effective rate of 35% in 1996 and 36% in 1995. Excluding the equity in Conrail's after-tax earnings, the effective rate for 1997 was 34%. The effective rates in all three years were below the statutory federal and state rates as a result of investments in corporate-owned life insurance and in coal-seam gas properties and favorable adjustments upon filing the prior year tax returns. In addition, 1997 benefited from favorable adjustments of accrued liabilities for state income taxes. 1996 benefited from favorable adjustments resulting from settlement of federal income tax years 1990-1992. DETAILED RESULTS OF DISCONTINUED OPERATIONS - MOTOR CARRIER As a result of the agreement to sell NAVL, motor carrier results are presented, net of taxes, as "Discontinued operations" (see Note 3 on page 64). Income from motor carrier operations, net of taxes, was $22 million in 1997, compared with $17 million in 1996, and $15 million in 1995. Motor carrier operating income was $35 million in 1997, compared with $32 million in 1996, and $25 million in 1995. Because certain expenses were below original estimates, $4 million of reserves related to a former division were reversed in each of the three years. The Relocation Services (RS) and High Value Products (HVP) divisions generated operating income of $31 million in 1997, $28 million in 1996, and $21 million in 1995. The following table presents a three-year comparison of revenues by division. MOTOR CARRIER REVENUES BY DIVISION ($ in millions)
1997 1996 1995 ----- ----- ----- Relocation Services $ 519 $ 528 $ 517 High Value Products 423 402 379 ----- ----- ----- Total $ 942 $ 930 $ 896 ===== ===== ===== Note: Certain motor carrier expenses previously reported net in revenues have been reclassified to motor carrier expenses. Income from motor carrier operations is not affected by this change in presentation.
RS' revenues decreased 2% in 1997, but increased 2% in 1996. In 1997, domestic shipments declined 6% due to weakness in all segments and the loss of the largest sales agent. International commercial shipments were down 3%. The effects of the volume decreases were mitigated by a 3% gain in average revenue per domestic shipment. In 1996, domestic shipments declined 4% due to weakness in all segments, and international shipments were down 1%. Average revenue per shipment increased 3%. HVP's revenues increased 5% in 1997 and 6% in 1996, as all business units experienced growth in both years. Customized Logistics Services (CLS) volume posted the largest percentage gains, due in part to new customer programs as well as the continued expansion of its commercial air freight operations and the expansion of the emergency parts service business. PAGE 45 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Motor carrier operating expenses as a percentage of revenues were 97% in 1997, 96% in 1996, and 97% in 1995, excluding the reversals related to a former division. The improvement in 1996 was partly due to a favorable appeals decision on certain aspects of a legal claim for which a reserve had been established in 1992. Also, the CLS segment reduced its costs as it moved out of the start-up phase of several of its logistics and parts distribution programs. 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 No. 128, "Earnings per Share," for the year ended December 31, 1997, and AICPA Statement of Position 96-1, "Environmental Remediation Liabilities," (SOP 96-1) effective January 1, 1997. The adoption of SOP 96-1 did not have a material effect on NS' financial statements. During 1997, Statements of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," and No. 131, "Disclosures About Segments of an Enterprise and Related Information," were issued. Neither statement is expected to have a material effect on NS' financial statements. FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES Cash provided by operating activities, NS' principal source of liquidity, decreased $48 million, or 4%, in 1997, and $36 million, or 3%, in 1996. Since consolidation in 1982, cash provided by operating activities has been sufficient to fund dividend requirements, debt repayments, and a significant portion of capital spending. The decrease in 1997 was principally the result of interest on the debt issued to finance NS' portion of the cost of the acquisition of Conrail stock. The increase in "Current liabilities other than debt" is primarily due to interest accruals. The decrease in 1996 was largely attributable to lump- sum wage payments associated with labor contract settlements and higher income tax payments related to the settlement of federal income tax years 1990-1992. CASH PROVIDED BY OPERATIONS* (Shown as a Graph in the Annual Report to Stockholders) ($ in millions)
1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- $1,241* $1,198 $1,234 $1,144 $ 875 $ 958 Cash provided by operations in 1997 exceeded $1 billion for the fourth consecutive year and was sufficient to fund dividend requirements, debt repayments, and a significant portion of capital expenditures. * 1997 excludes Conrail-related items that reduced cash provided by operations $91 million.
Cash used for investing activities increased substantially in 1997 with NS' acquisition of a 58% economic interest in Conrail and decreased 6% in 1996. Property additions account for most of the recurring spending in this category. The following tables show capital spending, track, and equipment statistics for the past five years. PAGE 46 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- CAPITAL EXPENDITURES -------------------- (Also shown as a graph in the Annual Report to Stockholders)
($ in millions) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Road $599 $438 $386 $385 $418 Equipment 306 326 338 240 217 Other property 24 25 33 82 4 ---- ---- ---- ---- ---- Total $929 $789 $757 $707 $639 ==== ==== ==== ==== ====
Capital expenditures increased 18% in 1997 and 4% in 1996. The increase in 1997 was due to higher roadway additions that included construction costs for four motor vehicle distribution facilities scheduled to be completed early in 1998. TRACK STRUCTURE STATISTICS (CAPITAL AND MAINTENANCE) ----------------------------------------------------
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Track miles of rail installed 451 401 403 480 574 Miles of track surfaced 4,703 4,686 4,668 4,760 5,048 New crossties installed (millions) 2.2 1.9 2.0 1.7 1.6
AVERAGE AGE OF RAILWAY EQUIPMENT --------------------------------
(Years) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Freight cars 23.0 22.3 22.0 21.9 21.3 Locomotives 15.3 15.4 15.7 15.8 15.1 Retired locomotives 23.3 24.4 22.6 23.6 24.7
Since 1988, NS has rebodied about 25,000 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, with total proceeds of $104 million included in "Property sales and other transactions" in the 1997, 1996, and 1995 Consolidated Statements of Cash Flows. In 1995 and 1996, this line item also reflected greater proceeds from land sales. PAGE 47 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- For 1998, NS has budgeted $903 million of capital expenditures, of which $149 million are initial outlays for facilities and equipment related to the Conrail transaction. Capital spending is expected to be affected significantly by Conrail-related expenditures, which are expected to incrementally add approximately $500 million over the next three years. Cash 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 (see "Joint Acquisition of Conrail," below, Note 2 on page 62, and Note 9 on page 68). Also included is $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 1997 included repayment of some of the commercial paper. NS' debt-to-total capitalization ratio was 58% at the end of 1997. In 1996, cash used for financing activities declined 20%, a result of amounts received in connection with the issuance of $200 million principal amount of medium-term notes. Cash spent to purchase and retire common stock was $389 million in 1996 and $338 million in 1995. On Oct. 23, 1996, NS announced that the share purchase program had been suspended (see Note 15 on page 77). NS currently has in place a $2.8 billion credit facility to support its commercial paper program. During 1998, as in prior years, NS expects to finance a portion of its equipment acquisitions. JOINT ACQUISITION OF CONRAIL On May 23, 1997, NS and CSX completed the acquisition of Conrail stock that was tendered in response to the NS/CSX tender offer (see Note 2). On June 2, 1997, a merger subsidiary jointly controlled by NS and CSX was merged into Conrail. Pursuant to the merger, all previously issued Conrail stock either was canceled or converted into the right to receive $115 per share in cash. NS' total cost for its portion of the acquisition, including NS' fees, was $5.8 billion. On June 23, 1997, NS and CSX filed a joint application with the Surface Transportation Board (STB) for control and division of the use and operations of Conrail's assets and for authority to implement the transaction. The application addresses projected traffic flows, proposed operations, and related matters; outlines the capital investments NS and CSX each plan to make in new connections and facilities and to increase capacity on critical routes; and details operating savings and other public benefits resulting from the transaction. The application also contains certain historical and pro forma financial information required by the STB. The joint application is a public document, available for review in its entirety at the office of the STB, located at 1925 K Street, NW, Washington, D.C. 20423-0001. In May 1997, the STB issued a scheduling order providing for issuance of a final STB decision no later than June 8, 1998, to become effective 30 days thereafter. On Nov. 3, 1997, the STB extended the period for issuing its final decision by 45 days, to July 23, 1998, to become effective 30 days thereafter. This extension was in conjunction with a new requirement that NS and CSX comply with the STB's order to submit detailed safety integration plans, and it is likely to delay realization of the expected transaction benefits. No assurance can be given with respect to the receipt of STB approval or as to modifications or conditions that may be imposed in connection therewith, or their impact, if any, on the expected transaction benefits. The STB has the authority to modify contract terms and impose additional conditions, including divestitures, grants of trackage rights, modification of other proposed aspects of operations, and requirements that could affect the timing of implementation and realization of benefits. PAGE 48 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Until NS and CSX are permitted by the STB to assume control over Conrail (the "Control Date"), Conrail will continue to be managed by its current Board of Directors and Management. Following the Closing Date, which will occur as soon as practicable after the Control Date, various agreements between NS and CSX provide, among other things, for each of the parties: (1) separately to operate pursuant to lease agreements portions of the routes and assets now owned and operated by Conrail, and (2) jointly to operate other Conrail properties. The closing is contingent upon, among other things, attainment of necessary labor implementing agreements and is expected to occur as soon as practicable after satisfaction of those contingencies and consistent with ensuring safe and efficient operations. NS is in the process of negotiating necessary implementing agreements with representatives of the affected employees. The United Transportation Union, the nation's largest rail union, and the Brotherhood of Locomotive Engineers have advised the STB that they have withdrawn their opposition and have agreed to support the transaction. Employees represented by these two unions make up 44% of the NS work force covered by labor agreements. The NS/CSX agreements also provide for the allocation of responsibility for certain known and contingent Conrail liabilities. Until the STB renders a final decision on the control application filed by NS and CSX, NS will not have complete access to Conrail's related books, records, and physical assets, and will not know precisely which Conrail properties NS will have responsibility for or control over pursuant to its agreements with CSX. As a consequence, it is not possible at this time for NS to state or to assess with precision the amount of its share of Conrail assets and liabilities. During 1997, the dilutive effect of Conrail on net income was higher than earlier expected. As a result of the intensive efforts under way to plan for the integration of NS' portion of Conrail's assets, the timing of integration expenses has accelerated; moreover, because of uncertainties concerning both the conditions that the STB may impose and the timing of other matters, the anticipated transaction synergies may be realized later than originally believed. As a result, the dilutive effect is likely to be higher in 1998 than earlier expected. Certain of the foregoing are forward-looking statements, and attention is called to the related cautionary language at the end of Management's Discussion and Analysis. OTHER MATTERS 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 9 on page 68), all is fixed-rate debt, except for commercial paper and $244 million of capital leases. The average interest rate on commercial paper was 5.4% on Dec. 31, 1996, and 6.0% on Dec. 31, 1997. During 1997, NS' commercial paper interest rates ranged from a low of 5.2% to a high of 6.5%. The capital leases, which carry an average fixed rate of 7.4%, were converted to variable rate obligations using interest rate swap agreements. On Dec. 31, 1997, the average pay rate was 6.1% and the average receive rate was 7.4% under these agreements. During 1997, the effect of the swaps was to reduce interest expense by $3 million. A portion of the lease obligations is payable in Japanese yen. NS 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. PAGE 49 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Counterparties to the interest rate swaps and Japanese banks holding yen deposits are major financial institutions believed by Management to be creditworthy. NS' debt subject to interest rate exposure totaled $2.1 billion on Dec. 31, 1997. A 1% increase in interest rates would increase NS' total annual interest expense related to all its variable debt by approximately $20 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. 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 non-jury trial on liability, which the Corporation vigorously defended, concluded in June 1997, and the parties await the setting of a briefing schedule. 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 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. Management will continue to monitor the progress of this litigation. If the jury verdict is not vacated or modified in an acceptable manner, appropriate appeals will be pursued. Management believes that the jury verdicts are both grossly excessive and without factual or legal justification. While the final outcome of 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 can be reasonably estimated. 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 50 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- Operating expenses for environmental matters totaled approximately $21 million in 1997, and capital expenditures totaled approximately $6 million. Both are expected to be at similar levels in 1998. As of Dec. 31, 1997, NS' 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 costs based on available information at 111 identified locations. On that date, 11 sites accounted for $25 million of the reserve, and no individual site was considered to be material. NS anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period. At many of the 111 locations, certain NS 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 The Alabama Great Southern Railroad Company (AGS), a subsidiary of NS' rail subsidiary, is responsible -- along with four other parties believed to be financially solvent and with two of which the EPA and state authorities have reached settlements -- for past and future clean-up and monitoring costs at the Bayou Bonfouca NPL Superfund site located in Slidell, La. The EPA indicates that it has expended or expects to expend a total of approximately $130 million at the site. NS continues to contest liability on a variety of grounds, and trial now is scheduled to begin on Feb. 22, 1999. The EPA bases its claim of NS' liability on (a) the alleged activities in the 1880s of a company not at the time owned or controlled by an NS rail subsidiary but acquired in 1916, and (b) certain servitudes possessed by that subsidiary only for a rail right-of-way. With respect to known environmental sites (whether identified by NS 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 in the past, land used as operating property, or which is leased or may have been leased and operated by others, or held for sale. Because environmental problems may exist on these properties that are latent or undisclosed, there can be no assurance that NS will not incur environmentally related liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and other now-unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial condition, results of operations, or liquidity in a particular year or quarter. However, based on its assessments of the facts and circumstances now known, Management believes that it has recorded the probable costs for those environmental matters of which the Corporation is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in the aggregate, will have a material adverse effect on NS' financial position, results of operations, or liquidity. PAGE 51 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- 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 approximately $14 billion invested in such assets. The replacement cost of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical cost. Trends - ------ - - Federal Economic Regulation - Efforts will be made in 1998 to re- subject the rail industry to unwarranted federal economic regulation. The Staggers Rail Act of 1980, which substantially reduced such regulation, encouraged and enabled rail carriers to innovate and to compete for business, thereby contributing to the economic health of the nation and to the revitalization of the industry. Accordingly, NS 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 patrons 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 or of actual future results; nor will they necessarily prove to be accurate indications of the times at or by which any such performance or result will be achieved. Accordingly, actual outcomes and results may differ materially from those expressed in such forward-looking statements. This caveat has particular importance in the context of all such statements that relate to the realization and the timing of benefits expected to result from consummation of the Conrail transaction. PAGE 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) 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 Earnings per share-diluted $0.34 $0.50 $0.47 $0.59 1996 ---- Railway operating revenues $1,017 $1,038 $1,020 $1,026 Income from railway operations 262 300 300 303 Income from continuing operations 169 193 193 198 Net income 168 200 202 200 Earnings per share-basic $0.44 $0.52 $0.54 $0.53 Earnings per share-diluted $0.43 $0.52 $0.53 $0.53 NOTE:All per share amounts have been restated to reflect the Sept. 5, 1997, three-for-one stock split.
PAGE 53 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- Index to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1997, 1996 and 1995 54 Consolidated Balance Sheets As of December 31, 1997 and 1996 55 Consolidated Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995 57 Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1997, 1996 and 1995 59 Notes to Consolidated Financial Statements 60 Independent Auditors' Report 80 The Index to Consolidated Financial Statement Schedule appears in Item 14 on page 82. PAGE 54 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Statements Of Income
Years ended December 31, 1997 1996 1995 ------- ------- ------- ($ in millions, except earnings per share) Railway Operating Revenues $ 4,223 $ 4,101 $ 4,012 Railway Operating Expenses Compensation and benefits (Note 12) 1,405 1,400 1,480 Materials, services, and rents 685 624 619 Depreciation 421 408 389 Diesel fuel 227 233 190 Casualties and other claims 123 123 121 Other 149 148 151 ------- ------- ------- Total railway operating expenses 3,010 2,936 2,950 ------- ------- ------- Income from railway operations 1,213 1,165 1,062 Equity in earnings of Conrail (Note 2) 117 -- -- Charge for credit facility costs (Note 2) (77) -- -- Other income - net (Note 4) 130 117 140 Interest expense on debt (Note 7) (385) (116) (113) ------- ------- ------- Income from continuing operations before income taxes 998 1,166 1,089 Provision for income taxes (Note 5) 299 413 391 ------- ------- ------- Income from continuing operations 699 753 698 Discontinued operations - motor carrier, net of taxes (Note 3) 22 17 15 ------- ------- ------- Net Income $ 721 $ 770 $ 713 ======= ======= ======= Earnings Per Share (Note 15) Income from continuing operations - Basic $ 1.85 $ 1.98 $ 1.78 - Diluted $ 1.84 $ 1.96 $ 1.77 Net income - Basic $ 1.91 $ 2.03 $ 1.81 - Diluted $ 1.90 $ 2.01 $ 1.80 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, 1997 1996 ------- ------- ($ in millions) Assets Current assets: Cash and cash equivalents $ 34 $ 207 Short-term investments 125 194 Accounts receivable net of allowance for doubtful accounts of $3 million and $4 million, respectively 552 558 Materials and supplies 58 61 Deferred income taxes (Note 5) 114 132 Other current assets 119 121 Net assets of discontinued operations 101 83 ------- ------- Total current assets 1,103 1,356 ------- ------- Investment in Conrail (Note 2) 5,888 -- Other investments (Note 6) 333 275 Properties less accumulated depreciation (Note 7) 9,904 9,472 Other assets 122 131 ------- ------- Total Assets $17,350 $11,234 ======= ======= Liabilities And Stockholders' Equity Current liabilities: Short-term debt (Note 9) $ 27 $ 43 Accounts payable (Note 8) 624 594 Income and other taxes 169 166 Other current liabilities (Note 8) 212 201 Current maturities of long-term debt (Note 9) 61 56 ------- ------- Total current liabilities 1,093 1,060 ------- ------- Long-term debt (Note 9) 7,398 1,800 Other liabilities (Note 11) 885 927 Minority interests 49 50 Deferred income taxes (Note 5) 2,480 2,420 ------- ------- Total Liabilities 11,905 6,257 ------- ------- (continued)
PAGE 56 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (continued)
As of December 31, 1997 1996 ------- ------- ($ in millions) Stockholders' equity: Common stock $1.00 per share par value, 1,350,000,000 shares authorized (Note 15); issued 398,912,698 shares (265,847,132 issued for stock split)and 132,350,009 shares, respectively 399 132 Additional paid-in capital (Note 15) 241 462 Retained income 4,826 4,404 Less treasury stock at cost, 21,757,902 shares (14,505,268 issued for stock split) and 7,252,634 shares, respectively (21) (21) ------- ------- Total Stockholders' Equity 5,445 4,977 ------- ------- Total Liabilities And Stockholders' Equity $17,350 $11,234 ======= ======= See accompanying notes to consolidated financial statements.
PAGE 57 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Consolidated Statements Of Cash Flows
Years ended December 31, 1997 1996 1995 ------- ------- ------- ($ in millions) Cash Flows From Operating Activities Net income $ 721 $ 770 $ 713 Reconciliation of net income to net cash provided by continuing operations: Depreciation 432 419 399 Deferred income taxes 75 92 73 Equity in earnings of Conrail (117) -- -- Charge for credit facility costs 77 -- -- Nonoperating gains and losses on properties and investments (63) (57) (72) Income from discontinued operations (22) (17) (15) Changes in assets and liabilities affecting continuing operations: Accounts receivable (23) (1) 12 Materials and supplies 3 (1) (1) Other current assets (8) (13) (2) Current liabilities other than debt 115 (8) 64 Other - net (44) (16) 15 ------- ------- ------- Net cash provided by continuing operations 1,146 1,168 1,186 Net cash provided by discontinued operations 4 30 48 ------- ------- ------- Net cash provided by operating activities 1,150 1,198 1,234 Cash Flows From Investing Activities Property additions (875) (680) (652) Property sales and other transactions 74 130 128 Investment in Conrail (5,741) (10) -- Investments, including short-term (185) (209) (260) Investment sales and other transactions 217 245 224 ------- ------- ------- Net cash used for investing activities (6,510) (524) (560) Cash Flows From Financing Activities Dividends (301) (284) (274) Common stock issued - net 24 29 19 Purchase and retirement of common stock -- (389) (338) Commercial paper proceeds 1,540 -- -- Credit facility costs paid (72) (5) -- Proceeds from long-term borrowings 4,241 209 8 Debt repayments (245) (93) (74) ------- ------- ------- Net cash provided by (used for) financing activities 5,187 (533) (659) Net increase (decrease) in cash and cash equivalents (173) 141 15 (continued)
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, 1997 1996 1995 ------- ------- ------- ($ in millions) Cash And Cash Equivalents At beginning of year 207 66 51 ------- ------- ------- At end of year $ 34 $ 207 $ 66 ======= ======= ======= Supplemental Disclosures Of Cash Flow Information Cash paid during the year for: Interest (net of amounts capitalized) $ 379 $ 128 $ 119 Income taxes $ 209 $ 324 $ 283 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
Additional Common Paid-In Retained Treasury Stock Capital Income Stock Total ----- ---------- ------- ------- ------- ($ in millions) Balance December 31, 1994 $ 140 $ 411 $4,155 $(21) $4,685 Net income - 1995 713 713 Dividends on common stock $0.69 1/3 per share (274) (274) Purchase and retirement of common stock (5) (15) (314) (334) Other 1 35 3 39 ----- ----- ------ ---- ------ Balance December 31, 1995 136 431 4,283 (21) 4,829 Net income - 1996 770 770 Dividends on common stock $0.74 2/3 per share (284) (284) Purchase and retirement of common stock (5) (15) (365) (385) Other 1 46 -- 47 ----- ----- ------ ---- ------ Balance December 31, 1996 132 462 4,404 (21) 4,977 Net income - 1997 721 721 Dividends on common stock $0.80 per share (301) (301) 3-for-1 stock split, effective September 5 266 (266) -- -- Other 1 45 2 48 ----- ----- ------ ---- ------ Balance December 31, 1997 $ 399 $ 241 $4,826 $(21) $5,445 ===== ===== ====== ==== ====== 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, primarily in the Southeast and Midwest. The consolidated financial statements include Norfolk Southern Corporation (Norfolk Southern) and its majority- owned and controlled subsidiaries (collectively NS). The major subsidiary is Norfolk Southern Railway Company. Financial results of a 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. Rail freight consists of raw materials, intermediate products, and finished goods classified in the following market groups: coal; paper, clay, and forest products; chemicals; automotive; agriculture, government, and consumer products; metals and construction, and intermodal. All groups are approximately equal in size based on revenues except for coal, which accounts for almost one-third of total railway operating revenues. Ultimate destinations for some of the freight and a portion of the coal shipped are outside the United States. Use Of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents - ---------------- "Cash equivalents" are highly liquid investments purchased three months or less from maturity. Investments - ----------- Marketable equity and debt securities are reported at amortized cost or fair value, depending upon their classification as held-to-maturity, trading, or available-for-sale securities. On Dec. 31, 1997 and 1996, all "Short-term investments," consisting primarily of United States government and federal agency securities, were designated as available- for-sale. Accordingly, unrealized gains and losses, net of taxes, are recognized in "Stockholders' equity." Materials And Supplies - ---------------------- "Materials and supplies," consisting mainly of fuel oil and items for maintenance of property and equipment, are stated at average cost. The cost of materials and supplies expected to be used in capital additions or improvements is included in "Properties." PAGE 61 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Properties - ---------- "Properties" are stated principally at cost and are depreciated using group depreciation. Rail is primarily depreciated on the basis of use measured by gross ton-miles. The effect of this method is to depreciate these assets over 42 years on average. Other properties are depreciated generally using the straight-line method over estimated service lives at annual rates that range from 1% to 20%. In 1997, the overall depreciation rate averaged 2.8% for roadway and 4.1% 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 non-rail assets are sold or retired in the ordinary course of business, the cost of the assets, net of sale proceeds or salvage, is charged to accumulated depreciation rather than recognized through income. Gains and losses on disposal of land and non-rail assets are included in "Other income" (see Note 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 is a party to a limited number of derivative agreements that hedge interest rate exposures on certain components of its debt portfolio. Differentials paid or received as a result of fluctuations in market interest rates are recognized in interest expense over the outstanding lives of the related obligations. Unamortized balances are included in "Long-term debt" in the Consolidated Balance Sheets. Required Accounting Changes - --------------------------- NS adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128), for the year ended Dec. 31, 1997. Basic earnings per share as calculated in accordance with SFAS 128 excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. For NS, basic earnings per share corresponds to earnings per share as calculated and shown in previous Consolidated Statements of Income. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, converted, or otherwise resulted in the issuance of common stock that then shared in NS' earnings. Effective Jan. 1, 1997, NS adopted AICPA Statement of Position 96-1, "Environmental Remediation Liabilities" (SOP 96-1), which provides guidance with respect to recognition and measurement of environmental remediation liabilities and disclosure of such liabilities in financial statements. The adoption of SOP 96-1 did not have a material effect on NS' financial statements. PAGE 62 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. JOINT ACQUISITION OF CONRAIL On May 23, 1997, NS and CSX Corporation (CSX), through a jointly owned entity, completed the acquisition of Conrail Inc. (Conrail) stock that was tendered in response to the NS/CSX tender offer. On June 2, 1997, a merger subsidiary jointly controlled by NS and CSX was merged into Conrail. Pursuant to the merger, all previously outstanding Conrail stock either was canceled or was converted into the right to receive $115 per share in cash. NS' share of the cost of the acquisition, plus NS' fees, totaled $5.8 billion. NS has a 58% economic and 50% voting interest in the entity that owns Conrail. All Conrail stock owned by NS and CSX remains in a voting trust pending approval of the transaction by the Surface Transportation Board (STB). STB approval, while anticipated, cannot be assured, and a final decision is not expected to be effective prior to Aug. 22, 1998 (the "Control Date"). Should the STB not approve the transaction, NS could incur a significant loss on the disposition of its investment in Conrail. On June 10, 1997, NS, CSX, and Conrail entered into an agreement (the Transaction Agreement) covering division of Conrail's operations and use of Conrail's assets (collectively, the Transaction). The Transaction Agreement provides, among other things, for NS and CSX after the Control Date: (1) separately to operate, pursuant to lease agreements, portions of the routes and assets now owned and operated by Conrail, and (2) jointly to operate other Conrail properties. In addition, Conrail will continue certain operations as agent for NS and CSX. The Transaction Agreement and various other agreements between and among NS, CSX, and Conrail also provide for the allocation between NS and CSX of responsibility for certain known and contingent Conrail liabilities. The Transaction will be consummated as soon as practicable after STB approval. Closing is contingent upon, among other things, attainment of necessary labor implementing agreements, and a determination that implementation can be accomplished safely and without service disruptions, either of which might delay closing and realization of the expected transaction benefits. The STB has the authority to modify contract terms and impose conditions, including divestitures, grants of trackage rights, and limitations upon proposed operations. Until the Control Date, Conrail will continue to be managed by its current Board of Directors and Management, and, due to regulatory constraints, NS will not have complete access to Conrail's related books, records, and physical assets. Further, until the STB renders its final decision, NS will not know with certainty which Conrail properties it will have responsibility for or control over pursuant to its agreements with CSX and Conrail, or the effects of any other conditions that may be imposed by the STB. The equity method of accounting has been applied to NS' investment in Conrail in accordance with APB No. 18, "The Equity Method of Accounting for Investments in Common Stock." As a result, the Dec. 31, 1997, Consolidated Balance Sheet includes $5.9 billion comprising: (1) the amounts paid and accrued to acquire Conrail stock, including related fees and expenses, and (2) NS' equity in the undistributed earnings of Conrail, which is net of $44.5 million amortization of the difference between NS' investment in Conrail and the underlying equity in net assets. NS is amortizing the difference between the purchase price for its investment in Conrail and its equity in the underlying net assets of Conrail based on preliminary estimates of: (1) the fair values of Conrail's property and equipment, (2) their remaining useful lives, (3) the fair values of other Conrail assets and liabilities, and (4) the deferred tax effect of the bases differences. The Consolidated Statement of Income for the year ended Dec. 31, 1997, includes several Conrail-related items. These principally consist of: (1) interest expense on debt issued to finance NS' share of the NS/CSX joint acquisition of Conrail stock, (2) equity in the earnings of Conrail, net of amortization, (3) credit facility costs, including a $77 million charge incurred in conjunction with certain now-terminated commitments that provided financing for NS' then-proposed acquisition of all Conrail stock, and (4) identified integration costs. PAGE 63 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. JOINT ACQUISITION OF CONRAIL (continued) The following summary financial information was provided by Conrail's Management and should be read in conjunction with Conrail's audited financial statements included as an exhibit to NS' Annual Report for the year ended Dec. 31, 1997, on Form 10-K filed with the Securities and Exchange Commission (SEC) and Consolidated Rail Corporation's latest Annual Report on Form 10-K filed with the SEC. SUMMARIZED CONSOLIDATED STATEMENTS OF INCOME - CONRAIL
($ in millions) 1997 1996 1995 ------- ------- ------- Operating revenues $ 3,765 $ 3,714 $ 3,686 Operating expenses 3,443 3,113 3,230 ------- ------- ------- Operating income 322 601 456 Other - net (87) (70) (64) ------- ------- ------- Income before income taxes 235 531 392 Provision for income taxes 228 189 128 ------- ------- ------- Net income $ 7 $ 342 $ 264 ======= ======= ======= Note: Conrail's operating expenses for 1997 included the following: (1) a $221 million charge in conjunction with the termination of the Conrail ESOP that NS treated as a cost of the acquisition of Conrail stock, and (2) $173 million ($142 million after taxes) for merger-related stock compensation costs and severance benefits that NS treated as a cost of the acquisition of Conrail stock.
SUMMARIZED CONSOLIDATED BALANCE SHEETS - CONRAIL
December 31, ------------------- ($ in millions) 1997 1996 -------- -------- Assets Current assets $ 954 $ 1,117 Noncurrent assets 7,530 7,285 ------- ------- Total assets $ 8,484 $ 8,402 ======= ======= Liabilities and Stockholders' Equity Current liabilities $ 1,208 $ 1,092 Noncurrent liabilities 4,111 4,203 Stockholders' equity 3,165 3,107 ------- ------- Total liabilities and stockholders' equity $ 8,484 $ 8,402 ======= =======
PAGE 64 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 3. DISCONTINUED OPERATIONS - MOTOR CARRIER On Jan. 12, 1998, NS announced that it signed an agreement to sell all the common stock of North American Van Lines, Inc. (NAVL), its motor carrier subsidiary. The transaction is subject to customary closing conditions and is expected to be consummated before May 31, 1998. NS expects to report a gain on the consummated sale. NAVL's results of operation, financial position, and cash flows are presented as "Discontinued operations" in the accompanying financial statements. A summary of the results of operations and the net assets of discontinued operations follows:
($ in millions) 1997 1996 1995 ----- ----- ----- Motor carrier revenue $ 942 $ 930 $ 896 Motor carrier expenses $ 907 $ 898 $ 871 Other income (expense) -- (1) -- Provision for income taxes 13 14 10 ----- ----- ----- Income from discontinued operations 22 17 15 ----- ----- ----- Earnings per share (basic and diluted) from discontinued operations $0.06 $0.05 $0.03 ===== ===== =====
December 31, --------------- ($ in millions) 1997 1996 ----- ----- Current assets $ 192 $ 196 Long-term assets 100 88 Current liabilities (130) (140) Long-term liabilities (61) (61) ----- ----- Net assets of discontinued operations $ 101 $ 83 ===== =====
4. OTHER INCOME - NET
($ in millions) 1997 1996 1995 ------ ------ ------ Royalties from coal $ 58 $ 59 $ 59 Gains from sale of properties and investments 56 57 41 Interest income 30 22 26 Rental income 22 20 21 Gain from partial redemption of partnership interest 7 -- 31 Corporate-owned life insurance - net 7 6 7 Other interest expense (27) (29) (23) Nonoperating depletion and depreciation (11) (11) (10) Taxes on nonoperating property (5) (8) (7) Other - net (7) 1 (5) ------ ------ ------ Total $ 130 $ 117 $ 140 ====== ====== ======
PAGE 65 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 5. INCOME TAXES Provision For Income Taxes - --------------------------
($ in millions) 1997 1996 1995 ------ ------ ------ Current: Federal $ 197 $ 280 $ 267 State 27 41 51 ----- ----- ----- Total current taxes 224 321 318 Deferred: Federal 78 75 65 State (3) 17 8 ----- ----- ----- Total deferred taxes 75 92 73 ----- ----- ----- Provision for income taxes $ 299 $ 413 $ 391 ===== ===== =====
Reconciliation Of Statutory Rate To Effective Rate - -------------------------------------------------- Total income taxes as reflected in the Consolidated Statements of Income differ from the amounts computed by applying the statutory federal corporate tax rate as follows:
1997 1996 1995 ----------- ----------- ----------- ($ in millions) Amount % Amount % Amount % ------ --- ------ --- ------ --- Federal income tax at statutory rate $ 349 35 $ 408 35 $ 381 35 State income taxes, net of federal tax benefit 16 2 37 3 39 4 Equity in earnings of Conrail (41) (4) -- -- -- -- Corporate-owned life insurance (10) (1) (15) (1) (17) (2) Other - net (15) (2) (17) (2) (12) (1) ----- -- ----- -- ----- -- Provision for income taxes $ 299 30 $ 413 35 $ 391 36 ===== == ===== == ===== ==
Tax Benefit Leases - ------------------ In January 1995, the United States Tax Court issued a preliminary decision that would disallow some of the tax benefits a subsidiary of NS purchased from a third party pursuant to a safe harbor lease agreement in 1981. The Tax Court finalized this decision in February 1997. This decision has been appealed, and Management continues to believe that NS ultimately should incur no loss from this decision, because the lease agreement provides for full indemnification if any such disallowance is sustained. PAGE 66 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 5. INCOME TAXES (continued) 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:
December 31, ----------------------- ($ in millions) 1997 1996 -------- -------- Deferred tax assets: Reserves, including casualty and other claims $ 144 $ 149 Employee benefits 155 175 Retiree health and death benefit obligation 133 138 Taxes, including state and property 171 176 Other 52 77 ------- ------- Total gross deferred tax assets 655 715 Less valuation allowance (2) (2) ------- ------- Net deferred tax assets 653 713 ------- ------- Deferred tax liabilities: Property (2,925) (2,892) Other (94) (109) ------- ------- Total gross deferred tax liabilities (3,019) (3,001) ------- ------- Net deferred tax liability (2,366) (2,288) Net current deferred tax assets 114 132 ------- ------- Net long-term deferred tax liability $(2,480) $(2,420) ======= =======
Internal Revenue Service (IRS) Reviews - -------------------------------------- Consolidated federal income tax returns have been examined and Revenue Agent Reports have been received for all years up to and including 1992. The consolidated federal income tax returns for 1993 and 1994 are being audited by the IRS. Management believes that adequate provision has been made for any additional taxes and interest thereon that might arise as a result of IRS examinations. PAGE 67 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 6. OTHER INVESTMENTS
December 31, ---------------------- ($ in millions) 1997 1996 ------- ------- Corporate-owned life insurance at net cash surrender value $ 247 $ 212 Marketable equity securities 10 6 Other 76 57 ----- ----- Total $ 333 $ 275 ===== =====
7. PROPERTIES
December 31, ----------------------- ($ in millions) 1997 1996 -------- -------- Railway property: Road $ 8,853 $ 8,439 Equipment 4,881 4,716 Other property 605 591 ------- ------- 14,339 13,746 Less: Accumulated depreciation 4,435 4,274 ------- ------- Net properties $ 9,904 $ 9,472 ======= =======
Capitalized Interest - -------------------- Total interest cost incurred on debt in 1997, 1996, and 1995 was $402 million, $128 million, and $127 million, respectively, of which $17 million, $12 million, and $14 million was capitalized. PAGE 68 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 8. CURRENT LIABILITIES
December 31, --------------------- ($ in millions) 1997 1996 ------ ------ Accounts payable: Accounts and wages payable $ 281 $ 270 Casualty and other claims 172 166 Vacation liability 80 75 Equipment rents payable - net 67 61 Other 24 22 ----- ----- Total $ 624 $ 594 ===== ===== Other current liabilities: Interest payable $ 115 $ 39 Liabilities for forwarded traffic 31 63 Accrued acquisition costs (Note 2) 25 61 Retiree health and death benefit obligation (Note 12) 23 23 Other 18 15 ----- ----- Total $ 212 $ 201 ===== =====
9. DEBT Long-Term Debt - --------------
December 31, ----------------- ($ in millions) 1997 1996 ------- ------- Commercial paper classified as long-term debt at an average rate of 6.0% $ 1,871 $ 500 Notes at average rates and maturities as follows: 6.85%, maturing 2000 to 2002 1,096 -- 7.45%, maturing 2004 to 2007 1,191 449 8.10%, maturing 2017 to 2021 798 248 7.80%, maturing 2027 792 -- 7.05%, maturing 2037 745 -- 7.90%, maturing 2097 350 -- Railroad equipment obligations at an average rate of 7.8% maturing to 2009 355 397 Capitalized leases at an average rate of 6.1% maturing to 2015 246 197 Other debt at an average rate of 7.0% maturing to 2015 15 65 ------- ------- Total long-term debt 7,459 1,856 ------- ------- Less: Current maturities 61 56 ------- ------- Long-term debt less current maturities $ 7,398 $ 1,800 ======= =======
PAGE 69 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 9. DEBT (continued)
Long-term debt matures as follows: 1999 $ 131 2000 462 2001 256 2002 551 2003 and subsequent years 5,998 ------- Total $ 7,398 =======
The railroad equipment obligations and the capitalized leases are secured by liens on the underlying equipment. Unsecured Notes Issued In 1997 - ------------------------------ On May 19, 1997, NS issued and sold $4.3 billion of unsecured term notes to finance part of the cost of the Conrail acquisition. None of the notes are entitled to any sinking fund. If certain tax laws are changed, NS has the right to shorten the maturity of the 2097 notes. NS is subject to various financial covenants while the notes are outstanding. On May 14, 1997, NS terminated $1.25 billion notional amount of contracts and agreements previously entered into to hedge its exposure to changes in interest rates in anticipation of issuing certain Conrail- related debt. The related costs were capitalized and are being amortized as interest expense over the life of the underlying debt. Commercial Paper - ---------------- NS' commercial paper debt totaled $1,871 million and $516 million as of Dec. 31, 1997, and Dec. 31, 1996, respectively. Most all of the increase was related to the Conrail acquisition. 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, 5-year credit agreement to convert this obligation into longer term debt. NS intends to refinance the commercial paper either by issuing additional commercial paper or by replacing commercial paper notes with long-term debt. The credit agreement provides for interest on borrowings at prevailing rates and contains customary financial covenants, including an initial minimum net worth requirement of $4 billion. Short-Term Debt - ---------------
December 31, ---------------- ($ in millions) 1997 1996 ------ ------ Commercial paper notes $ -- $ 16 Other notes 27 27 ----- ----- Total $ 27 $ 43 ===== =====
PAGE 70 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 9. DEBT (continued) Capital Lease Obligations - ------------------------- During 1997 and 1996, an NS rail subsidiary entered into capital leases covering new locomotives. The related capital lease obligations, totaling $64 million in 1997 and $108 million in 1996, were reflected in the Consolidated Balance Sheets as debt and, because they were non-cash transactions, were excluded from the Consolidated Statements of Cash Flows. The lease obligations carry an average stated interest rate of 7.0% for those entered into in 1997 and 6.5% for those entered into in 1996. All were converted to variable rate obligations using interest rate swap agreements. The interest rates on these obligations are based on the six-month London Interbank Offered Rate and are reset every six months with changes in interest rates accounted for as an adjustment of interest expense over the terms of the leases. As of Dec. 31, 1997, the average interest rate on these locomotive leases was 6.1%. As a result, NS is exposed to the market risk associated with fluctuations in interest rates. To date, the effects of the rate fluctuations have been favorable and not material. Counterparties to the interest rate swap agreements are major financial institutions believed by Management to be creditworthy. 10. LEASE COMMITMENTS NS is committed under long-term lease agreements, which expire on various dates through 2067, for equipment, lines of road, and other property. Future minimum lease payments are as follows:
($ in millions) Operating Leases Capital Leases ---------------- -------------- 1998 $ 50 $ 35 1999 47 35 2000 39 35 2001 35 34 2002 32 34 2003 and subsequent years 627 164 ---- ---- Total $830 337 ==== Less imputed interest on capital leases at an average rate of 7.4% 91 ---- Present value of minimum lease payments included in debt $246 ====
Operating Lease Expense - -----------------------
($ in millions) 1997 1996 1995 ------ ------ ------ Minimum rents $ 68 $ 65 $ 59 Contingent rents 43 38 36 ----- ----- ----- Total $ 111 $ 103 $ 95 ===== ===== =====
PAGE 71 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 11. OTHER LIABILITIES
December 31, ---------------- ($ in millions) 1997 1996 ------ ------ Casualty and other claims $ 253 $ 248 Net pension obligation (Note 12) 57 82 Retiree health and death benefit obligation (Note 13) 281 288 Other 294 309 ----- ----- Total $ 885 $ 927 ===== =====
12. PENSION PLANS Norfolk Southern and certain subsidiaries have defined benefit pension plans that principally cover salaried employees. Pension benefits are based primarily on years of creditable service with NS and compensation rates near retirement. Contributions to the plans are made on the basis of not less than the minimum funding standards set forth in the Employee Retirement Income Security Act of 1974, as amended. Assets in the plans consist mainly of common stocks. Pension Cost (Benefit) Components - ---------------------------------
($ in millions) 1997 1996 1995 ------- ------- ------- Service cost-benefits earned during the year $ 11 $ 12 $ 10 Interest cost on projected benefit obligation 66 67 65 Actual return on assets in plans (273) (170) (257) Net amortization and deferral 171 83 172 ----- ----- ----- Net pension benefit (25) (8) (10) Cost of early retirement benefits -- -- 23 ----- ----- ----- Total $ (25) $ (8) $ 13 ===== ===== =====
Pension cost is determined based on an actuarial valuation that reflects appropriate assumptions as of the beginning of each year. The funded status of the plans is determined using appropriate assumptions as of each year end. A summary of the major assumptions follows:
1997 1996 1995 ------- ------- ------- Discount rate for determining funded status 7.25% 7.75% 7.25% Future salary increases 5.25% 5.25% 6% Return on assets in plans 9% 9% 9%
PAGE 72 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 12. PENSION PLANS (continued) The funded status of the plans and the amounts reflected in the accompanying balance sheets are as follows:
December 31, ------------------------------------- 1997 1996 ----------------- ----------------- Funded Unfunded Funded Unfunded ($ in millions) Plans Plans Plans Plans ------- -------- ------- -------- Actuarial present value of benefit obligations: Vested benefits $ 810 $ 62 $ 759 $ 59 Non-vested benefits 2 -- 1 -- ------ ------ ------ ------ Accumulated benefit obligation 812 62 760 59 Effect of expected future salary increases 78 4 68 5 ------ ------ ------ ------ Projected benefit obligation 890 66 828 64 Fair value of assets in plans 1,360 -- 1,158 -- ------ ------ ------ ------ Funded status 470 (66) 330 (64) Unrecognized initial net asset (23) -- (30) -- Unrecognized (gain) loss (466) 24 (344) 21 Unrecognized prior service cost (benefit) 9 (5) 2 3 ------ ------ ------ ------ Net pension liability included in the balance sheets $ (10) $ (47) $ (42) $ (40) ====== ====== ====== ======
Early Retirement Program In 1995 - -------------------------------- During 1995, NS completed a voluntary early retirement program for certain salaried employees. The principal benefit for those who participated in this program was enhanced pension benefits, which are reflected in the accumulated benefit obligation. The charge for the 272 employees who accepted the offer is included in "Compensation and benefits" expense and totaled $34 million (including $8 million related to postretirement benefits other than pensions). 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 $9 million, $8 million, and $7 million in 1997, 1996, and 1995, respectively. PAGE 73 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Norfolk Southern and certain subsidiaries provide specified health care and death benefits to eligible retired employees and their dependents. Under the present plans, which may be amended or terminated at NS' option, a defined percentage of health care expenses is covered, reduced by any deductibles, co-payments, Medicare payments and, in some cases, coverage provided by other group insurance policies. The cost of such health care coverage to a retiree may be determined, in part, by the retiree's years of creditable service with NS prior to retirement. Death benefits are determined based on various factors, including, in some cases, salary at time of retirement. NS continues to fund benefit costs principally on a pay-as-you-go basis. However, in 1991, NS established a Voluntary Employee Beneficiary Association (VEBA) account to fund a portion of the cost of future health care benefits for retirees. The VEBA trust holding the plan assets is not expected to be subject to federal income taxes, as the assets are invested entirely in trust- owned life insurance. NS last made a corporate contribution to the VEBA in 1994. Postretirement Benefit Cost Components - --------------------------------------
($ in millions) 1997 1996 1995 ------ ------ ------ Service cost-benefits attributable to service during the year $ 9 $ 10 $ 9 Interest cost on accumulated postretirement benefit obligation 25 24 28 Actual return on plan assets (25) (14) (18) Net amortization and deferral 6 (4) 2 ----- ----- ----- Net postretirement benefit cost $ 15 $ 16 $ 21 Cost of early retirement benefits -- -- 8 ----- ----- ----- Total $ 15 $ 16 $ 29 ===== ===== =====
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation, the salary increase assumption, and the long-term rate of return on plan assets are the same as those used for the pension plans (see table of rate assumptions in Note 12). PAGE 74 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (continued) The following table sets forth these plans' total accumulated postretirement benefit obligation, reconciled with the accrued postretirement benefit obligation:
December 31, ------------------------------------------- 1997 1996 ------------------ ------------------ Health Health Care Death Care Death ($ in millions) Benefits Benefits Benefits Benefits -------- -------- -------- -------- Accumulated postretire- ment benefit obligation: Retirees $ 163 $ 85 $ 164 $ 83 Fully eligible active plan participants 32 9 21 7 Other active plan participants 54 17 42 12 ----- ----- ----- ----- Total 249 111 227 102 Plan assets at fair value 111 -- 86 -- ----- ----- ----- ----- Funded status (138) (111) (141) (102) Unrecognized loss (gain) (33) 3 (27) (3) Unrecognized prior service cost (benefit) (25) -- (38) -- ----- ----- ----- ----- Accrued postretire- ment benefit obligation $(196) $(108) $(206) $(105) ===== ===== ===== =====
For measurement purposes, increases in the per capita cost of covered health care benefits were assumed to be 9.8% for 1998 and 10.4% for 1997. The rate was assumed to decrease gradually to an ultimate rate of 5.5% and remain at that level for 2005 and thereafter. The health care cost trend rate has a significant effect on the amounts reported in the financial statements. To illustrate, increasing the assumed trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of Dec. 31, 1997, by about $32 million and the aggregate of the service and interest cost components of net postretirement benefit cost for 1997 by about $4 million. Under collective bargaining agreements, NS 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 $4 million in each of 1997, 1996, and 1995. 14. LONG-TERM INCENTIVE PLAN Under the stockholder-approved Long-Term Incentive Plan, a committee of non-employee 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. 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 Norfolk Southern Common Stock on the date of grant. PAGE 75 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 14. LONG-TERM INCENTIVE PLAN (continued) 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 an amount 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. Plan participants surrendered, without cash or other consideration, all outstanding SARs granted after 1988 because of regulations issued by the SEC in 1991. Future grants of SARs are not anticipated at this time. SARs outstanding as of each year end were: none in 1997; 97,944 in 1996; and 139,686 in 1995. Accounting Method - ----------------- NS applies APB Opinion 25 and related interpretations in accounting for awards made under the plan. Accordingly, SARs, PSUs, restricted stock, tax absorption, and dividend equivalents result in charges to net income, while stock options have no effect on net income. Compensation costs were $29 million, $35 million, and $43 million for 1997, 1996, and 1995, respectively. Had compensation costs been determined in accordance with SFAS 123, net income would have been $714 million in 1997, $763 million in 1996, and $704 million in 1995; basic earnings per share would have been $1.90 in 1997, $2.01 in 1996, and $1.79 in 1995; and diluted earnings per share would have been $1.88 in 1997, $1.99 in 1996, and $1.78 in 1995. These pro forma amounts include compensation costs as calculated using the Black-Scholes option-pricing model with an expected option life of 5 years; risk-free interest rates of 6.3% in 1997, 5.2% in 1996, and 7.5% in 1995; stock-price volatility of 0.16 in 1997, 0.18 in 1996, and 0.21 in 1995; and, because dividend equivalents are paid, no dividend yield was assumed. Stock Option Activity - ---------------------
Weighted Average Option Shares Exercise Price -------------- ---------------- Balance 12/31/94 10,494,906 $ 17.65 Granted 2,154,750 20.83 Exercised (1,970,229) 14.61 Surrendered for SAR (40,320) 7.98 Cancelled (11,250) 23.15 ---------- Balance 12/31/95 10,627,857 18.89 Granted 2,058,750 26.02 Exercised (1,648,743) 17.96 Surrendered for SAR (15,000) 7.42 Cancelled (140,577) 19.62 ---------- Balance 12/31/96 10,882,287 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 11,371,168 $ 22.32
Except for those granted during 1997, all outstanding options were exercisable on Dec. 31, 1997. The difference between the weighted average exercise prices for all outstanding options and those exercisable on Dec. 31, 1997, was not significant. PAGE 76 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 14. LONG-TERM INCENTIVE PLAN (continued) Stock Options Outstanding - -------------------------
Exercise Price Number Weighted Average --------------------- Weighted Outstanding Remaining Range Average at 12/31/97 Contractual Life --------------------- -------- ----------- ---------------- $ 11.02 $11.02 381,828 1.1 years 12.56 to 18.81 15.77 2,435,640 3.3 years 20.83 to 24.31 22.17 4,705,950 6.2 years 26.02 to 29.46 27.78 3,847,750 8.6 years ---------- $ 11.02 to $ 29.46 $22.32 11,371,168 6.2 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 529,500 and $29.46 in 1997; 601,200 and $26.02 in 1996; and 757,500 and $20.83 in 1995, respectively. PSUs may be paid in the form of shares of common stock, cash, or a combination. Shares earned and issued may be subject to share retention agreements and held by NS for up to five years. Shares Available And Issued - --------------------------- Shares of stock available for future grants or issued in connection with all features of the Long-Term Incentive Plan are as follows:
1997 1996 1995 ---------- ---------- ---------- Available for future grants 12/31 19,931,103 22,394,187 24,840,933 Shares of common stock issued 1,933,703 2,072,616 2,423,280
PAGE 77 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 15. COMMON STOCK Earnings Per Share - ------------------ The following table sets forth the calculation of basic and diluted earnings per share:
($ in millions except per share, shares in millions) 1997 1996 1995 ------- ------- ------- Basic earnings per share: Income available to common stockholders for basic and diluted computations $ 721 $ 770 $ 713 Weighted-average shares outstanding 377 379 394 ------ ------ ------ Basic earnings per share $ 1.91 $ 2.03 $ 1.81 Diluted earnings per share: Weighted-average shares outstanding per above 377 379 394 Diluted effect of outstanding options, SARs, and PSUs (as determined by the application of the treasury stock method) 3 5 3 Adjusted weighted-average shares outstanding 380 384 397 ------ ------ ------ Diluted earnings per share $ 1.90 $ 2.01 $ 1.80 ====== ====== ======
There are no adjustments to "Net income" or "Income from continuing operations" for the diluted earnings per share computations. 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 common stock 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. The effect of the split was reflected within "Stockholders' equity" by transferring the par value of the additional shares issued from "Additional paid-in capital" to "Common stock." Unless otherwise noted, all share and per share amounts in this report have been restated to reflect the split. Stock Purchase Programs - ----------------------- Since 1987, the Board of Directors has authorized the purchase and retirement of up to 285 million shares (post-split) 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 (post-split) of its Common Stock under these programs at a cost of $3.2 billion. On Oct. 23, 1996, NS announced that the stock purchase program had been suspended. Future purchase decisions are dependent on the economy, cash needs, and alternative investment opportunities. PAGE 78 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 16. FAIR VALUES OF FINANCIAL INSTRUMENTS The fair values of "Cash and cash equivalents," "Short-term investments," "Accounts receivable," "Short-term debt," and "Accounts payable" approximate carrying values because of the short maturity of these financial instruments. The carrying and fair values of long-term investments, excluding those accounted for under the equity method in accordance with APB Opinion No. 18, were $293 million and approximately $366 million on Dec. 31, 1997, and $275 million and approximately $315 million on Dec. 31, 1996, respectively. The fair value of corporate-owned life insurance approximates carrying value. Quoted market prices were used to determine the fair value of marketable securities that are recorded at fair value. Marketable securities reflect $8 million and $3 million of unrealized holding gains on Dec. 31, 1997, and Dec. 31, 1996, respectively. Underlying net assets were used to estimate the fair value of other investments. The fair value of "Long-term debt," including current maturities, approximated $7.89 billion on Dec. 31, 1997, and $1.95 billion on Dec. 31, 1996. The fair values of debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, company rating, and remaining maturity (see Note 9 for carrying values of "Long-term debt"). The fair value of interest rate swaps is immaterial. 17. 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 can be reasonably estimated. 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. As of Dec. 31, 1997, 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 costs based on available information at 111 identified locations. On that date, 11 sites accounted for $25 million of the reserve, and no individual site was considered to be material. NS anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period. At many of the 111 locations, certain NS 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. PAGE 79 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 17. COMMITMENTS AND CONTINGENCIES (continued) 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 in the past, land used as operating property, or which is leased or may have been leased and operated by others, or held for sale. Because environmental problems may exist on these properties that are latent or undisclosed, there can be no assurance that NS will not incur environmentally related liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and other now-unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial condition, results of operations, or liquidity in a particular year or quarter. However, based on its assessments of the facts and circumstances now known, Management believes that it has recorded the probable costs for those environmental matters of which the Corporation is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in the aggregate, will have a material adverse effect on NS' financial position, results of operations, or liquidity. Change-In-Control Arrangements - ------------------------------ Norfolk Southern has compensation agreements with officers and certain key employees, which 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, 1997, certain Norfolk Southern subsidiaries are contingently liable as guarantors with respect to $77 million of indebtedness of related entities. PAGE 80 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 also have 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, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP Norfolk, Virginia January 27, 1998 PAGE 81 Item 9. Changes in and Disagreements with Accountants on Accounting - ------ ----------------------------------------------------------- and Financial Disclosure. ------------------------ None. PART III Item 10. Directors and Executive Officers of the Registrant. - ------- -------------------------------------------------- Item 11. Executive Compensation. - ------- ---------------------- Item 12. Security Ownership of Certain Beneficial Owners - ------- ----------------------------------------------- and Management. -------------- and Item 13. Certain Relationships and Related Transactions. - ------- ---------------------------------------------- In accordance with General Instruction G(3), the information called for by Part III is incorporated herein by reference from Norfolk Southern's definitive Proxy Statement, to be dated April 1, 1998, for the Norfolk Southern Annual Meeting of Stockholders to be held on May 14, 1998, which definitive Proxy Statement will be filed electronically with the Commission pursuant to Regulation 14A. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I hereof beginning on page 22 under "Executive Officers of the Registrant." PAGE 82 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, 1997, 1996 and 1995 54 Consolidated Balance Sheets As of December 31, 1997 and 1996 55 Consolidated Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995 57 Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1997, 1996 and 1995 59 Notes to Consolidated Financial Statements 60 Independent Auditors' Report 80 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 89 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 83 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 27, 1998, and effective May 14, 1998, are filed herewith. 4 Instruments Defining the Rights of Security Holders, Including Indentures - In accordance with Item 601(b)(4)(iii) of Regulation S-K, copies of instruments of Norfolk Southern 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. (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. PAGE 84 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------- Form 8-K. (continued) -------- Exhibit Number Description - ------- -------------------------------------------------- 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 January 23, 1996, is incorporated herein by reference from Exhibit 10(d) to Norfolk Southern's 1995 Annual Report on Form 10-K. (f) The Norfolk Southern Corporation Officers' Deferred Compensation Plan is incorporated herein by reference from Exhibit 10(g) to Norfolk Southern's 1993 Annual Report on Form 10-K. (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, is incorporated herein by reference from Exhibit 99 to Norfolk Southern's Form S-8 filed electronically on January 26, 1994. (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. PAGE 85 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------- Form 8-K. (continued) -------- Exhibit Number Description - ------- -------------------------------------------------- (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 filed herewith. (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. 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 Peat Marwick LLP. (b) Consent of Price Waterhouse LLP. 27 Financial Data Schedule. 99 Conrail Inc. 1997 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, 1997. PAGE 86 Item 14. Exhibits, Financial Statement Schedule, and Reports on - ------- ------------------------------------------------------- Form 8-K. (continued) -------- Exhibit Number Description - ------- -------------------------------------------------- (c) Exhibits. The Exhibits required by Item 601 of Regulation S-K as listed in Item 14(a)3 are filed herewith or incorporated herein by reference. (d) Financial Statement Schedules. Financial statement schedules and separate financial statements specified by this Item are included in Item 14(a)2 or are otherwise not required or are not applicable. PAGE 87 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 24th day of March, 1998. 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 24th day of March, 1998, 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 - ------------------------------ Executive Vice President-Finance (Henry C. Wolf) (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 88 Signature Title --------- ----- /s/ Carroll A. Campbell, Jr. - ------------------------------ Director (Carroll A. Campbell, Jr.) - ------------------------------ Director (Gene R. Carter) /s/ L. E. Coleman - ------------------------------ Director (L. E. Coleman) /s/ T. Marshall Hahn, Jr. - ------------------------------ Director (T. Marshall Hahn, Jr.) /s/ Landon Hilliard - ------------------------------ Director (Landon Hilliard) /s/ E. B. Leisenring, Jr. - ------------------------------ Director (E. B. Leisenring, Jr.) /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 89 Schedule II Page 1 of 2 Norfolk Southern Corporation and Subsidiaries --------------------------------------------- Valuation and Qualifying Accounts Years Ended December 31, 1995, 1996 and 1997 (In millions of dollars)
Additions charged to -------------------- Beginning Other Ending Balance Expenses Accounts Deductions Balance --------- -------- -------- ---------- ------- Year ended December 31, 1995 - ---------------------------- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 1 $ -- $ -- $ -- $ 1 Casualty and other claims included in other liabilities $264 $100 $ 3 $110 $257 Current portion of casualty and other claims included in accounts payable $166 $ 21 $164 $186 $165 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 $129 $248 Current portion of casualty and other claims included in accounts payable $165 $ 16 $154 $169 $166 Includes revenue overcharges provided through charges to operating revenues, and transfers from other accounts. Payments and reclassifications to/from accounts payable. 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 90 Schedule II Page 2 of 2 Norfolk Southern Corporation and Subsidiaries --------------------------------------------- Valuation and Qualifying Accounts Years Ended December 31, 1995, 1996 and 1997 (continued) (In millions of dollars)
Additions charged to -------------------- Beginning Other Ending Balance Expenses Accounts Deductions Balance --------- -------- -------- ---------- ------- Year ended December 31, 1997 - ---------------------------- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 2 $ -- $ -- $ -- $ 2 Casualty and other claims included in other liabilities $248 $108 $ 2 $105 $253 Current portion of casualty and other claims included in accounts payable $166 $ 14 $170 $178 $172 Includes revenue overcharges provided through charges to operating revenues, and transfers from other accounts. Payments and reclassifications to/from accounts payable. 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 91 EXHIBIT INDEX ------------- Electronic Submission Exhibit Page Number Description Number - ---------- ------------------------------------------------ -------- 3(ii) The Bylaws of Norfolk Southern Corporation, as amended January 27, 1998, and effective May 14, 1998. 92-99 10(m) The Norfolk Southern Corporation Outside Directors' Deferred Stock Unit Program, as amended on September 23, 1997. 100-102 12 Statement re: Computation of Ratio of Earnings to Fixed Charges. 103 21 Subsidiaries of Norfolk Southern Corporation. 104-106 23(a) Consent of KPMG Peat Marwick LLP 107 23(b) Consent of Price Waterhouse LLP 108 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). 109 99 Conrail Inc. Annual Report to Stockholders 110-139 Exhibits 3(ii), 10(m), 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 AMENDED 1/27/98 EFFECTIVE 5/14/98 PAGE 92 EXHIBIT 3(ii) TITLE PAGE B Y L A W S OF NORFOLK SOUTHERN CORPORATION AS AMENDED JANUARY 27, 1998 EFFECTIVE MAY 14, 1998 PAGE 93 EXHIBIT 3(ii) Page 1 of 7 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. 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. PAGE 94 EXHIBIT 3(ii) Page 2 of 7 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 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 the directors shall be ten, 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. PAGE 95 EXHIBIT 3(ii) Page 3 of 7 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. 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 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. PAGE 96 EXHIBIT 3(ii) Page 4 of 7 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, 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. PAGE 97 EXHIBIT 3(ii) Page 5 of 7 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. 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 depositaries 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 98 EXHIBIT 3(ii) Page 6 of 7 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 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. PAGE 99 EXHIBIT 3(ii) Page 7 of 7 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 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.M 3 NSC OUTSIDE DIRECTORS DEFERRED STOCK UNIT PROGRAM 09/23/97 PAGE 100 EXHIBIT 10(m), Page 1 of 3 NORFOLK SOUTHERN CORPORATION Outside Directors' Deferred Stock Unit Program I. Effective Date: May 9, 1996 (effective at the Organization Meeting of the Board of Directors), amended to and including September 23, 1997. II. Purpose: To align further each outside director's ownership interest in Norfolk Southern Corporation ("Corporation") with that of stockholders generally. III. Eligibility: Each outside director of the Corporation serving on the Effective Date and any such outside director whose term as director begins after the Effective Date ("Eligible Director"). For purposes of this Program, an "outside director" is a director who is not an officer of the Corporation or any of its subsidiaries. IV. Benefits: (1) Each Eligible Director shall be granted from time to time such deferred stock units (each such stock unit representing at the time of grant the value of one share of Norfolk Southern Corporation Common Stock) ("Stock Units"), as the Board of Directors may authorize. Each Eligible Director's Stock Units will be recorded in an individual memorandum account ("Account") maintained by the Corporate Secretary or designated agent. On each dividend payment date, an amount equivalent to the dividend paid on the Common Stock ("Dividend Equivalent") will be credited for each Stock Unit and each fraction thereof in the Account and converted into additional Stock Units and fractions thereof (rounded to four decimal places) based on the Fair Market Value of the Common Stock on the dividend payment date. For purposes of this Program, "Fair Market Value" on a particular date is the mean of the high and low prices at which the Common Stock 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 the Common Stock was traded. PAGE 101 NORFOLK SOUTHERN CORPORATION EXHIBIT 10(m), Page 2 of 3 Outside Directors' Deferred Stock Unit Program (2) Each outside director of the Corporation serving on June 1, 1996, also shall have credited to the Account the number of Stock Units, including fractions thereof to which such director is entitled under the Norfolk Southern Corporation Directors' Pension Plan. Such Stock Units will be accounted for separately from any Stock Units credited under paragraph (1) above but will be treated the same in all other respects. (3) Each Eligible Director may make an election at any time up to one year prior to leaving the Board of Directors to receive in cash any Stock Units in the Account either in a lump sum or in 10 annual installments upon leaving the Board of Directors for any reason. The most current election on file with the Corporate Secretary shall become irrevocable one year prior to the eligible Director leaving the Board of Directors. Failure to make a valid election will result in the Account being distributed in a lump sum. Separate elections will be made for Stock Units credited under paragraphs (1) and (2) above. A lump-sum payment will be valued based on the Fair Market Value of Common Stock on the last market day of the month following a director's termination of service and will be paid to an Eligible Director or beneficiary as soon as practicable thereafter. The first distribution under an election to receive installment payments will be made in January following the year in which the Eligible Director terminates service; Stock Units at any time remaining in the Account will be credited with Dividend Equivalents until the final installment has been paid. Each annual distribution will be valued based on the Fair Market Value of the Common Stock on the third business day after the date in January that the Corporation first makes publicly available its most recent regular annual financial statements. The first such installment will be an amount equal to one tenth of the total value of the Stock Units in the Account at that time; the second installment, one ninth of the remaining total value; the third installment, one eighth; and so forth, until the Account is depleted with payment of the tenth installment. PAGE 102 NORFOLK SOUTHERN CORPORATION EXHIBIT 10(m), Page 3 of 3 Outside Directors' Deferred Stock Unit Program (4) The Board of Directors may make such adjustments in the number of Stock Units as may be 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: (1) Each Eligible Director may designate in writing the person or persons ("Beneficiary") who shall acquire the rights of the Eligible Director to the Account in the event of the Eligible Director's death before final distribution. In order to be effective, an Eligible Director's designation of a Beneficiary must be on file with the Corporate Secretary before the Eligible Director's death. Any such designation may be revoked and a new designation substituted therefor by the Eligible Director at any time before death. If the named Beneficiary does not survive the Eligible Director, or if there is no named Beneficiary, then the rights with respect to an Eligible Director's Account shall be acquired by the person or persons who shall acquire the Eligible Director's rights to the Account by bequest or inheritance in accordance with the applicable laws of descent and distribution. (2) This Program may be amended or terminated by the Board of Directors of the Corporation at any time; however, no such amendment or termination shall deprive an Eligible Director of any Stock Units previously credited to his or her Account. EX-12 4 1997 10-K405 EX-12 COMPUTATION-RATIO/EARNINGS TO FIXED CHARGES PAGE 103 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 ----------------------------------------------- 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ EARNINGS Income from continuing operations before income taxes as reported $ 998 $1,166 $1,089 $1,028 $ 952 Add: Total interest expenses (as detailed below) 530 182 173 156 158 Amortization of capitalized interest 3 3 2 2 1 Income (loss) of partially owned entities 113 1 -- 1 (3) Subsidiaries' preferred dividend requirement 2 2 3 3 3 ------ ------ ------ ------ ------ Income before income taxes, as adjusted $1,646 $1,354 $1,267 $1,190 $1,111 ====== ====== ====== ====== ====== FIXED CHARGES Interest expense on debt $ 385 $ 116 $ 113 $ 101 $ 98 Other interest expense 32 36 31 30 38 Calculated interest portion of rent expense 30 30 29 25 22 NS' share of Conrail interest 83 -- -- -- -- ------ ------ ------ ------ ------ Total interest expenses 530 182 173 156 158 Capitalized interest 17 12 14 18 22 Subsidiaries' preferred dividend requirement on a pretax basis 4 4 4 4 4 ------ ------ ------ ------ ------ Total fixed charges $ 551 $ 198 $ 191 $ 178 $ 184 ====== ====== ====== ====== ====== RATIO OF EARNINGS TO FIXED CHARGES 2.99 6.84 6.63 6.69 6.04 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 5 1997 10-K405 EX-21 NSC LISTING OF SUBSIDIARIES PAGE 104 EXHIBIT 21 PAGE 1 of 3 NAME AND STATE OF INCORPORATION OF SUBSIDIARIES OF NORFOLK SOUTHERN CORPORATION AS OF MARCH 1, 1998 Agency Media Services, Inc., Indiana Atlantic Acquisition Corporation, Pennsylvania Atlantic Investment Company, Delaware Norfolk Southern Properties, Inc., Virginia Norfolk Southern Railway Company, Virginia North American Van Lines, Inc., Delaware 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 CRR Holdings LLC 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 Norfolk and Western Railway 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 105 EXHIBIT 21 PAGE 2 of 3 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 Crosspoint Disposition LLC Lambert's Point Docks, Incorporated, Virginia NS-Charlotte Tower Corporation, North Carolina Nickel Plate Improvement Company, Inc., The; Indiana NKPI Management, Inc., Indiana Norfolk Southern Industrial Development Corp., Virginia 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 North American Van Lines, Inc. domestic subsidiaries: A Five Star Forwarding, Inc., Delaware A Three Rivers Forwarding, Inc., Indiana Alaska USA Van Lines, Inc., Indiana Americas Quality Van Lines, Inc., Indiana City Storage & Transfer, Inc., Colorado Fleet Insurance Management, Inc., Indiana FrontRunner Worldwide, Inc., Delaware Great Falls North American, Inc., Montana Manufacturing Support Services, L.L.C., Delaware Move Management Services, Inc., Indiana NACAL, Inc., California NALOG, Inc., Delaware NAVTRANS Container Lines, Inc., Florida NAVTRANS International Freight Forwarding, Inc., Indiana NorAm Forwarding, Inc., Indiana North American Distribution Systems, Inc., Indiana North American Forwarding, Inc., Indiana North American Logistics, Ltd., Indiana North American Moving & Storage, Inc., Indiana North American Transport Insurance Company, Indiana North American Van Lines of Texas, Inc., Texas Relocation Management Systems, Inc., Delaware PAGE 106 EXHIBIT 21 PAGE 3 of 3 North American Van Lines, Inc. foreign subsidiaries: Cavalier Moving & Storage Co. Ltd., Canada Cold Lake Moving & Storage Ltd., Alberta Curry Moving & Storage Ltd., Ontario midiData Logistik GmbH, Germany midiData Spedition Systems, Inc., Germany NAVTRANS International Speditions GmbH, Germany North American Van Lines Ltd., United Kingdom North American Van Lines Canada Ltd., Canada North American Van Lines (Alberta) Ltd., Alberta North American Van Lines (Atlantic) Ltd., Nova Scotia Star Storage Ltd., Manitoba Tru-Flite Transportation Systems Inc., Canada Westlake Moving & Storage, Ltd., Ontario Westmount Moving & Storage, Inc. (Demanagement Et Entreposage Westmount), Quebec 153843 Canada Inc., Canada NOTE: Of the above subsidiaries, each of which is more than 50% owned, only Norfolk Southern Railway Company and Norfolk and Western Railway Company meet the Commission's "significant subsidiary" test. EX-23.A 6 1997 10-K405 EX-23 CONSENT OF KPMG PEAT MARWICK LLP PAGE 107 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 Statements Nos. 33-61317, 33-52031, 333-40993, 33-57417. and 33-556 on Form S-8 of Norfolk Southern Corporation of our report dated January 27, 1998, relating to the consolidated balance sheets of Norfolk Southern Corporation and subsidiaries as of December 31, 1997 and 1996, 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, 1997, which report appears in the December 31, 1997 annual report on Form 10-K405 of Norfolk Southern Corporation. /s/ KPMG Peat Marwick LLP Norfolk, Virginia March 24, 1998 EX-23.B 7 1997 10-K405 EX-23 CONSENT OF PRICE WATERHOUSE LLP PAGE 108 EXHIBIT 23(b) PAGE 1 of 1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-61317, 33-52031, 333-40993, 33-57417, and 33-556) of Norfolk Southern Corporation of our report dated January 19, 1998 on the consolidated financial statements of Conrail Inc. and subsidiaries for the year ended December 31, 1997, which appears in the Annual Report on Form 10-K of Norfolk Southern Corporation filed as of March 24, 1998. /s/ Price Waterhouse LLP PRICE WATERHOUSE LLP Philadelphia, PA March 24, 1998 EX-27 8 YEAR END 1997 EX-27 NSC FINANCIAL DATA SCHEDULE
5 1,000,000 YEAR YEAR YEAR DEC-31-1997 DEC-31-1996 DEC-31-1995 DEC-31-1997 DEC-31-1996 DEC-31-1995 34 207 65 125 194 262 555 562 552 3 4 3 58 61 60 1,103 1,356 1,243 14,339 13,746 13,396 4,435 4,274 4,198 17,350 11,234 10,718 1,093 1,060 1,069 7,398 1,800 1,553 0 0 0 0 0 0 399 132 136 5,046 4,845 4,693 17,350 11,234 10,718 0 0 0 4,223 4,101 4,012 0 0 0 3,010 2,936 2,950 (170) (117) (140) 0 0 0 385 116 113 998 1,166 1,089 299 413 391 699 753 698 22 17 15 0 0 0 0 0 0 721 770 713 1.91 2.03 1.81 1.90 2.01 1.80 Financial data schedules for 1996 and 1995 are restated to reflect discontinued operations and the effect of adoption of Statement of Financial Accounting Standards No. 128, "Earnings per Share."
EX-99 9 1997 CONRAIL INC. ANNUAL REPORT PAGE 110 EXHIBIT 99, Page 1 of 30 COVER PAGE FOR CONRAIL INC. 1997 ANNUAL REPORT TO STOCKHOLDERS PAGE 111 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 Board of Directors pursues its oversight responsibilities for the financial statements and corporate conduct through its Audit and Ethics Committees. Each Committee consists of Directors who are not employees of the Company. The Audit Committee recommends the appointment of the independent accountants, and meets several times a year with management, the internal auditors and the independent accountants. The independent accountants and internal auditors have unrestricted access to the Audit Committee to discuss audit scope, the results of their audits, the adequacy of internal accounting controls and financial reporting. The Ethics Committee meets several times a year with management to review matters of public interest, including safety, equal employment and compliance with environmental regulations. /s/ David M. LeVan - ----------------------- David M. LeVan Chairman, President and Chief Executive Officer /s/ John A. McKelvey - ----------------------- John A. McKelvey Senior Vice President- Finance January 19, 1998 PAGE 112 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, 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/ Price Waterhouse LLP Price Waterhouse LLP Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 January 19, 1998 PAGE 113 EXHIBIT 99, Page 4 of 30 CONRAIL INC. CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, --------------------------- ($ In Millions Except Per Share Data) 1997 1996 1995 ------ ------ ------ Revenues $3,765 $3,714 $3,686 ------ ------ ------ Operating expenses Way and structures 458 462 485 Equipment 776 803 766 Transportation 1,388 1,385 1,324 General and administrative 313 312 370 ESOP termination charge (Note 3) 221 Merger-related compensation costs (Note 3) 222 Merger costs (Note 3) 65 16 Voluntary separation programs (Note 10) 135 Asset disposition charge (Note 11) 285 ------ ------ ------ Total operating expenses 3,443 3,113 3,230 ------ ------ ------ Income from operations 322 601 456 Interest expense (170) (182) (194) Other income, net (Note 12) 83 112 130 ------ ------ ------ Income before income taxes 235 531 392 Income taxes (Note 7) 228 189 128 ------ ------ ------ Net income $ 7 $ 342 $ 264 ====== ====== ====== Net income per common share (Note 1) Basic $ - $ 4.29 $ 3.21 Diluted - 3.91 2.94 Ratio of earnings to fixed charges (Note 1) 1.98x 3.19x 2.51x
See accompanying notes. PAGE 114 EXHIBIT 99, Page 5 of 30 CONRAIL INC. CONSOLIDATED BALANCE SHEETS
December 31, ---------------- ($ In Millions) 1997 1996 ------ ------ ASSETS Current assets Cash and cash equivalents $ 97 $ 30 Accounts receivable 623 630 Deferred tax assets (Note 7) 115 293 Material and supplies 104 139 Other current assets 15 25 ------ ------ Total current assets 954 1,117 Property and equipment, net (Note 4) 6,830 6,590 Other assets 700 695 ------ ------ Total assets $8,484 $8,402 ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Short-term borrowings - 99 Current maturities of long-term debt (Note 6) 112 130 Accounts payable 113 135 Wages and employee benefits 366 143 Casualty reserves 141 141 Accrued and other current liabilities (Note 5) 476 444 ------ ------ Total current liabilities 1,208 1,092 Long-term debt (Note 6) 1,732 1,876 Casualty reserves 198 190 Deferred income taxes (Note 7) 1,453 1,478 Special income tax obligation (Note 7) 283 346 Other liabilities 445 313 ------ ------ Total liabilities 5,319 5,295 ------ ------ Commitments and contingencies (Note 13) Stockholders' equity (Notes 2, 3 and 9) Preferred stock (no par value; 15,000,000 shares authorized; no shares issued) Series A ESOP convertible junior preferred stock (no par value; 10,000,000 shares authorized; 0 and 7,303,920 shares issued and outstanding, respectively) - 211 Unearned ESOP compensation (155) (222) Common stock ($1 par value; 250,000,000 shares authorized; 6,320,349 and 87,768,428 shares issued, respectively; 100 and 82,244,973 shares outstanding, respectively) 6 88 Additional paid-in capital 3,006 2,404 Employee benefits trust (0 and 3,394,988 shares, respectively) (274) (384) Retained earnings 1,324 1,357 ------ ------ 3,907 3,454 Treasury stock, at cost (742) (347) ------ ------ Total stockholders' equity 3,165 3,107 ------ ------ Total liabilities and stockholders' equity $8,484 $8,402 ====== ======
See accompanying notes. PAGE 115 EXHIBIT 99, Page 6 of 30 CONRAIL INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Series A Unearned Additional Employee Preferred ESOP Common Paid-in Benefits Retained Treasury ($ In Millions Except Per Share Data) Stock Compensation Stock Capital Trust Earnings Stock --------- ------------ ------ ---------- -------- -------- -------- Balance, January 1, 1995 $ 283 $(243) $80 $1,848 $1,056 $ (99) Amortization 10 Net income 264 Common dividends, $1.60 per share (129) Preferred dividends, $2.165 per share (21) Common shares acquired (92) Exercise of stock options 6 Establishment of employee benefits trust 5 245 $(250) Employee benefits trust transactions, net 84 (79) Other (1) 4 6 ----- ----- --- ------ ----- ------ ----- Balance, December 31, 1995 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 $(742) ===== ===== === ====== ===== ====== =====
See accompanying notes. PAGE 116 EXHIBIT 99, Page 7 of 30 CONRAIL INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, ------------------------ ($ In Millions) 1997 1996 1995
----- ----- ----- Cash flows from operating activities Net income $ 7 $ 342 $ 264 Adjustments to reconcile net income to net cash provided by operating activities: ESOP termination charge 221 Merger-related compensation costs 159 Voluntary separation programs 135 Asset disposition charge 285 Depreciation and amortization 293 283 293 Deferred income taxes 152 183 108 Special income tax obligation (63) (94) (73) Gains from sales of property (23) (24) (27) Pension credit (61) (46) (43) Changes in: Accounts receivable 7 (16) 32 Accounts and wages payable 42 (18) 8 Deferred tax assets 178 40 (84) Settlement of tax audit 6 (39) Other (34) (77) 10 ----- ----- ----- Net cash provided by operating activities 884 669 773 ----- ----- ----- Cash flows from investing activities Property and equipment acquisitions (439) (387) (415) Proceeds from disposals of properties 25 34 38 Other (31) (46) (59) ----- ----- ----- Net cash used in investing activities (445) (399) (436) ----- ----- ----- Cash flows from financing activities Repurchase of common stock (156) (92) Net proceeds from (repayments of) short-term borrowings (99) 10 (23) Proceeds from long-term debt 26 85 Payment of long-term debt (238) (184) (134) Loans from and redemptions of insurance policies 95 Dividends on common stock (40) (146) (129) Dividends on Series A preferred stock (3) (25) (21) Proceeds from stock options and other 8 67 7 ----- ----- ----- Net cash used in financing activities (372) (313) (307) ----- ----- ----- Increase(decrease) in cash and cash equivalents 67 (43) 30 Cash and cash equivalents Beginning of year 30 73 43 ----- ----- ----- End of year $ 97 $ 30 $ 73 ===== ===== =====
See accompanying notes. PAGE 117 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"), however, the transaction is pending the approval of the Surface Transportation Board ("STB") (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 118 EXHIBIT 99, Page 9 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 1997 as a result of the acquisition of the Company's common stock 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 and deregistered with the Securities and Exchange Commission. 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 are not materially different than those previously presented by the Company for 1996 and 1995. For 1996 and 1995, basic earnings per share are 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 assume conversion of 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 have been 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 are not considered outstanding for computing earnings per share. The weighted average number of shares of common stock outstanding during each of the two years ended December 31, 1996 are as follows: 1996 1995 ---------- ---------- Basic weighted average shares 76,903,665 78,144,694 Diluted weighted average shares 87,022,413 88,533,558 PAGE 119 EXHIBIT 99, Page 10 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Company has determined that adoption of these statements will not impact its consolidated financial position, results of operations or cash flows. Both pronouncements are effective for fiscal years beginning after December 15, 1997. 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. Reclassification of Prior-Year Data ----------------------------------- Certain amounts have been reclassified in the consolidated financial statements to conform to the current year presentation. 2. Acquisition of Conrail Inc. -------------------------- On April 8, 1997, Conrail and CSX entered into the Fourth Amendment (the "Fourth Amendment") to the Agreement and Plan of Merger (as amended through the Fourth Amendment, the "Merger Agreement") which facilitated CSX and NSC entering into an agreement with respect to their joint acquisition of Conrail as contemplated by the Third Amendment to the Merger Agreement, dated as of March 7, 1997. The terms of the CSX-NSC Agreement are embodied in a letter agreement dated as of April 8, 1997 (the "CSX/NSC Letter Agreement") and the Transaction Agreement dated as of June 10, 1997 among Conrail, CSX and NSC. PAGE 120 EXHIBIT 99, Page 11 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The CSX/NSC Letter Agreement provided, among other things, (i) for the termination of the NSC's outstanding offer to purchase Conrail shares and the dismissal of litigation between CSX and NSC, (ii) that Conrail would, after the effective time of its merger into a wholly-owned subsidiary of CSX, become a direct or indirect jointly-owned subsidiary of CSX and NSC, (iii) that CSX and NSC would jointly acquire, for $115 in cash, all Conrail shares not already owned by CSX and NSC through a tender offer that closed on May 23, 1997 and subsequent merger, and (iv) that Conrail would continue to be managed by its existing Board of Directors until the requisite approval of the STB is obtained, at which time CSX and NSC will be separately allocated certain of Conrail's railroad assets and will jointly operate certain other railroad activities of Conrail. The Fourth Amendment also provided that, following April 8, 1997, Conrail's Board of Directors would not declare, and Conrail would not pay, any dividend on Conrail's capital stock with a record date on or prior to May 30, 1997. On May 23, 1997, the CSX-NSC joint tender offer for the remaining outstanding shares of Conrail's common and ESOP Stock was concluded, with 53.4 million shares having been tendered. On June 2, 1997, Conrail became the surviving corporation in a merger with Green Acquisition Corp., a jointly-owned, indirect subsidiary of CSX and NSC, as a result of which the remaining outstanding capital stock of Conrail was acquired by NSC and CSX. Simultaneous with the merger, Conrail's common stock was delisted from the New York Stock Exchange and, through the filing of a Form 15, deregistered with the Securities and Exchange Commission. The Conrail stock acquired by NSC and CSX is being held in a voting trust pending approval of the joint acquisition by the STB, which is expected to occur in the third quarter of 1998. In the course of normal business, the Company 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. PAGE 121 EXHIBIT 99, Page 12 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. Merger-Related Costs -------------------- In connection with its joint acquisition by NSC and CSX, the Company has incurred pre-tax merger-related costs totaling $65 million ($41 million after income taxes) during 1997. Merger costs of $16 million ($10 million after income taxes) were incurred during 1996 related to the previously proposed merger of Conrail with CSX. Merger costs incurred during both years are composed primarily of fees for investment banking, legal and consulting services. In the second quarter of 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 had 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 is being reduced as the cash proceeds, which the ESOP currently holds as a result of selling its ESOP Stock in the joint tender offer, are allocated to eligible ESOP participants. During the second quarter of 1997, the Company recorded a charge of $110 million ($103 million after income taxes) in connection with employment agreements with certain executives, which became operative upon a change in control as defined in such agreements. The agreement with CSX permits Conrail to enter into new agreements with executives to pay some or all of these benefits upon the earlier of the STB's approval or disapproval of the transaction or May 31, 1998, if the executives are employed on that date. Severance benefits to be paid to other Company employees will be determined and accrued when the employees adversely affected by the transaction are identified, which is expected to occur near the time of the STB decision. During 1997, the Company recorded cumulative charges totaling $49 million ($31 million after income taxes) representing a portion of an amount to be paid to certain non-union employees as an incentive to continue their employment with the Company through the effective date of the requisite STB approval of the transaction and subsequent transition period. The total amount of these incentive payments is expected to be approximately $125 million and will continue to be accrued ratably through the fourth quarter of 1998. The Company has recorded a short-term liability of $159 million included in "wages and employee benefits" on the 1997 balance sheet related to the above- mentioned merger-related compensation costs through December 31, 1997, however, such liability is not expected to require future use of the Company's cash for settlement as funding is expected from other sources, including the Employee Benefits Trust. PAGE 122 EXHIBIT 99, Page 13 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Also, as a result of the acquisition of Conrail, all outstanding performance shares and all outstanding unvested stock options, restricted shares and phantom shares vested during the second quarter of 1997. The Company paid all of the amounts due employees under these arrangements and recorded a $63 million charge ($39 million after income taxes). 4. Property and Equipment ---------------------- December 31, ----------------- 1997 1996 ------- ------- (In Millions) Roadway $ 7,167 $ 7,021 Equipment 1,398 1,231 Less: Accumulated depreciation (1,736) (1,654) Allowance for disposition (392) (408) ------- ------- 6,437 6,190 ------- ------- Capital leases (primarily equipment) 869 908 Accumulated amortization (476) (508) ------- ------- 393 400 ------- ------- $ 6,830 $ 6,590 ======= ======= Conrail acquired equipment and incurred related long-term debt under various capital leases of $79 million in 1997, $82 million in 1996 and $71 million in 1995. In 1995 (Note 11) and 1991, the Company recorded allowances for disposition for the sale or abandonment of certain under-utilized rail lines and other facilities. 5. Accrued and Other Current Liabilities ------------------------------------- December 31, ----------------- 1997 1996 ---- ---- (In Millions) Freight settlements due others $ 43 $ 48 Equipment rents (primarily car hire) 74 74 Unearned freight revenue 77 79 Property and corporate taxes 55 49 Other 227 194 ---- ---- $476 $444 ==== ==== PAGE 123 EXHIBIT 99, Page 14 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. Long-Term Debt -------------- Long-term debt outstanding, including the weighted average interest rates at December 31, 1997, is composed of the following: December 31, ------------------ 1997 1996 ------ ------ (In Millions) Capital leases $ 465 $ 491 Medium-term notes payable, 7.50%, due 1998 to 1999 60 109 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, 6.66% 275 262 Commercial paper - 100 ------ ------ 1,844 2,006 Less current portion (112) (130) ------ ------ $1,732 $1,876 ====== ====== 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 $1,607 million and $1,685 million at December 31, 1997 and 1996, respectively, compared with carrying values of $1,379 million and $1,515 million at December 31, 1997 and 1996, respectively. 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 $393 million at December 31, 1997. PAGE 124 EXHIBIT 99, Page 15 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Minimum commitments, exclusive of executory costs borne by the Company, are: Capital Operating Leases Leases ------- --------- (In Millions) 1998 $ 107 $119 1999 99 94 2000 76 83 2001 60 74 2002 57 68 2003 - 2017 239 476 ----- ---- Total 638 $914 ==== Less interest portion (173) ----- Present value $ 465 ===== Operating lease rent expense was $122 million in 1997, $127 million in 1996 and $130 million in 1995. In June 1993, the Company and CRC filed a shelf registration statement on Form S-3 to enable 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. The remaining balance under this shelf registration was $312 million at December 31, 1997, although restrictions arising from the Company's acquisition may prevent its use. In January 1997, CRC assumed $31 million of Equipment Trust Certificates, at an interest rate of 8.31%, due 2012, to finance the lease buyout of 20 locomotives from Locomotive Management Services, a general partnership of which the Company holds a fifty percent interest. Equipment and other obligations mature in 1998 through 2043 and are collateralized by assets with a net book value of $266 million at December 31, 1997. Maturities of long-term debt other than capital leases are $48 million in 1998, $48 million in 1999, $268 million in 2000, $19 million in 2001, $18 million in 2002 and $978 million in total from 2003 through 2043. During 1997, CRC repaid all of its commercial paper, and no commercial paper remains outstanding at December 31, 1997. PAGE 125 EXHIBIT 99, Page 16 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) CRC maintains a $440 million uncollateralized bank credit agree- ment with a group of banks which is used for general corporate purposes and to support CRC's commercial paper program. The agreement matures in 2000 and requires interest to be paid on amounts borrowed at rates based on various defined short-term rates and an annual maximum fee of .110% of the facility amounts. The agreement contains, among other conditions, restrictive covenants relating to a debt ratio and consolidated tangible net worth. During 1997, CRC had no borrowings under this agreement. Interest payments were $163 million in 1997, $170 million in 1996 and $177 million in 1995. 7. Income Taxes ------------ The provisions for income taxes are composed of the following: 1997 1996 1995 ---- ---- ----- (In Millions) Current Federal $122 $ 90 $ 78 State 17 10 15 ---- ---- ---- 139 100 93 ---- ---- ---- Deferred Federal 115 151 110 State 37 32 (2) ---- ---- ---- 152 183 108 ---- ---- ---- Special income tax obligation Federal (54) (80) (61) State (9) (14) (12) ---- ---- ---- (63) (94) (73) ---- ---- ---- $228 $189 $128 ==== ==== ==== 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 an estimated effective federal and state income tax rate of 37.0%. PAGE 126 EXHIBIT 99, Page 17 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The nondeductibility of the ESOP termination charge and certain merger-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"). As a result of a decrease in a state income tax rate enacted during 1995, income tax expense for that year was reduced by $21 million representing the effects of adjusting deferred income taxes and the special income tax obligation for the rate decrease as required by SFAS 109. Reconciliations of the U.S. statutory tax rates with the effective tax rates are as follows: 1997 1996 1995 ---- ---- ---- Statutory tax rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 3.2 3.4 3.5 ESOP termination charge 36.3 Nondeductible merger-related compensation costs 14.9 Effect of state tax increase (decrease) on deferred taxes 9.3 (5.3) Other (1.7) (2.8) (.5) ---- ---- ---- Effective tax rate 97.0% 35.6% 32.7% ==== ==== ==== 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 $120 million in 1997, $145 million in 1996 (excluding tax settlement) and $109 million in 1995. PAGE 127 EXHIBIT 99, Page 18 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Significant components of the Company's special income tax obligation and deferred income tax liabilities (assets) are as follows: December 31, ----------------- 1997 1996 ------ ------ (In Millions) Current assets $ (10) $ (9) Current liabilities (97) (245) Miscellaneous (8) (39) ------ ------ Current deferred tax asset, net $ (115) $ (293) ====== ====== Noncurrent liabilities: Property and equipment 1,877 1,939 Other long-term assets (primarily prepaid pension asset) 90 92 Miscellaneous 130 98 ------ ------ 2,097 2,129 ------ ------ Noncurrent assets: Nondeductible reserves and other liabilities (200) (174) Tax benefit transfer receivable (36) (36) Miscellaneous (125) (95) ------ ------ (361) (305) ------ ------ Special income tax obligation and deferred income tax liabilities, net $1,736 $1,824 ====== ====== PAGE 128 EXHIBIT 99, Page 19 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. Employee Benefits ----------------- Pension Plans ------------- The Company and certain subsidiaries maintain defined benefit pension plans which are noncontributory for all non-union employees and generally contributory for participating union employees. Benefits are based primarily on credited years of service and the level of compensation near retirement. Funding is based on the minimum amount required by the Employee Retirement Income Security Act of 1974. Pension credits include the following components: 1997 1996 1995 ----- ---- ---- (In Millions) Service cost - benefits earned during the period $ 8 $ 9 $ 8 Interest cost on projected benefit obligation 50 51 51 Return on plan assets - actual (197) (138) (254) - deferred 99 47 167 Net amortization and deferral (21) (15) (15) ----- ---- ---- $ (61) $(46) $(43) ===== ==== ==== The funded status of the pension plans and the amounts reflected in the balance sheets are as follows: 1997 1996 ------ ----- (In Millions) Accumulated benefit obligation ($605 million and $655 million vested, respectively) $ 610 $ 661 ====== ====== Market value of plan assets 1,308 1,187 Projected benefit obligation (699) (734) ------ ------ Plan assets in excess of projected benefit obligation 609 453 Unrecognized prior service cost 33 36 Unrecognized transition net asset (72) (90) Unrecognized net gain (343) (231) ------ ------ Net prepaid pension cost $ 227 $ 168 ====== ====== PAGE 129 EXHIBIT 99, Page 20 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The assumed weighted average discount rates used in 1997 and 1996 are 7.0% and 7.5%, respectively, and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation as of December 31, 1997 and 1996 is 6.0%. The expected long-term rate of return on plan assets (primarily equity securities) in 1997 and 1996 is 9.0%. 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 new contract provisions. Savings plan expense was $1 million in 1997 and $4 million in 1996 and 1995. 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, $40 million in 1996 and $31 million in 1995. 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 and 1995. Compensation expense related to the Non-union ESOP was $2 million in 1997, $11 million in 1996 and $10 million in 1995. PAGE 130 EXHIBIT 99, Page 21 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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, $20 million in 1996 and $21 million in 1995. Preferred dividend payments of $3 million, $25 million and $21 million were made in 1997, 1996 and 1995, respectively. Postretirement Benefits Other Than Pensions ------------------------------------------- The Company provides health and life insurance benefits to certain retired non-union employees. Certain non-union employees are eligible for retiree medical benefits, while substantially all non-union employees are eligible for retiree life insurance benefits. Generally, company-provided health care benefits terminate when individuals reach age 65. Retiree life insurance plan assets consist of a retiree life in- surance reserve held in the Company's group life insurance policy. There are no plan assets for the retiree health benefits plan. The following sets forth the plans' funded status reconciled with amounts reported in the Company's balance sheets: 1997 1996 ----------------- ----------------- Life Life Medical Insurance Medical Insurance Plan Plan Plan Plan (In Millions) Accumulated postretirement benefit obligation: Retirees $28 $20 $44 $20 Fully eligible active plan participants 1 1 Other active plan participants 5 3 --- --- --- --- Accumulated benefit obligation 29 25 45 23 Market value of plan assets (10) (10) --- --- --- --- Accumulated benefit obligation in excess of plan assets 29 15 45 13 Unrecognized gains and (losses) 9 1 (1) 2 --- --- --- --- Accrued benefit cost recognized in the Consolidated Balance Sheet $38 $16 $44 $15 === === === === Net periodic postretirement benefit cost, primarily interest cost $ 1 $ 1 $ 3 $ 1 === === === === PAGE 131 EXHIBIT 99, Page 22 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) An 8% percent rate of increase in per capita costs of covered health care benefits was assumed for 1998, gradually decreasing to 6% percent by the year 2007. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $2 million and would have an immaterial effect on the net periodic postretirement benefit cost for 1997. Discount rates of 7.0% and 7.5% were used to determine the accumulated postretirement benefit obligations for both the medical and life insurance plans in 1997 and 1996, respectively. The assumed rate of compensation increase was 6% in both 1997 1996. Retiree medical benefits are funded by a combination of Company and retiree contributions. Retiree life insurance benefits are provided by insurance companies whose premiums are based on claims paid during the year. 9. Capital Stock ------------- Preferred Stock --------------- The Company is authorized to issue 25 million shares of preferred stock with no par value. The Board of Directors has the authority to divide the preferred stock into series and to determine the rights and preferences of each. All of the Company's shares of ESOP Stock were converted to common shares when tendered as part of the joint acquisition of the Company's common stock (Notes 2 and 3). 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 proceeds it received from the sale of a portion of the common stock it held. The Trust is expected 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 severance benefits, 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. 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. PAGE 132 EXHIBIT 99, Page 23 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 activity and status of treasury stock follow: 1997 1996 1995 ---------- --------- --------- Shares, beginning of year 5,523,455 3,297,717 1,789,164 Acquired 2,225,738 1,508,553 Effects of Conrail acquisition 796,794 ---------- --------- ---------- Shares, end of year 6,320,249 5,523,455 3,297,717 ========== ========= ========== 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 the second quarter of 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. 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 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. PAGE 133 EXHIBIT 99, Page 24 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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, 1995 $14.000 - $ 66.938 1,363,955 Granted $50.688 - $ 68.563 516,757 Exercised $14.000 - $ 53.875 (200,940) Canceled $42.625 - $ 53.875 (123,560) ------------ Balance, December 31, 1995 $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, 1996 3,969,317 ============ December 31, 1997 - ============ The weighted average exercise prices of options granted during 1996 and 1995 were $70.130 per share and $51.204 per share, respectively. The weighted average exercise prices of options exercised during 1996 and 1995 were $48.32 per share and $31.16 per share, respectively. Pro forma disclosures of net income and earnings per share as if the Company had adopted the cost recognition requirements under SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123) in 1996 and 1995 are presented below ($ in millions except per share data): 1996 1995 ----- ----- Net income as reported $ 342 $ 264 Net income pro forma 335 262 Basic earnings per share $4.29 $3.21 Basic earnings per share pro forma 4.20 3.19 Diluted earnings per share $3.91 $2.94 Diluted earnings per share pro forma 3.82 2.92 PAGE 134 EXHIBIT 99, Page 25 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 and 1995 was $16.00 per share and $13.12 per share, respectively. 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 and $3 million in 1995. The weighted-average fair value for the phantom shares and restricted stock granted during 1996 and 1995 was $68.02 per share and $52.88 per share, respectively. As a result of its acquisition, the Company paid all of the amounts due to employees under stock-related compensation arrangements during the second quarter of 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 135 EXHIBIT 99, Page 26 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. Asset Disposition Charge ------------------------ Included in 1995 operating expenses is an asset disposition charge of $285 million, which reduced net income by $176 million. The asset disposition charge resulted from a review of the Company's route system and other operating assets to determine those that no longer effectively and economically supported current and expected operations. The Company identified and planned to sell 1,800 miles of rail lines that were expected to provide proceeds substantially less than net book value. In addition, other assets, principally yards and side tracks, identified for disposition were written down to estimated net realizable value (See Note 1 "Asset Impairment"). Currently, the asset disposition program is under review as a result of the Conrail acquisition (Note 2). 12. Other Income, Net ----------------- 1997 1996 1995 ---- ---- ---- (In Millions) Interest income $13 $ 29 $ 33 Rental income 41 50 57 Property sales 23 23 27 Other, net 6 10 13 --- ---- ---- $83 $112 $130 === ==== ==== 13. 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 govern- mental agencies with respect to other potential environmental issues. At December 31, 1997, 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 135 locations. However, based on currently available information, the Company believes CRC may have some potential responsibility at only 60 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. PAGE 136 EXHIBIT 99, Page 27 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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, 1997, the Company had accrued $48 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. The Company spent $9 million in 1997, $11 million in 1996 and $14 million in 1995 for environmental remediation and related costs and anticipates spending an amount comparable to that spent in 1997 during 1998. In addition, the Company's capital expenditures for environmental control and abatement projects were approximately $7 million in 1997 and $6 million in 1996 and 1995, and are anticipated to be approximately $11 million in 1998. 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. The Company may be contingently liable for approximately $50 million at December 31, 1997 under indemnification provisions related to sales of tax benefits. CRC had an average of 19,802 employees in 1997, approximately 86% 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, 1997. CRC currently guarantees the principal and interest payments in the amount of $48 million on Equipment Trust Certificates for Locomotive Management Services, a general partnership of which CRC holds a fifty percent interest. PAGE 137 EXHIBIT 99, Page 28 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) CRC has received an adverse jury verdict related to a railroad crossing accident in Ohio that includes a significant punitive damage award that approximates $15 million. CRC believes the punitive damage award in this case is improper and that it has meritorious defenses, which it is pursuing on appeal. The Company, currently, has not taken actions to resolve anticipated year 2000 issues related to its computer systems since it believes that such issues will be resolved in connection with the proposed integration of its systems with those of CSX and NSC following the requisite STB approval of the Conrail acquisition. In the event that the STB does not approve the sale of Conrail, the Company is developing a contingency plan to enable it to continue to operate into the year 2000 and beyond. While it is not possible, at this time, to quantify the overall cost of implementing this contingency plan, the Company believes that it would be material to its results of operations during the implementation period. In addition, were the STB to disapprove the sale of Conrail, the Company believes that failure to develop and implement such a plan could result in a material financial risk and serious disruption in its operations. 14. Condensed Quarterly Data (Unaudited) -----------------------------------
First Second Third Fourth -------------- -------------- --------------- --------------- 1997 1996 1997 1996 1997 1996 1997 1996 ------ ------ ------ ------ ------ ------ ------ ------ ($ In Millions Except Per Share) Revenues $906 $889 $ 937 $949 $944 $933 $978 $943 Income (loss) from operations 116 69 (231) 54 218 235 219 243 Net income (loss) 61 31 (273) 26 101 138 118 147 Net income (loss) per common share: Basic .74 .36 - .30 - 1.76 - 1.87 Diluted .70 .35 - .29 - 1.58 - 1.70 Ratio of earnings to fixed charges 2.52x 1.75x - 1.57x 4.82x 4.77x 4.76x 4.91x Dividends per common share .475 .425 - .425 - .475 - .475 Market prices per common share (New York Stock Exchange) High 113 1/4 77 1/4 - 73 1/4 - 74 5/8 - 100 7/8 Low 98 1/2 67 5/8 - 66 1/4 - 63 3/4 - 68 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. PAGE 138 EXHIBIT 99, Page 29 of 30 CONRAIL INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company recorded pre-tax 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 merger-related costs (Note 3). After the 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). During the second quarter of 1996, the Company recorded a one- time charge of $135 million for the non-union employee voluntary early retirement and separation programs and related costs, which reduced net income by $83 million (Note 10). During the fourth quarter of 1996, the Company recorded merger-related costs of $16 million ($10 million after income taxes) (Note 3). PAGE 139 EXHIBIT 99, Page 30 of 30 Schedule II CONRAIL INC. VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, (In Millions)
Additions ---------------------- Balance at Charged to Charged Balance Beginning Costs and to Other At End Description of Period Expenses Accounts Deductions of Period - ----------- ------------ ---------- --------- ------------ ----------- (1) 1995 Casualty reserves Current............... $103 $ 3 $ (4) (2) $110 Noncurrent............ 212 $171 14 180 (3) 217 Allowance for disposition of property and equipment (4)(5)........ 241 261 63 439 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 disposition of property and equipment (4)............ 408 16 392
(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 $63 million, $31 million and $16 million in 1995, 1996 and 1997, respectively, represent net losses on asset dispositions. (5) In 1995, the Company recorded an asset disposition charge, which resulted from a review of the Company's route system and other operating assets to determine those that no longer effectively and economically support current and expected operations. The Company identified and planned to sell 1,800 miles of rail lines that were expected to provide proceeds substantially less than net book value. In addition, other assets, principally yards and side tracks, identified for disposition have been written down to estimated net realizable value.(See Note 11 to the Consolidated Financial Statements.) -----END PRIVACY-ENHANCED MESSAGE-----