Item 1. Business. ------ --------
and
Item 2.
Item 2. Properties. ------ ----------
GENERAL - Norfolk Southern Railway Company (Norfolk Southern Railway) was incorporated in 1894 under the name Southern Railway Company (Southern) in the Commonwealth of Virginia and, together with its consolidated subsidiaries (collectively, NS Rail), is primarily engaged in the transportation of freight by rail.
On June 1, l982, Southern and Norfolk and Western Railway Company (NW) became subsidiaries of Norfolk Southern Corporation (NS), a transportation holding company. Effective December 31, 1990, NS transferred all the common stock of NW to Southern, and Southern's name was changed to Norfolk Southern Railway Company. Accordingly, all the common stock of NW, which is its only voting security, is owned by Norfolk Southern Railway, and all the common stock of Norfolk Southern Railway (16,668,997 shares) is owned directly by NS. NS common stock is publicly held and listed on the New York Stock Exchange.
There remain issued and outstanding as of February 28, 1995, 1,197,027 shares of Norfolk Southern Railway's $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of which 1,096,907 shares (including 74 shares not entitled to vote) were held by other than subsidiaries. The Series A Stock is entitled to one vote per share, is nonconvertible, and is traded on the New York Stock Exchange.
STOCK PURCHASE PROGRAM - On June 2, 1989, NS announced that it intended to purchase up to 250,000 shares of Norfolk Southern Railway's Series A Stock during the subsequent two-year period. In May 1991, NS extended the previously announced stock purchase program through 1993. In March 1994, NS announced that it would continue purchasing up to 250,000 shares of the Series A Stock through 1996. As of February 28, 1995, NS had purchased 104,727 shares of preferred stock at a total cost of approximately $3.71 million. Consequently, as of February 28, 1995, NS held 94.4 percent of the voting stock of Norfolk Southern Railway.
OPERATIONS - As of December 3l, l994, NS Rail operated 14,652 miles of road in the states of Alabama, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Virginia and West Virginia, and the Province of Ontario, Canada. Of this total, 12,780 miles are owned, 677 miles are leased and 1,195 miles are operated under trackage rights; also, of this total, 11,991 miles are main line and 2,661 miles are branch line. In addition, NS Rail operates approximately 10,907 miles of passing, industrial, yard and side tracks.
NS Rail has major leased lines in North Carolina and between Cincinnati, Oh., and Chattanooga, Tn. The North Carolina leases, covering approximately 300 miles, expired by their terms at the end of 1994. However, NS Rail expects these leases to be renewed or extended and has reached tentative understandings for such renewal or extension. The tentative arrangements call for payment of an annual rental of $8 million in 1995, with inflation adjustments in succeeding years. Pending the approval of a form of lease extension agreement by the parties, NS Rail continues to operate over these lines under the terms of the expired leases. If these leases ultimately are not renewed or extended, NS Rail could be required to continue using the lines subject to conditions prescribed by the Interstate Commerce Commission (ICC) or might find it necessary to operate over an alternate route or routes. It is not expected that the resolution of this matter (whether resulting in renewal or extension of the leases, continued use of the leased lines under prescribed conditions or operation over one or more alternate routes) will have a material effect on NS Rail's consolidated financial position.
The Cincinnati-Chattanooga lease, covering about 335 miles, expires in 2026, subject to an option to extend the lease for an additional 25 years at terms to be agreed upon.
NS Rail's lines carry raw materials, intermediate products and finished goods primarily in the Southeast and Midwest and to and from the rest of the United States and parts of Canada. These lines also transport overseas freight through several Atlantic and Gulf Coast ports. Atlantic ports served by NS Rail include: Norfolk, Va.; Morehead City, N.C.; Charleston, S.C.; Savannah and Brunswick, Ga.; and Jacksonville, Fl. Gulf Coast ports served include: Mobile, Al., and New Orleans, La.
NS Rail's lines reach most of the larger industrial and trading centers of the Southeast and Midwest, with the exception of those in central and southern Florida. Atlanta, Birmingham, New Orleans, Memphis, St. Louis, Kansas City (Missouri), Chicago, Detroit, Cincinnati, Buffalo, Norfolk, Charleston, Savannah and Jacksonville are among the leading centers originating and terminating freight traffic on the system. In addition to serving other established centers, the system's lines reach many industries, mines (in western Virginia, eastern Kentucky and southern West Virginia) and businesses located in smaller communities in its service area. The traffic corridors carrying the heaviest volumes of freight include those from the Appalachian coal fields of Virginia, West Virginia and Kentucky to Norfolk and Sandusky, Oh.; Buffalo to Chicago and Kansas City; Chicago to Jacksonville (via Cincinnati, Chattanooga and Atlanta); and Washington, D.C./Hagerstown, Md., to New Orleans (via Atlanta and Birmingham).
Buffalo, Chicago, Hagerstown, Jacksonville, Kansas City, Memphis, New Orleans and St. Louis are major gateways for interterritorial system traffic.
NS Rail and other railroads have entered into service interruption agreements, effective December 30, 1994, providing indemnities to parties affected by a strike over specified industry issues. If NS Rail were so affected, it could receive daily
indemnities from non-affected parties; if parties other than NS Rail were affected, NS Rail could be required to pay indemnities to those parties. If NS Rail were required to pay the maximum amount of indemnities required of it under these agreements--an event considered unlikely at this time--such liability should not exceed approximately $85 million.
COAL TRAFFIC - Ranked by tons handled, coal, coke and iron ore--most of which is bituminous coal--is NS Rail's principal commodity group. NS Rail originated 114.7 million tons of coal, coke and iron ore in 1994 and handled a total of 125.9 million tons. Originated tonnage increased 2.3 percent from 112.1 million tons in 1993, and total tons handled increased 6.7 percent from 118.0 million tons in 1993. Revenues from coal, coke and iron ore, which accounted for 32 percent of NS Rail's total railway operating revenues and 36 percent of total revenue ton miles in 1994, were $1.26 billion, an increase of 4 percent from $1.21 billion in 1993.
Of the 112.0 million tons of coal originating on NS Rail in 1994, the approximate breakdown is as follows: 41.2 million tons from West Virginia, 36.5 million tons from Virginia, 23.6 million tons from Kentucky, 5.7 million tons from Alabama, 3.0 million tons from Illinois, 1.5 million tons from Tennessee, and 0.5 million tons from Indiana. Of this NS Rail-origin coal, approximately 25.0 million tons moved for export, principally through NS Rail's pier facilities at Norfolk (Lamberts Point), Virginia; 18.3 million tons moved to domestic and Canadian steel industries; 59.8 million tons of steam coal moved to electric utilities; and 8.9 million tons moved to other industrial and miscellaneous users. NS Rail moved 10.4 million tons of originated coal to various docks on the Ohio River for further movement by barge and 5.2 million tons to various Lake Erie ports. Other than coal for export, virtually all coal handled by NS Rail was terminated in states situated east of the Mississippi River.
Total NS Rail coal tonnage handled through all system ports in 1994 was 43.6 million. Of this total, 64 percent moved through the pier facilities at Lamberts Point. In 1994, total tonnage handled at Lamberts Point, including coastwise traffic, was 27.8 million tons, a 0.7 percent increase from the 27.6 million tons handled in 1993.
See the discussion of coal traffic, by type of coal, in Part II, Item 7, "Management's Discussion and Analysis," on page 25.
MERCHANDISE RAIL TRAFFIC - The merchandise traffic group consists of Intermodal and five major commodity groupings (Chemicals; Paper/Forest; Automotive; Agriculture; and Metals/Construction). Total NS Rail merchandise revenues increased in 1994 to $2.54 billion, a 6 percent increase over 1993. Merchandise carloads handled in 1994 were 3.03 million, compared with 2.82 million handled in 1993, an increase of 8 percent.
In 1994, 106.4 million tons of merchandise freight, or approximately 68 percent of total merchandise tonnage handled by NS Rail, originated on line. The balance of NS Rail's merchandise traffic was received from connecting carriers (mostly railroads, with some intermodal, water and highway as well), usually at interterritorial gateways. The principal interchange points for NS Rail-received traffic included Chicago, Memphis, New Orleans, Cincinnati, Kansas City, Detroit, Hagerstown, St. Louis/East St. Louis, and Louisville.
Revenues in all six market groups comprising merchandise traffic improved over 1993, with four of the six increasing by 8% or more. The biggest gains were in Intermodal, up $53.7 million; Chemicals, up $39.3 million; Agriculture, up $27.8 million; and Metals/Construction, up $25.3 million.
See the discussion of merchandise rail traffic by commodity group in Part II, Item 7, "Management's Discussion and Analysis," on page 25.
FREIGHT RATES - In 1994 NS Rail continued its reliance on private contracts and exempt price quotes as its predominant pricing mechanisms. Thus, a major portion of NS Rail's freight business is not economically regulated by the government. In general, market forces have been substituted for government regulation and now are the primary determinant of rail service prices. Proposals pending in Congress in early 1995 would further reduce rate regulation of railroads.
In 1994, the ICC found NS Rail "revenue inadequate" based on results for the year 1993. A railroad is "revenue inadequate" under the Interstate Commerce Act when its return on net investment does not exceed the rail industry's composite cost of capital. The absence of "revenue adequacy" lets a railroad use a provision in the Interstate Commerce Act allowing increases in regulated rates by a specific percentage. However, with the decreasing importance of regulated tariff traffic to NS Rail, the ICC's "revenue adequacy" findings have less impact than formerly.
PASSENGER OPERATIONS - Regularly scheduled passenger operations on NS Rail's lines consist of Amtrak trains operating between Alexandria and New Orleans, and between Charlotte and Selma, N.C. Former Amtrak operations between East St. Louis and Centralia, Il., were discontinued by Amtrak on November 3, 1993. Commuter trains continued operations on the NS Rail line between Manassas and Alexandria under contract with two transportation commissions of the Commonwealth of Virginia, providing for reimbursement of related expenses incurred by NS Rail. During 1993, a lease of the Chicago to Manhattan, Il., line to the Commuter Rail Division of the Regional Transportation Authority of Northeast Illinois replaced an agreement under which NS Rail had provided commuter rail service for the Authority.
The average age of the freight car fleet at December 31, 1994, was 21.9 years. During 1994, NS Rail retired 3,333 freight cars. As of December 31, 1994, the average age of the locomotive fleet was 15.8 years. During 1994, NS Rail retired 24 locomotives, the average age of which was 23.6 years. Since 1988, NS Rail has rebodied more than 17,200 coal cars. As a result, the remaining serviceability of the freight car fleet is greater than is indicated by the percentage of freight cars built in earlier years.
NS Rail continues freight car and locomotive maintenance programs to ensure the highest standards of safety, reliability, customer satisfaction and equipment marketability. In recent years, as illustrated in the table below, the bad order ratio has risen or remained fairly stable primarily due to the storage of certain types of cars which are not in high demand. Funds were not spent to repair certain types of cars for which present and future customers' needs could be adequately met without such repair programs. Also, NS Rail's own standards of what constitutes a "serviceable" car have risen, and NS continues a rational disposition program for underutilized, unserviceable and overage cars.
TRACKAGE - All NS Rail trackage is standard gauge, and the rail in approximately 96 percent of the main line trackage (including first, second, third and branch main tracks, all excluding trackage rights) is heavyweight rail ranging from 90 to 155 pounds per yard. Of the 23,172 miles of track maintained by NS Rail as of December 31, 1994, 15,712 miles were laid with welded rail.
MICROWAVE SYSTEM - The NS Rail microwave system, consisting of 6,584 radio path miles, 374 active stations and 7 passive repeater stations, provides communications for Norfolk, Buffalo, Detroit, Fort Wayne, Chicago, Kansas City, St. Louis, Washington, D.C., Atlanta, New Orleans, Jacksonville, Memphis, Cincinnati and most operating locations between these cities. The microwave system provides approximately 2,168,990 individual voice channel miles of circuits. 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. Extension of microwave communications to low density or operations support facilities is accomplished via microwave interface to buried fiber-optic or copper cables.
TRAFFIC CONTROL - Of a total of 13,457 road miles operated by NS Rail, excluding trackage rights over foreign lines, 5,274 road miles are governed by centralized traffic control systems (of which 81 miles are controlled by data radio from seven microwave site locations) and 2,734 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 locations on NS Rail to the central computer complex in Atlanta, Ga. System operating and traffic data are compiled and stored to provide customers with information on their shipments throughout the system. Data processing facilities are capable of providing current information on the location of every train and each car on line, as well as related waybill and other train and car movement data. Additionally, this facility affords substantial capacity for, and is 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.
OTHER - NS Rail has extensive facilities for support of railroad operations, including freight depots, car construction shops, maintenance shops, office buildings, and signals and communications facilities.
ENCUMBRANCES - Certain rail rolling stock is subject to the prior lien of equipment financing obligations amounting to approximately $497.2 million as of December 31, 1994, and $521.8 million as of December 31, 1993. In addition, a significant portion of NS Rail's properties are subject to liens securing as of December 31, 1994, and 1993, approximately $33.9 million and $74.8 million of mortgage debt, respectively.
NS Rail's capital spending and maintenance programs are and have been designed to assure the Company's ability to provide safe, efficient and reliable transportation services. For 1995, NS Rail is planning $686 million of capital spending, and anticipates new equipment financing of approximately $110 million. Looking further ahead, capital spending is expected to remain in the $600 to $700 million range for the next few years. A substantial portion of future capital spending is expected to be funded through internally generated cash, although debt financing will continue as the primary funding source for equipment acquisitions.
ENVIRONMENTAL MATTERS - Compliance with federal, state and local laws and regulations relating to the protection of the environment is a principal NS Rail goal. To date, such compliance has not affected materially NS Rail's capital additions, earnings, liquidity or competitive position.
See the discussion of "Environmental Matters" in Part II, Item 7, "Management's Discussion and Analysis," on page 34, and in Note 17 to the Consolidated Financial Statements on page 59.
EMPLOYEES - NS Rail employed an average of 24,710 employees in 1994, compared with an average of 25,531 in 1993 (including Norfolk Southern Corporation's employees whose primary duties relate to rail operations). The approximate average cost per rail-related employee during 1994 was $41,528 in wages and $18,344 in employee benefits. Approximately 82 percent of these employees are represented by various labor organizations.
GOVERNMENT REGULATION - In addition to environmental, safety, securities and other regulations generally applicable to all businesses, NS Rail is subject to regulation by the ICC, various state regulatory agencies and the Department of Transportation. The ICC has jurisdiction over many rates, routes, conditions of service, and the extension or abandonment of rail lines. The ICC 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 the railroads by the ICC, started over a decade ago under the Staggers Rail Act of l980, has continued. The ICC has recently authorized the partial deregulation of the charges railroads pay for the use of rail cars. NS Rail is expected to benefit from the deprescription of car hire because it owns older cars of types which are in high demand. These cars will likely bring higher rentals under deprescription than under regulated rates.
Certain revenue transactions and classes of traffic already have been exempted from ICC regulation. Those most significant for NS Rail 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, after approval by the ICC, effectively remove those shipments from regulation as well. Over 80 percent of NS Rail's freight revenues come from either exempt traffic or traffic moving under ICC approved transportation contracts.
In early 1995, Congress had under consideration proposals for additional reductions in economic regulation of railroads, including proposals for "sunsetting" the ICC and transferring its remaining functions to another agency.
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 Rail's primary competitor is the CSX system, which operates throughout much of the same territory served by NS Rail. Other railroads also operate in parts of the territory. NS Rail also competes with motor carriers and water carriers, and with shippers who have the additional option of handling their own goods in private carriage. Increasingly, cooperative strategies between railroads and between railroads and motor carriers enable carriers to compete more effectively in specific markets. A subsidiary of NS, which is not part of NS Rail, entered into such a strategy with a Conrail subsidiary forming a partnership in 1993 which offered intermodal service using RoadRailer(Registered Trademark) equipment. NS Rail provides some of the rail line-haul for this partnership.
Item 3.
Item 3. Legal Proceedings. ------ -----------------
None.
Item 4.
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 1994.
Executive Officers of the Registrant. ------------------------------------ Norfolk Southern Railway's officers are elected annually by the Board of Directors at its first meeting held after the annual meeting of stockholders, and they hold office until their successors are elected. There are no family relationships among the officers, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The following table sets forth certain information, as of March 1, 1995, relating to these officers:
Business Experience during Name, Age, Present Position past 5 Years --------------------------- -------------------------------------- David R. Goode, 54, Present position since September 1992. President and Chief Also, Chairman, President and Chief Executive Officer Executive Officer of Norfolk Southern Corporation since September 1992, President from October 1991 to September 1992, and Executive Vice President-Administration from January to October 1991. Served as Vice President-Administration of Norfolk Southern Railway from January 1991 to February 1992, Vice President from February to September 1992, and prior thereto as Vice President-Taxation of Norfolk Southern Railway and NS.
Paul N. Austin, 51, Vice Present position since June 1994. President-Personnel Also, Vice President-Personnel of Norfolk Southern Corporation since June 1994. Served as Assistant Vice President- Personnel of NS from February 1993 to June 1994, and prior thereto as Director Compensation.
William B. Bales, 60, Vice Present position since August 1993. President-Coal Marketing Also, Vice President-Coal Marketing of Norfolk Southern Corporation since August 1993. Served prior thereto as Vice President-Coal and Ore Traffic of Norfolk Southern Railway and NS.
Business Experience during Name, Age, Present Position past 5 Years --------------------------- -------------------------------------- R. Alan Brogan, 54, Vice Present position since December 1992. President-Transportation Also, Executive Vice President- Logistics Transportation Logistics of Norfolk Southern Corporation since December 1992, Vice President- Quality Management from April 1991 to December 1992, Vice President- Material Management and Property Services from July 1990 to April 1991, and prior thereto as Vice President of Material Management. Served as Vice President-Quality Management of Norfolk Southern Railway from June 1991 to December 1992, and prior thereto as Vice President-Material Management.
Thomas L. Finkbiner, 42, Vice Present position since August 1993. President-Intermodal Also, Vice President-Intermodal of Norfolk Southern Corporation since August 1993. Served as Senior Assistant Vice President- International and Intermodal of NS from April to August 1993, and prior thereto as Assistant Vice President- International and Intermodal.
James A. Hixon, 41, Vice Present position since June 1993. President-Taxation Also, Vice President-Taxation of Norfolk Southern Corporation since June 1993. Served as Assistant Vice President-Tax Counsel of NS from January 1991 to June 1993, and prior thereto as General Tax Attorney.
Jon L. Manetta, 57, Vice Present position since June 1994. President-Transportation Also, Vice President- Transportation of Norfolk Southern Corporation since June 1994. Served as Assistant Vice President-Transportation of NS from October 1993 to June 1994. Served as Assistant Vice President-Strategic Planning of NS from January 1993 to October 1993, Director Joint Facilities and Budget from March 1992 to January 1993, Assistant Terminal Superintendent-Transportation from January 1991 to March 1992, and prior thereto as Assistant Superintendent-St. Louis Terminal.
Business Experience during Name, Age, Present Position past 5 Years --------------------------- -------------------------------------- Harold C. Mauney, Jr., 56, Present position since December 1992. Vice President-Quality Also, Vice President-Quality Management Management of Norfolk Southern Corporation since December 1992. Served as Assistant Vice President- Quality Management of NS from April 1991 to December 1992, and prior thereto as General Manager- Intermodal Transportation Services.
Donald W. Mayberry, 51, Vice Present position since October 1987. President-Mechanical Also, Vice President-Mechanical of Norfolk Southern Corporation since October 1987.
James W. McClellan, 55, Vice Present position since October 1993. President-Strategic Planning Also, Vice President-Strategic Planning of Norfolk Southern Corporation since October 1993. Served as Assistant Vice President- Corporate Planning of NS from March 1992 to October 1993, and prior thereto as Director-Corporate Development.
Kathryn B. McQuade, 38, Vice Present position since December 1992. President-Internal Audit Also, Vice President-Internal Audit of Norfolk Southern Corporation since December 1992. Served as Director-Income Tax Administration of NS from May 1991 to December 1992, and prior thereto as Director-Federal Income Tax Administration.
Charles W. Moorman, 43, Vice Present position since October 1993. President-Information Also, Vice President-Information Technology Technology of Norfolk Southern Corporation since October 1993. Served as Vice President-Employee Relations of Norfolk Southern Railway and NS from December 1992 to October 1993, Vice President-Personnel and Labor Relations from February to December 1992, Assistant Vice President-Stations, Terminals and Transportation Planning of NS from March 1991 to February 1992, Senior Director Transportation Planning from March 1990 to March 1991, and prior thereto as Director, Transportation Planning.
Business Experience during Name, Age, Present Position past 5 Years --------------------------- -------------------------------------- Phillip R. Ogden, 54, Vice Present position since December 1992. President-Engineering Also, Vice President-Engineering of Norfolk Southern Corporation since December 1992. Served as Assistant Vice President-Maintenance of NS from November 1990 to December 1992, and prior thereto as Chief Engineer-Line Maintenance North.
L. I. Prillaman, Jr., 51, Present position since December 1992. Vice President-Properties Also, Vice President-Properties of Norfolk Southern Corporation since December 1992. Served prior thereto as Vice President and Controller of Norfolk Southern Railway and NS.
John P. Rathbone, 43, Vice Present position since December 1992. President and Controller Also, Vice President and Controller of Norfolk Southern Corporation since December 1992 and prior thereto as Assistant Vice President-Internal Audit.
William J. Romig, 50, Present position since December 1992. Vice President Also, Vice President and Treasurer of Norfolk Southern Corporation since December 1992 and prior thereto as Assistant Vice President-Finance.
Donald W. Seale, 42, Vice Present position since August 1993. President-Merchandise Also, Vice President-Merchandise Marketing Marketing of Norfolk Southern Corporation since August 1993. Served as Assistant Vice President- Sales and Service of NS from May 1992 to August 1993, Director- Metals, Waste and Construction from March 1990 to May 1992, and prior thereto as Director-Marketing Development.
John S. Shannon, 64, Vice Present position since May 1984. President-Law Also, Executive Vice President- Law of Norfolk Southern Corporation since June 1982.
Business Experience during Name, Age, Present Position past 5 Years --------------------------- -------------------------------------- Powell F. Sigmon, 55, Vice Present position since January 1995. President-Research and Also, Vice President-Research and Tests Tests of Norfolk Southern Corporation since January 1995. Served as Vice President-Safety, Environmental and Research Development from October 1993 to January 1995, Assistant Vice President-Mechanical (Car) of NS from January 1991 to October 1993, and prior thereto as General Manager- Mechanical Facilities.
Robert S. Spenski, 60, Vice Present position since June 1994. President-Labor Relations Also, Vice President-Labor Relations of Norfolk Southern Corporation since June 1994, and prior thereto as Senior Assistant Vice President-Labor Relations.
Stephen C. Tobias, 50, Present position since October 1993. Vice President Also, Senior Vice President- Operations of Norfolk Southern Corporation since October 1993. Served as Vice President-Strategic Planning of Norfolk Southern Railway and NS from December 1992 to October 1993, and prior thereto as Vice President-Transportation.
John R. Turbyfill, 63, Vice Present position since June 1993. President Also, Vice Chairman of Norfolk Southern Corporation since June 1993. Served prior thereto as Executive Vice President-Finance of NS since June 1982, and Vice President-Finance of Norfolk Southern Railway since March 1984.
D. Henry Watts, 63, Vice Present position since July 1986. President and Chief Also, Executive Vice President- Traffic Officer Marketing of Norfolk Southern Corporation since July 1986.
Business Experience during Name, Age, Present Position past 5 Years --------------------------- -------------------------------------- Henry C. Wolf, 52, Vice Present position since June 1993. President-Finance Also, Executive Vice President- Finance of Norfolk Southern Corporation since June 1993. Served as Vice President-Taxation of Norfolk Southern Railway and NS from January 1991 to June 1993, and prior thereto as Assistant Vice President-Tax Counsel.
Dezora M. Martin, 47, Present position since October 1993. Corporate Secretary Served prior thereto as Assistant Corporate Secretary of Norfolk Southern Railway and NS.
Ronald E. Sink, 52, Present position since September Treasurer 1987.
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related ------ ---------------------------------------------------- Stockholder Matters. -------------------
COMMON STOCK ------------ Since June 1, 1982, NS has owned all the common stock of Norfolk Southern Railway Company. The common stock is not publicly traded.
SERIAL PREFERRED STOCK ---------------------- There are 10,000,000 shares of no par value serial preferred stock authorized. This stock may be issued in series from time to time at the discretion of the Board of Directors with any series having such voting and other powers, designations, dividends and other preferences deemed appropriate at the time of issuance.
The $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of which 1,197,027 shares were issued and 1,096,907 shares were held other than by subsidiaries as of February 28, 1995, has no par value but has a $50 per share stated value. As indicated in the title, the stock pays a dividend of $2.60 per share annually, payable quarterly on March 15, June 15, September 15 and December 15. Dividends on this stock are cumulative and in preference to dividends on all other classes of stock. Except for any shares held by Norfolk Southern Railway Company subsidiaries and/or in a fiduciary capacity, each share is entitled to one vote per share on all matters, voting as a single class with holders of other stock. Should dividends become delinquent for six quarters, this class of stock, voting as a class, may elect two directors so long as any default in dividend payments continues. The stock is redeemable at the option of Norfolk Southern Railway Company at $50 per share plus accrued dividends. On liquidation, the stock is entitled to $50 per share plus accrued dividends before any amounts are paid on any other class of stock.
In June 1989, NS announced that it intended to purchase up to 250,000 shares of the outstanding Series A Stock during the subsequent two-year period. In May 1991, NS extended the previously announced stock purchase program through 1993. In March 1994, NS announced that it would continue purchasing up to 250,000 shares of the Series A Stock through 1996. As of February 28, 1995, NS had purchased 104,727 shares of Series A Stock at a total cost of $3,708,463; as of the same date, NS held a total of 104,822 shares.
Item 6.
Item 6. Selected Financial Data. ------ -----------------------
Item 7.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. -----------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes beginning on page 37 and the Five-Year Financial Review on page 24. The Condensed Summary provides a brief overview of results of operations, and the text beginning under "Results of Operations" is a more detailed analyses.
CONDENSED SUMMARY OF RESULTS OF OPERATIONS
1994 Compared with 1993 ----------------------- Net income was $682.0 million in 1994, compared with $782.0 million in 1993. However, net income in 1993 was increased by $247.8 million related to the implementation of required accounting changes (see Note 1 on page 43) and reduced by $51.6 million for the prior years' effect of a federal income tax rate increase (see Note 4 on page 46). Excluding the effect of the 1993 accounting changes and the tax rate increase related to prior years, 1994's net income was 16% above the $585.8 million in 1993, setting a record for NS Rail. Income from railway operations rose $127.2 million, or 14%, compared with 1993, producing most of the improvement. These results reflected a 5% increase in railway operating revenues (largely due to higher traffic volume) combined with only a 2% increase in railway operating expenses. Nonoperating income was $46.6 million, compared with $57.6 million in 1993 (see Note 3 on page 46), principally a result of reduced gains on sales of property.
1993 Compared with 1992 ----------------------- Net income was $782.0 million in 1993, compared with $606.5 million in 1992. However, as discussed previously, results for 1993 were significantly affected by required accounting changes and by an increase in the federal income tax rate. Excluding the effect of the accounting changes and the tax rate increase related to prior years, 1993's earnings would have been $585.8 million, a $20.7 million decrease from 1992. Railway operating revenues increased less than 1%, compared with 1992, as gains in merchandise traffic were substantially offset by lower coal traffic levels. Railway operating expenses increased 1%, compared with 1992. Nonoperating income in 1993 rose $8.1 million, compared with 1992, due to gains from sales of property (see Note 3 on page 46).
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
RESULTS OF OPERATIONS
Railway Operating Revenues -------------------------- Railway operating revenues were $3.92 billion in 1994, compared with $3.73 billion in 1993 and $3.71 billion in 1992. The following table presents a three-year comparison of revenues by market group.
Traffic volume increased or remained steady for all market groups in 1994 and increased for all market groups except coal in 1993. The revenue per unit/mix variance in both years was attributable to shorter haul business and increased double-stack business, both of which have lower average rates.
Some of the fastest growing market segments are in shorter haul, repetitive movements. This type of traffic complements NS Rail's efforts to improve asset utilization and demonstrates that efficient operations can generate profit opportunities in nontraditional markets. COAL (including coke and iron ore) traffic volume in 1994 increased 5%, and revenues, which represented 32% of total railway operating revenues, were up 4% from 1993. Coal accounted for about 98% of this market group's volume, and 91% of coal shipments originated on NS Rail's lines. As shown in the following table, the decline in steel coal was more than offset by a significant increase in utility coal, up 16%, compared with 1993.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
Utility coal traffic was up early in the year as a result of bitter weather and the resulting depletion of plant stockpiles. The pace at which 1994 outperformed 1993 slowed as the weather normalized, power generation demand lessened and coal inventories grew. New movements of western coal into Georgia also contributed to the 1994 increase. NS Rail handled five million tons of western coal in 1994, and this volume is expected to increase in 1995. The favorable outlook for utility coal reflects increasing demand for low-sulfur coal as utilities seek to comply with Clean Air Act Amendments. A high proportion of the mines served by NS Rail produce low- sulfur coal. The January 1, 1995, Phase I deadline under the Clean Air Act has already caused an increase in NS Rail's low-sulfur coal handlings. This trend is expected to accelerate as the Phase II deadline of January 1, 2000, approaches. Export coal traffic at the beginning of 1994 continued to reflect the poor demand seen in 1993. Shipments remained depressed as a result of the weak European economy and strong competition from other producing countries. Excess world capacity pushed coal prices lower in early 1994. However, by mid-1994, U.S. coal supplies for the export market had been reduced due to a strong domestic market and mine closings. Economic recovery in Europe and Japan improved demand for steel and electricity, and within a short time the coal supply-demand situation tightened. By the end of 1994, delivery times were longer and prices had risen. Continued economic growth in the Far East and Europe is expected to increase demand for U.S. coal, especially steam coal. Reduced mining subsidies in Europe, primarily in Germany, may reduce European coal production. On the other hand, overseas demand for coal used in steelmaking is expected to be flat in the short term and to decline over the longer term as new technologies slowly diminish the need for this type of coal. On balance, U.S. coal exports are expected to increase, but at rates below those seen in previous economic recoveries. During 1994, NS Rail completed modifications to the two shiploaders at Pier 6 in Norfolk, Va., enabling large vessels to be loaded more quickly. Steel coal domestic traffic was reduced by the closing of one coke battery and extended maintenance at another battery. These batteries produce coke for making steel; however, because advancing technologies allow for production of steel with little or no coke, this domestic market is expected to decline slowly. Coal traffic volume in 1993 decreased 6%, compared with 1992, and revenues also were down 6%. The export coal market was weak for all of 1993. Additionally, stockpiles were at high levels in the United Kingdom, and two Italian generating stations were closed all year. A UMWA strike, settled in December 1993, although not widespread at mines served by NS Rail, idled four operations heavily oriented toward export shipments. In contrast to the export market, domestic coal remained steady in 1993, compared with 1992, as extended periods of warmer-than-usual summer temperatures in the Southeast resulted in increased business for a number of utility
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
customers. NS Rail also did well in 1993 in the domestic steel market. While total volumes in this market remained flat, compared with 1992, NS Rail was able to increase its market share. MERCHANDISE traffic volume in 1994 increased 8%, and revenues increased 6%, compared with 1993. Merchandise carloads handled in 1994 were 3.0 million, compared with 2.8 million in 1993. Revenues in all six market groups comprising merchandise traffic improved over 1993, with four of the six increasing 8% or more. CHEMICALS traffic rose 9% over 1993, and revenues increased 8%. A strong economy strengthened the demand for chemicals, and shipments of fertilizer and plastics were stronger in 1994 than in recent years. NS Rail is continuing its expansion of rail-truck bulk distribution facilities to handle a variety of dry and liquid products. One new Thoroughbred Bulk Transfer facility opened in 1994, and construction started on five more. These facilities should play an important part in fostering the growth of chemicals traffic in 1995 and beyond. PAPER/FOREST traffic and revenues were both about even with 1993, reflecting weak production, severe winter weather and floods in south Georgia. Some of the weakness in paper was offset by an 8% gain in lumber traffic, in part, due to the opening of five new lumber distribution centers. These centers facilitate combined rail-truck movements of lumber and wood products to retail outlets. A resumption of moderate growth is expected as paper market conditions improve and distribution center traffic increases. AUTOMOTIVE traffic remained steady in 1994, compared with 1993, and revenues increased to their highest level in NS Rail's history. NS Rail's revenues from automotive traffic have grown 32% since 1991, although only 1% of this growth occurred in 1994. Traffic volume in 1994 was adversely affected by retooling at four plants located on NS Rail's lines. These plants are scheduled to resume production between early 1995 and mid- 1996. During 1994, NS Rail implemented a number of train coordination projects with Conrail and Florida East Coast Railway to improve transit times for the growing network of automotive assembly plants. Over the next few years, growth in NS Rail's automotive traffic is expected to resume as the plant retoolings are completed and new plants come on line. Production began at Toyota's second Georgetown, Ky., plant in March 1994 and at BMW's new facility in Greer, S.C., in September 1994. Mercedes' plant in Alabama is expected to come on line in 1997. AGRICULTURE traffic rose 7%, and revenues increased 9%. Early in the year, favorable harvest conditions in NS Rail sourcing areas and poor conditions elsewhere boosted traffic. Later in the year, NS Rail traffic levels also were very strong, reflecting record corn and soybean harvests and aggressive programs to increase car utilization through greater use of 50- and 100-car unit trains. Agriculture has become a growth market for NS Rail, with revenues increasing 21% during the last five years. This group is expected to continue to grow as poultry consumption, with the commensurate rise in demand for feed grain, increases. In 1995, three new feed mills are expected to open along NS Rail's lines. NS Rail is continuing efforts to locate new poultry processing facilities on its lines. Growth also is expected from short-haul movements diverted from truck due to improved train service. METALS/CONSTRUCTION traffic and revenues both rose 9%. Most of the revenue gain was in shipments of steel, as this industry had its best year since 1973. Business also increased because of new steel plants and from aluminum traffic diverted from truck. Late in 1994, NS Rail began sheet-steel movements to Mexico under a new six-year contract. Construction markets were strong, with output up 5%. Movements of sand and gravel were up 13% due to increased highway repair and construction activity. Growth prospects for metals/construction appear good. Business is expected to benefit from new steel plants on NS Rail's lines, new municipal solid waste movements and the increased business to Mexico.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
INTERMODAL traffic rose 13%, and revenues increased 14%, compared with 1993. Intermodal is NS Rail's fastest growing line of business, achieving record levels of volume, revenue and profitability in 1994. Intermodal growth in 1994 was led by an increase in trailer-on-flatcar (TOFC) business and, in particular, the less-than-truckload segment. Notably, these customers, generally major trucking companies, tend to use their own trailers rather than NS Rail's trailers. During 1994, these trucking companies switched substantial amounts of business from highway to rail. This trend is expected to continue in 1995 and beyond, although at a rate lower than that experienced in 1994. Containers-on-flatcar (COFC) business also improved in 1994. The export container segment, NS Rail's largest COFC market, improved as the economies in Europe recovered, and the countries in the Asia/Pacific region experienced rapid growth in production. Revenues from domestic COFC movements also improved, as NS Rail increased its market share. Much of this growth was related to aggressive facility and transit-time improvements, including expanding or upgrading five terminal facilities. Current capacity, combined with three planned terminal expansions, will accommodate an expected growth in COFC and double-stack business. During 1993, all six merchandise market groups showed improvement over 1992. Traffic volume increased 6%, and revenues increased 4%. The largest revenue increases were in the intermodal group, up $30.9 million, or 9%, the automotive group, up $28.0 million, or 7%, and metals/construction, up $19.8 million, or 7%. The 1993 growth in intermodal was led by a 21% increase in services provided to Triple Crown Services Company (a partnership between subsidiaries of NS and Consolidated Rail Corporation) due to strong automotive shipments and expansion of service to the Northeast. COFC revenues were up 6% compared with 1992, a smaller increase than in previous years due to recessions in Europe and Japan. TOFC revenues were up 11%, boosted by gains from haulage arrangements with truckload carriers. The 1993 growth in automotive traffic was primarily due to strong demand for vehicles produced at plants served by NS Rail. In addition, NS Rail benefited from a full year of production at the Ford/Nissan plant located near Avon Lake, Ohio. Successful marketing efforts, such as the program with GM for just-in-time movement of auto parts, also contributed to the higher traffic levels in 1993. The improvement in the metals/construction group in 1993, compared with 1992, was largely a result of increased iron and steel shipments related to strong industry production and new plants located on NS Rail's lines. Shipments of construction commodities also were strong due to a recovery in housing.
Railway Operating Expenses -------------------------- Railway operating expenses in 1994 totaled $2.87 billion, only 2% higher than 1993, despite a 7% increase in traffic volume. Railway operating expenses in 1993 were $2.81 billion, a 1% increase compared with 1992. The 1994 NS Rail railway operating ratio continued to be the best among the major railroads in the United States and improved by more than two full points compared with 1993.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
The following table shows the changes in railway operating expenses summarized by major classifications.
COMPENSATION AND BENEFITS represents about half of total railway operating expenses and declined 1% in 1994, compared with 1993, but increased 1% in 1993, compared with 1992. The 1994 decline was principally a result of (1) lower accruals for stock-based compensation plans as a result of a lower NS stock price; (2) reduced accruals for postretirement benefits resulting from a change in the benefit plan's creditable service period (see Note 13 on page 55); (3) the expiration of the Railroad Retirement Repayment Tax in June 1993; (4) the early retirement program in 1993 (see Note 12 on page 53); and (5) productivity improvements as a result of continuing reductions in train crew sizes. The slightly higher expenses in 1993, compared with 1992, were mainly due to accruals for postretirement and postemployment benefits that, prior to 1993, were accounted for on a pay-as-you-go basis (see "Required Accounting Changes" in Note 1 on page 43) and to higher costs for stock-based compensation plans. A voluntary early retirement program was completed in 1993, which resulted in a $42.4 million charge in compensation and benefits expense (see Note 12 on page 53). Also in 1993, a $46 million credit was recorded in compensation and benefits, reflecting a partial reversal of the 1991 special charge (see Note 15 on page 57). MATERIALS, SERVICES AND RENTS consists of items used for maintenance of road (rail line and related structures) and equipment (locomotives and freight cars); equipment rents representing the cost to NS Rail of using freight equipment owned by other railroads or private owners, less the rent paid to NS Rail for the use of its equipment; and the cost of services purchased from outside contractors, including the net costs of operating joint (or leased) facilities with other railroads. This category increased 4% in 1994, compared with 1993, and less than 1% in 1993, compared with 1992. The 1994 increase was principally due to higher joint-facility and leased-road costs and to increased locomotive repair costs resulting mostly from higher traffic volume. However, a decrease in usage by other railroads of NS Rail's facilities also contributed to the increase in joint facilities expense. The cost of leasing lines of road is expected to increase in the future as a result of tentative understandings reached with respect to certain North Carolina leases (see Note 9 on page 51). Partly offsetting these increases was a decline in equipment rent expenses resulting from the partial deprescription (deregulation by the ICC) of car hire rates among railroads. NS Rail expects additional future benefits as deprescription is fully implemented. DEPRECIATION expense (see Note 1, "Properties", on page 43, for NS Rail's depreciation policy) was up 4% in 1994, compared with 1993, and 5% in 1993, compared with 1992. The increases in both periods were due to property additions, reflecting substantial levels of capital spending during the three-year period ended December 31, 1994.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
Diesel fuel costs increased 5% in 1994, compared with 1993, but declined 2% in 1993, compared with 1992. The 1994 increase was entirely due to higher consumption, driven by a 7% increase in carloadings. On average, 1994's prices were slightly lower than 1993's. NS Rail uses substantial quantities of diesel fuel; therefore, changes in price or consumption have a significant impact on the cost of providing transportation services. Diesel fuel expenses declined in 1993, compared with 1992, mainly due to a lower price offset partially by increased consumption. CASUALTIES AND OTHER CLAIMS (including insurance costs, estimates of costs related to personal injury, property damage and environmental matters) increased 14% in 1994, compared with 1993, but decreased 2% in 1993, compared with 1992. The 1994 increase was primarily attributable to environmental cleanup costs associated with a tankcar leak (see also "Environmental Matters" on page 34) and to higher personal injury claim settlement costs. By far the largest component, personal injury expenses, which relates primarily to the cost of on-the-job employee injuries, has shown a favorable trend in the number of incidents since 1990, reflecting success in reducing accidental employee injuries. Unfortunately, the favorable trend in the number of accidental injuries has been more than offset by increased claim costs and higher costs related to non- accidental "occupational" claims. The rail industry remains uniquely susceptible to both 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 provides the sole basis for compensating railroad employees who sustain job-related injuries. The system produces results that are unpredictable, inconsistent and frequently unfair, at a cost to the rail industry that is two or three times greater than that under the no-fault workers' compensation systems to which non-rail competitors are universally subject. The railroads have been unsuccessful so far in efforts to persuade Congress to replace the FELA with a no- fault workers' compensation act. OTHER expenses increased 12% in 1994, compared with 1993, and declined 3% in 1993, compared with 1992. The increase over 1993 was due to favorable property tax settlements in 1993 and to higher relocation expenses in 1994 related to new job assignments following 1993's early retirement program. The 1993 decline was largely the result of favorable settlements of issues related to property and other taxes.
Other Income - Net ------------------ Nonoperating income decreased $11.0 million, or 19%, in 1994, compared with 1993, but increased $8.1 million, or 16%, in 1993, compared with 1992 (see Note 3 on page 46). These fluctuations principally arose because of large gains on sales of property in 1993. Some of the decline in 1994 was offset by an increase in interest income (see Note 3 on page 46). Interest income in 1995 is expected to decrease, reflecting in part the $400.1 million dividend to NS (see Note 2 on page 44).
Interest Expense on Debt ------------------------ Interest expense on debt declined 12% in 1994, compared with 1993, and 28% in 1993, compared with 1992, due principally to lower levels of equipment debt and fluctuations in the amount of capitalized interest (see Note 6 on page 49).
Income Taxes ------------ Income tax expense in 1994 was $385.2 million for an effective rate of 36.1%, compared with an effective rate of 43.6% in 1993 and 34.9% in 1992. Income tax expense in 1994 and 1993 was accrued under Statement of Financial Accounting Standards No. 109, rather than under the prior accounting rules (see "Required Accounting Changes" in Note 1 on page 43). Absent the federal income tax rate increase imposed by the Revenue Reconciliation Act of 1993, income tax expense in 1993 would have been $352.0 million for an effective rate of 37.2%.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
The effective rate in 1994 benefited from favorable adjustments resulting from settlement of the consolidated federal income tax years 1988 and 1989 and from a favorable adjustment upon filing the 1993 tax return. Deferred tax expense was an unusually high proportion of total tax expense in 1994. A corresponding reduction is reflected in 1994's current tax expense for the effects of expenditures that affect book and tax accounts in different years, primarily in the areas of compensation and property. Current income tax expense in 1993 was a higher proportion of total taxes, primarily because of tax payments made in anticipation of Revenue Agent Reports for the 1988-1989 federal income tax audit. Deferred tax expense for 1993, compared with 1992, decreased primarily for the same reason (see Note 4 on page 46 for the components of income tax expense).
Required Accounting Changes --------------------------- Effective January 1, 1994, NS Rail adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). The principal result was a significant write-up of NS Rail's investment in NS stock. This non-cash adjustment had no income statement effect and increased "Investments" and "Stockholders' equity" in the December 31, 1994, Consolidated Balance Sheet by $417.5 million and $253.1 million, respectively (see Note 1 on page 43). Effective January 1, 1993, NS Rail adopted required accounting for postretirement benefits other than pensions, postemployment benefits and income taxes (see Note 1 on page 43 for a discussion of these accounting changes). The net cumulative effect of these non-cash adjustments increased 1993's net income by $247.8 million.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
FINANCIAL CONDITION refers to the assets, liabilities and stockholders' equity of an organization (see Consolidated Balance Sheets on page 39). LIQUIDITY refers to the ability of an organization to generate adequate amounts of cash, principally from operating results or through borrowing power, to meet its short-term and long-term cash requirements (see Consolidated Statements of Cash Flows on page 40). CAPITAL RESOURCES refers to the ability of an organization to raise funds through the sale of either debt or equity (stock) securities.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES, which is NS Rail's principal source of liquidity, increased $289.4 million, or 33%, in 1994, compared with 1993, but declined $82.3 million, or 9%, in 1993, compared with 1992. Since the 1982 consolidation, cash provided by operating activities has been sufficient to fund dividend requirements, debt repayments and a significant portion of capital spending (see Consolidated Statements of Cash Flows on page 40). The improvement in 1994 was primarily a result of increased income from operations, which was $127.2 million higher than 1993, and to lower income tax payments. The 1993 decline was largely attributable to the timing of tax payments, which were $146.0 million higher than in 1992 due to payments related to the 1988-1989 federal income tax audit, higher 1993 earnings and the fact that 1992's tax payments had been low. Implementation of the labor portion of the 1991 special charge also contributed to the fluctuations in cash provided by operations. In 1994, 1993 and 1992, $41.9 million, $36.1 million and $134.7 million, respectively, were used for labor costs related to the special charge. The lower payments in 1994 and 1993 were partly due to the failure to reach agreement on terms for certain further labor savings. This situation also led to a partial reversal of the 1991 special charge (see Note 15 on page 57). Looking ahead, the labor portion of the special charge is expected to require $30 million in each of the next two years to achieve productivity gains permitted by the agreements. NS Rail regards this cash outflow as an investment because, in view of the high cost of labor and fringe benefits, these payments produce significant future labor savings. In 1994, it is estimated that NS Rail's expenses were reduced by $130 million as a result of these programs, and upon full implementation of the labor agreements, there will be additional savings of about $20 million per year. CASH USED FOR INVESTING ACTIVITIES increased 45% in 1994, compared with 1993, but declined 22% in 1993, compared with 1992. The higher use in 1994 was due to significant advances made to NS which were then dividended to NS at the end of the year (see Note 2 on page 44). The other significant use of cash was for property additions, totaling $639.6 million, largely for railway projects. Efforts to maintain a reasonable level of capital spending while increasing business are ongoing as NS Rail seeks to maximize utilization of its assets. In this connection, NS Rail continues to review its route network to identify areas where efficiency can be enhanced by coordinated agreements with other railroads, or through sales or abandonments. Large borrowings on corporate owned life insurance, reflected in "Investment sales and other transactions" in the Consolidated Statements of Cash Flows (see Note 5 on page 49), partially offset the use of cash for intercompany advances and property additions in 1994. In 1993, a combination of repayments on advances to NS and higher proceeds from sales of property was responsible for the improvement compared with 1992.
The preceding chart shows capital spending over the past five years, and the following table summarizes track maintenance statistics and the average ages of railway equipment.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
The average age of locomotives retired during 1994 was 23.6 years. Since 1988, NS Rail has rebodied more than 17,200 coal cars and plans to continue that program at the rate of about 3,500 cars per year for the next several years. This work, performed at NS Rail's Roanoke Car Shop, converts hopper cars into high-capacity steel gondolas or hoppers. As a result, the remaining serviceability of the freight car fleet is greater than indicated by the increasing average age shown above. For 1995, NS Rail is planning $686 million of capital spending and anticipates new equipment financing of approximately $110 million. Barring unforeseen events, total capital spending is expected to remain in the $600 to $700 million range for the next few years. A substantial portion of future capital spending is expected to be funded through internally generated cash, although debt financing will continue as the primary funding source for equipment acquisitions.
Debt requirements for 1995 are expected to increase related to the planned acquisition of 125 locomotives.
Hedging Activities ------------------ NS Rail has entered into hedging transactions relating to diesel fuel purchases. No agreements related to the hedges were settled from 1992 through 1994, and outstanding agreements at December 31, 1994, were less than $5 million.
ENVIRONMENTAL MATTERS
NS Rail is subject to various jurisdictions' environmental laws and regulations. It is NS Rail's policy to record a liability where such liability or loss is probable and can be reasonably estimated. Claims, if any, against third parties for recovery of cleanup costs incurred by NS Rail are reflected as receivables in the balance sheet and are not netted against the associated NS Rail liability. Environmental engineers participate in ongoing evaluations of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are made. NS also has established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
Operating expenses for environmental protection totaled approximately $20 million in 1994 and are anticipated to decrease in 1995. Expenses in 1994 included $10.5 million associated with emergency response and cleanup resulting from release of arsenic acid from a tankcar leased by the shipper from a third party. Capital expenditures for environmental projects amounted to approximately $4 million in 1994 and are expected to be approximately $4 million in 1995. As of December 31, 1994, NS Rail's balance sheet included a reserve for environmental exposures in the amount of $50 million (of which $13 million is accounted for as a current liability), which is NS Rail's best estimate of ultimate liability at 80 identified locations. On that date, eight sites accounted for $23 million of the reserve, and no individual site was considered to be material. NS Rail anticipates that the majority 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 80 locations, NS Rail and/or certain of its subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs. With respect to known environmental sites (whether identified by NS Rail or by the EPA or comparable state authorities), estimates of NS Rail's ultimate potential financial exposure for a given site or in the aggregate for all such sites are necessarily imprecise because of the widely varying costs of currently available cleanup techniques, the likely development of new cleanup 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, particularly those classified as hazardous materials, in NS Rail's traffic mix can pose special risks that NS Rail works diligently to minimize. In addition, NS Rail has land holdings that serve as operating property, or which are leased or may have been leased and operated by others, or held for sale. Because certain conditions may exist on these properties related to environmental problems that are latent or undisclosed, there can be no assurance that NS Rail will not incur liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably now. 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 and, after consulting with its legal counsel, Management believes that it has recorded appropriate estimates of liability for those environmental matters of which NS Rail is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in aggregate, will have a material adverse effect on NS Rail's financial position, results of operations or liquidity.
INFLATION
Generally accepted accounting principles require the use of historical costs in preparing financial statements. This approach disregards the effects of inflation on the replacement cost of property and equipment. NS Rail, a capital-intensive company, has approximately $12 billion invested in such assets. The replacement costs of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical costs.
Item 7. Management's Discussion and Analysis of Financial ------ ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------
RAIL INDUSTRY TRENDS
- Negotiations at the national level on agreements with the major labor organizations were under way during 1994, but no new agreements have been concluded. The outcome of these negotiations is uncertain at this time.
- The Interstate Commerce Commission (ICC) may be abolished or its role substantially redefined. Whether and to what extent the ICC's traditional regulatory functions will be carried out at the federal level--and if so, by what agency or agencies--remain unclear and are a source of uncertainty.
- NS Rail and other railroads are continuing to seek opportunities to share traffic routes and facilities, furthering the goals of providing seamless service to customers and maximizing efficiency of the respective railroads.
- NS Rail and the rail industry are continuing their efforts to replace the FELA with no-fault workers' compensation laws comparable to those covering employees in other industries.
- There have been some recent merger and consolidation overtures within the railroad industry. NS Rail is closely monitoring this activity in light of its own long-term strategic objectives to protect the interests of its stockholders.
Item 8.
Item 8. Financial Statements and Supplementary Data. ------ -------------------------------------------
Index to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1994, 1993 and 1992 38
Consolidated Balance Sheets As of December 31, 1994 and 1993 39
Consolidated Statements of Cash Flows Years ended December 31, 1994, 1993 and 1992 40-41
Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1994, 1993 and 1992 42
Notes to Consolidated Financial Statements 43-61
Independent Auditors' Report 62
The Index to Consolidated Financial Statement Schedule appears in Item 14 on page 64.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements
The following notes are an integral part of the consolidated financial statements.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation --------------------------- The consolidated financial statements include Norfolk Southern Railway Company, Norfolk and Western Railway Company (NW) and their majority-owned and controlled subsidiaries (collectively, NS Rail). All significant intercompany balances and transactions have been eliminated in consolidation (see Note 16 for NW's summarized consolidated financial information).
Cash Equivalents ---------------- "Cash equivalents" are highly liquid investments purchased three months or less from maturity.
Investments ----------- "Investments" are reported at amortized cost or fair value depending upon their classification as held-to-maturity, trading or available-for- sale securities in accordance with SFAS No. 115 (see "Required Accounting Changes").
Materials and Supplies ---------------------- "Materials and supplies," consisting mainly of fuel oil and items for maintenance of property and equipment, are stated at average cost. The cost of materials and supplies expected to be used in capital additions or improvements is included in "Properties."
Properties ---------- "Properties" are stated principally at cost and are depreciated using group depreciation. Rail is primarily depreciated on the basis of use measured by gross ton-miles. The effect of this method is to write off 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 1994, the overall depreciation rate averaged 2.7% for roadway and 4.0% for equipment. NS Rail capitalizes interest on major capital projects during the period of their construction. Maintenance expense is recognized when repairs are performed. When properties other than land 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, a nondepreciable asset, are included in other income (see Note 3).
Revenue Recognition ------------------- Revenue is recognized proportionally as a shipment moves from origin to destination.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Required Accounting Changes --------------------------- 1994 - Effective January 1, 1994, NS Rail adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115), which addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. The implementation of SFAS 115 increased "Investments," the deferred tax liability and "Stockholders' equity" at December 31, 1994, and had no impact on earnings. The total unrealized holding gain on NS Rail's investments classified as "available for sale" at December 31, 1994, net of related deferred taxes is reflected as a separate component of "Stockholders' equity" in the Consolidated Balance Sheet at December 31, 1994 (see also Note 14). 1993 - Effective January 1, 1993, NS Rail adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" (SFAS 106), and Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" (SFAS 112). SFAS 106 requires accrual of the cost of specified health care and death benefits over an employee's creditable service period rather than, as was the previously prevailing practice, accounting for such expenses on a pay-as-you-go basis. SFAS 112 requires recognition of the cost of benefits payable to former or inactive employees after employment but before retirement on an accrual basis. For NS Rail, such postemployment benefits consist principally of benefit obligations under the long-term disability plan. NS Rail recognized the effects of these changes in accounting on the immediate recognition basis. The cumulative effect on years prior to 1993 of adopting SFAS 106 and 112 increased pretax expenses $336.3 million ($208.4 million after-tax), and $22.8 million ($14.2 million after-tax), respectively (see also Note 13). Also effective January 1, 1993, NS Rail adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires a liability approach for measuring deferred tax assets and liabilities based on differences between the financial statement and tax bases of assets and liabilities at each balance sheet date using enacted tax rates in effect when those differences are expected to reverse. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Under the deferred method, which applied for 1992 and prior years, deferred income taxes were recognized for income and expense items that were reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation, and deferred taxes were not adjusted for subsequent changes in tax rates. The cumulative effect on years prior to 1993 of adopting SFAS 109 increased net income $470.4 million (see also Note 4).
Reclassifications ----------------- Certain reclassifications of related party balances have been made in the December 31, 1993, Consolidated Balance Sheet to conform to the 1994 presentation.
2. RELATED PARTIES
General ------- NS is the parent holding company of NS Rail. The costs of functions performed by NS are allocated to NS Rail. Rail operations are coordinated at the holding company level by the NS Executive Vice President- Operations.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
2. RELATED PARTIES (continued)
Non-cash Dividends ------------------ In December 1994, NS Rail declared and issued to NS a non-cash dividend of $400.1 million which was settled by reduction of NS Rail's interest-bearing advances due from NS. On April 1, 1993, NS Rail declared and issued to NS a $104.7 million non-cash dividend representing the net assets of several non-railroad subsidiaries. These subsidiaries, principally involved in real estate, produce a small amount of rental income which are no longer part of NS Rail's results. Non-cash dividends are excluded from the Consolidated Statements of Cash Flows.
During 1993, NW issued a note for $112.6 million to an NS subsidiary for the purchase of a portfolio of short-term investments. This non-cash transaction was excluded from the Consolidated Statement of Cash Flows. Interest is applied to certain advances at the average NS yield on short-term investments and to the notes at specified rates. Included in interest income is $15.6 million, $6.7 million and $7.7 million in 1994, 1993 and 1992, respectively, related to amounts due from NS.
Intercompany Federal Income Tax Accounts ---------------------------------------- In accordance with the NS Tax Allocation Agreement, intercompany federal income tax accounts are recorded between companies in the NS consolidated group. At December 31, 1994 and 1993, NS Rail had intercompany federal income tax payables (which are included in "Deferred income taxes" in the Consolidated Balance Sheets) of $261.0 million and $175.1 million, respectively.
Cash Required for NS Stock Purchase Program and NS Debt ------------------------------------------------------- Since 1987, the NS Board of Directors has authorized the purchase and retirement of up to 65 million shares of NS common stock. Purchases under the programs initially were made with internally generated cash. Beginning in May 1990, NS financed some purchases with proceeds from the sale of commercial paper notes. As of December 31, 1994 and 1993, NS had recorded $517.3 million and $521.8 million, respectively, of notes under this program. In March 1991, NS issued $250 million of long-term notes and, in February 1992, NS issued an additional $250 million of long-term notes in part to repay a portion of the commercial paper notes, as well as to fund additional stock purchases.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
2. RELATED PARTIES (continued)
Since the first purchases in December 1987 and through December 31, 1994, NS has purchased and retired 59,160,800 shares of its common stock under these programs at a cost of $2.5 billion. Future purchases are dependent on market conditions, the economy, cash needs and alternative investment opportunities. Consistent with the earlier cash purchases, a significant portion of the funding for future NS stock purchases, either in the form of direct cash or cash used for debt service, will come from NS Rail through intercompany advances or dividends to NS.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
4. INCOME TAXES (continued)
1993 Federal Income Tax Rate Increase ------------------------------------- In August 1993, Congress enacted the Revenue Reconciliation Act of 1993, which increased the federal corporate income tax rate from 34% to 35%, retroactive to January 1, 1993. The tax rate increase had two components which, as required by SFAS 109, were recognized in 1993's earnings. The first component relates to the increased income tax rate's effect on 1993's earnings, which increased the provision for income taxes and reduced net income by $9.2 million. The second component increased the provision for the net deferred tax liability in the 1993 Consolidated Balance Sheet, which reduced net income by $51.6 million.
Inclusion in Consolidated Return -------------------------------- NS Rail is included in the consolidated federal income tax return of NS. The provision for current income taxes in the Consolidated Statements of Income reflects NS Rail's portion of NS' consolidated tax provision. Tax expense or tax benefit is recorded on a separate company basis whether or not such benefit would be currently available on a separate company basis.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
4. INCOME TAXES (continued)
Deferred Income Tax Expense --------------------------- Some income and expense items are reported differently for financial reporting and income tax purposes. Provisions for deferred income taxes were made in recognition of these differences in accordance with SFAS 109 for 1994 and 1993 (see Note 1) and with APB Opinion No. 11 for 1992. The components of deferred income tax expense for 1992 were as follows: employee separation costs, $48.9 million; property-related adjustments, principally depreciation, $41.4 million; casualty and other claims, $(5.0) million; tax benefit leases, $(7.2) million; employee benefits, $(2.8) million; and other items-net, $1.5 million--a total of $76.8 million.
Except for amounts for which a valuation allowance is provided, Management believes deferred tax assets will be realized. The valuation allowance for deferred tax assets as of January 1, 1993, was $3.4 million. The net change in the total valuation allowance was a $1.4 million decrease for both 1994 and 1993.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
4. INCOME TAXES (continued)
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 1989. The consolidated federal income tax returns for 1990 through 1992 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 these examinations.
Tax Benefit Leases ------------------ In January 1995, the United States Tax Court issued a preliminary decision that would disallow some of the tax benefits an NS Rail subsidiary purchased from a third party pursuant to a safe harbor lease agreement in 1981. Management continues to believe that NS Rail should realize no loss from this decision because the lease agreement provides for full indemnification if any such disallowance is sustained.
Corporate-Owned Life Insurance ------------------------------ The planned borrowing of $220 million of cash surrender value on certain corporate-owned life insurance policies resulted in this amount being reclassified in the December 31, 1993, Consolidated Balance Sheet from "Investments" to "Other current assets." The borrowing, which was completed in May 1994, resulted in the decline in "Other current assets."
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
6. PROPERTIES (continued)
Capitalized Interest -------------------- Total interest cost incurred on long-term debt for 1994, 1993 and 1992 was $46.1 million, $53.9 million and $62.5 million, respectively, of which $17.8 million, $21.6 million and $17.9 million was capitalized.
8. DEBT
Short-Term Debt --------------- Short-term debt consists of $27.2 million of notes assumed in connection with the 1990 acquisition of a coal terminal facility. The weighted average interest rate on these notes was 2.6% in 1994 and 2.3% in 1993.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
8. DEBT (continued)
A substantial portion of NS Rail's properties and certain investments in affiliated companies are pledged as collateral for much of the debt.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
9. LEASE COMMITMENTS (continued)
NS Rail has reached tentative understandings for leases on approximately 300 miles of road in North Carolina. These leases call for payment of an annual rental of $8 million in 1995, with inflation adjustments in succeeding years. These estimated payments are included in the future minimum operating lease commitments above.
11. STOCK
Preferred --------- There are 10,000,000 shares of no par value serial preferred stock authorized. This stock may be issued in series from time to time at the discretion of the Board of Directors with any series having such voting and other powers, dividends and other preferences as deemed appropriate at the time of issuance. At December 31, 1994 and 1993, 1,197,027 shares of $2.60 Cumulative Preferred Stock, Series A (Series A Stock) were issued, and 1,096,907 shares were held other than by subsidiaries. The Series A Stock has a $50 per share stated value. The Series A Stock is callable at any time at $50 per share plus accrued dividends and has one vote per share on all matters, voting as a single class with holders of other stock. On June 2, 1989, NS announced that it intended to purchase up to 250,000 shares of the outstanding Series A Stock during the subsequent two-year period. In May 1991, NS extended the previously announced stock purchase program through 1993. In March 1994, NS announced that it would continue purchasing up to 250,000 shares of the Series A Stock through 1996. NS had purchased 93,927 shares at a total cost of approximately $3.3 million as of December 31, 1994. NS purchased the shares in regular brokerage transactions on the open market at prevailing prices. At year end 1994 and 1993, NS held 94,022 shares and 77,721 shares, respectively.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
11. STOCK (continued)
Preference ---------- There are 10,000,000 shares of no par value serial preference stock authorized. None of these shares has been issued.
Common ------ There are 50,000,000 shares of no par value common stock with a stated value of $10 per share authorized. NS owns all 16,668,997 shares issued and outstanding at December 31, 1994 and 1993.
12. PENSION PLANS
NS Rail's defined benefit pension plans, which principally cover salaried employees, are part of NS' retirement plans. Pension benefits are based primarily on years of creditable service with NS and its participating subsidiary companies and compensation rates near retirement. Contributions to the plans are made on the basis of not less than the minimum funding standards set forth in the Employee Retirement Income Security Act of 1974, as amended. Assets in the plans consist mainly of common stocks. The following data relate principally to NS Rail's portion of the combined NS plans, since no separate NS Rail data are available.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
12. PENSION PLANS (continued)
Early Retirement Program in 1993 -------------------------------- During 1993, NS Rail completed a voluntary early retirement program for salaried employees that resulted in a $42.4 million charge in "Compensation and benefits" expense. The principal benefit for those who participated in the program was enhanced pension benefits, which are reflected in the accumulated benefit obligation.
Transfer of Pension Plan Assets ------------------------------- During 1991, the NS Retirement Plan was amended to establish a Section 401(h) account for the purpose of transferring a portion of pension plan assets in excess of the projected actuarial liability to fund current-year medical payments for retirees. No transfer was made in 1994. Since 1991, $42.5 million has been transferred from the pension plan to reimburse NS for retirees' medical payments. NS contributed equal amounts to a Voluntary Employee Beneficiary Association trust in those years to fund future benefit costs for retirees (see Note 13).
401(k) Plan ----------- NS Rail provides a 401(k) savings plan for salaried employees. Under the plan, NS Rail matches a portion of the employee contributions, subject to applicable limitations. NS Rail's expenses under this plan were $5.0 million, $5.1 million and $4.7 million in 1994, 1993 and 1992, respectively.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
NS Rail provides specified health care and death benefits to eligible retired employees and their dependents, principally salaried employees. Under the present plans, which may be amended or terminated at NS Rail's 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 Rail prior to retirement. Death benefits are determined based on various factors, including, in some cases, salary at time of retirement. NS Rail continues to fund benefit costs principally on a pay-as-you- go basis. However, in 1991, NS Rail established a Voluntary Employee Beneficiary Association (VEBA) account to fund a portion of the cost of future health care benefits for retirees. Although no 401(h) transfer occurred in 1994 (see Note 12), NS Rail made a corporate contribution of $10 million to the VEBA. Effective January 1, 1994, NS Rail amended the attribution period for postretirement health care benefits. The amendment provides for benefits to be determined ratably over a 10-year period based on creditable service commencing at age 45, or from date of hire if employment began after age 45. The amendment reduced the accumulated postretirement health care benefit obligation by $80 million and 1994's net periodic postretirement benefit cost by $13 million.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (continued)
For measurement purposes, a 12% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994; the rate in 1995 will be 11.5% and is assumed to decrease gradually to an ultimate rate of 6% for 2005 and remain at that level thereafter. The health care cost trend rate has a significant effect on the amounts reported in the financial statements. To illustrate, 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, 1994, by about $22 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year 1994 by about $4.1 million. 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). 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. Under collective bargaining agreements, NS Rail and certain subsidiaries participate in a multi-employer benefit plan, which provides certain postretirement health care and life insurance benefits to eligible union employees. Premiums under this plan are expensed as incurred and amounted to $4.8 million, $5.3 million and $5.6 million in 1994, 1993 and 1992, respectively.
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of "Cash and cash equivalents," "Accounts receivable," "Short-term debt" and "Accounts payable" approximate carrying values because of the short maturity of these financial instruments. The fair value of "Investments" approximated $658 million and $702 million as of December 31, 1994 and 1993, respectively. Quoted market prices were used to determine the fair value of marketable securities which, beginning in 1994 (see Note 1, "Required Accounting Changes"), were recorded at fair value. Carrying value adjustments, which are non- cash transactions, are not included in the Consolidated Statement of Cash Flows. Underlying net assets were used to estimate the fair value of non- marketable investments. For the remaining investments, consisting principally of corporate-owned life insurance, the carrying value
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
14. FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)
approximates fair value (see Note 5 for carrying values of "Investments").
Total unrealized holding gains from the implementation date of January 1, 1994, through December 31, 1994, declined $77.0 million. The reduced gains primarily reflect the change in NS stock price from $70-1/2 per share at December 31, 1993, to $60-5/8 per share at December 31, 1994. Stockholders' equity for the twelve months decreased $46.9 million as a result. The fair value of "Long-term debt," including current maturities, approximated $543 million at December 31, 1994, and $670 million at December 31, 1993. The fair values of debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, company rating and remaining maturity (see Note 8 for carrying values of "Long-term debt").
15. PARTIAL REVERSAL OF SPECIAL CHARGE IN 1993
Included in 1991 results was a $483 million special charge for labor force reductions and asset write-downs. However, based on NS Rail's success in eliminating reserve board positions in 1992 and 1993, and on events occurring in the third quarter of 1993, the accrual included in the 1991 special charge related to labor was reduced by $46 million which was reflected as a credit in "Compensation and benefits" expenses. The principal factor contributing to the reversal was the failure in 1993 to reach agreement on terms for certain further labor savings. Accordingly, it became apparent that a surplus existed in the labor portion of the provision established in the 1991 special charge.
16. NORFOLK AND WESTERN RAILWAY COMPANY AND SUBSIDIARIES (NW)--SUMMARIZED CONSOLIDATED FINANCIAL INFORMATION
NW is operated as an integral part of NS Rail. Revenues are allocated to NW based on actual traffic movements as determined by revenue ton miles within market groups. Expenses are allocated to NW based on appropriate criteria for the type of expense. The costs of functions performed by NS, the parent holding company of NS Rail, are also allocated to its rail operating subsidiaries.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
Effective January 1, 1994, NW adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). See Note 1 for a discussion of this new accounting pronouncement. The effect on NW, which was principally comprised of unrealized gain on its investments in NS stock, decreased "Short-term investments" (current assets) by $1.3 million, and increased "Investments" (noncurrent assets) by $46.4 million, "Deferred taxes" (noncurrent liabilities) by $16.9 million, and "Stockholder's equity" by $28.2 million as of December 31, 1994. Effective January 1, 1993, NW adopted SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions"; SFAS 109, "Accounting for Income Taxes"; and SFAS 112, "Employers' Accounting for Postemployment Benefits." See Note 1 for a discussion of these pronouncements (see NW's Consolidated Statement of Income for the cumulative effects of these changes).
17. CONTINGENCIES
Lawsuits -------- Norfolk Southern Railway Company and certain subsidiaries are defendants in numerous lawsuits relating principally to railroad operations. While the final outcome of these lawsuits cannot be predicted with certainty, it is the opinion of Management, after consulting with its legal counsel, that the amount of NS Rail's ultimate liability will not materially affect NS Rail's consolidated financial position.
Debt Guarantees --------------- As of December 31, 1994, NS Rail and certain subsidiaries were contingently liable as guarantors with respect to $72.5 million of indebtedness of related entities.
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
17. CONTINGENCIES (continued)
Change-in-Control Arrangements ------------------------------ NS 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.
Environmental Matters --------------------- NS Rail is subject to various jurisdictions' environmental laws and regulations. It is NS Rail's policy to record a liability where such liability or loss is probable and can be reasonably estimated. Claims, if any, against third parties for recovery of cleanup costs incurred by NS Rail are reflected as receivables in the balance sheet and are not netted against the associated NS Rail liability. Environmental engineers participate in ongoing evaluations of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are made. NS Rail also has established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives. Operating expenses for environmental protection totaled approximately $20 million in 1994 and are anticipated to decrease in 1995. Expenses in 1994 included $10.5 million associated with emergency response and cleanup resulting from release of arsenic acid from a tankcar leased by the shipper from a third party. Capital expenditures for environmental projects amounted to approximately $4 million in 1994 and are expected to be approximately $4 million in 1995. As of December 31, 1994, NS Rail's balance sheet included a reserve for environmental exposures in the amount of $50 million (of which $13 million is accounted for as a current liability), which is NS Rail's best estimate of ultimate liability at 80 identified locations. On that date, eight sites accounted for $23 million of the reserve, and no individual site was considered to be material. NS Rail anticipates that the majority 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 80 locations, NS Rail and/or certain of its subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs. With respect to known environmental sites (whether identified by NS Rail or by the EPA or comparable state authorities), estimates of NS Rail's ultimate potential financial exposure for a given site or in the aggregate for all such sites are necessarily imprecise because of the widely varying costs of currently available cleanup techniques, the likely development of new cleanup 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, particularly those classified as hazardous materials, in NS Rail's traffic mix can pose special risks that NS Rail works diligently to minimize. In addition, NS Rail has land holdings that serve as operating property, or which are leased or may have been leased and operated by others, or held for sale. Because certain conditions may exist on these properties related to environmental problems that are latent or undisclosed, there can be no assurance that NS Rail will not incur liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably now. Moreover, lawsuits and claims involving these and other now- unidentified environmental sites and matters are likely to arise from
Item 8. Financial Statements and Supplementary Data. (continued) ------ -------------------------------------------
17. CONTINGENCIES (continued)
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 and, after consulting with its legal counsel, Management believes that it has recorded appropriate estimates of liability for those environmental matters of which NS Rail is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in aggregate, will have a material adverse effect on NS Rail's financial position, results of operations or liquidity.
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors Norfolk Southern Railway Company:
We have audited the consolidated financial statements of Norfolk Southern Railway Company as listed in Item 8. In connection with our audits of the consolidated financial statements, we have also audited the consolidated financial statement schedule listed in Item 14(a)2. These consolidated financial statements and this consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and this consolidated financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norfolk Southern Railway Company and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, 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.
As discussed in Note 1, the Company changed its methods of accounting in 1994 by adopting the provisions of the Financial Accounting Standards Board's Statement 115, Accounting for Certain Investments in Debt and Equity Securities, and in 1993 by adopting the provisions of the Financial Accounting Standards Board's Statement 109, Accounting for Income Taxes; Statement 106, Employers' Accounting for Postretirement Benefits Other Than Pensions; and Statement 112, Employers' Accounting for Postemployment Benefits.
/s/ KPMG Peat Marwick LLP
Norfolk, Virginia January 24, 1995
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting ------ ----------------------------------------------------------- and Financial Disclosure. ------------------------
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant. ------- --------------------------------------------------
Item 11.
Item 11. Executive Compensation. ------- ----------------------
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners ------- ----------------------------------------------- and Management. --------------
and
Item 13.
Item 13. Certain Relationships and Related Transactions. ------- ----------------------------------------------
In accordance with General Instruction G(3), the information called for by Part III is incorporated herein by reference from Norfolk Southern Railway's definitive Proxy Statement, to be dated April 18, 1995, for the Norfolk Southern Railway Annual Meeting of Stockholders to be held on May 23, 1995, which definitive Proxy Statement will be filed electronically with the Commission pursuant to Regulation 14A. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I hereof beginning on page 17 under "Executive Officers of the Registrant."
PART IV
Item l4. Exhibits, Financial Statement Schedule, and Reports on ------- ------------------------------------------------------- Form 8-K. --------
(a) The following documents are filed as part of this report:
1. Index to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1994, 1993 and 1992 38
Consolidated Balance Sheets As of December 31, 1994 and 1993 39
Consolidated Statements of Cash Flows Years ended December 31, 1994, 1993 and 1992 40 - 41
Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1994, 1993 and 1992 42
Notes to Consolidated Financial Statements 43 - 61
Independent Auditors' Report 62
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 68
Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes.
3. Exhibits
Exhibit Number Description ------- ------------------------------------------------- 3 Articles of Incorporation and Bylaws -
3(i) The amended Restated Articles of Incorporation of Norfolk Southern Railway Company are incorporated herein by reference from Exhibit 3(a) of Norfolk Southern Railway's 1990 Annual Report on Form 10-K. Item l4. Exhibits, Financial Statement Schedule, and Reports on ------- ------------------------------------------------------- Form 8-K. (continued) -------- Exhibit Number Description ------- ------------------------------------------------- 3(ii) The Bylaws of Norfolk Southern Railway Company, as last amended March 3, 1993, are incorporated herein by reference from Exhibit 3(b) of Norfolk Southern Railway's 1992 Annual Report on Form 10-K.
4 Instruments Defining the Rights of Security Holders, Including Indentures -
In accordance with Item 601(b)(4)(iii) of Regulation S-K, copies of instruments of Norfolk Southern Railway and its subsidiaries with respect to the rights of holders of long-term debt are not filed herewith, or incorporated by reference, but will be furnished to the Commission upon request.
10 Material Contracts -
(a) The 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) of Southern's 1987 Annual Report on Form 10-K) - is filed herewith electronically.
21 Subsidiaries of the Registrant.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed for the three months ended December 31, 1994.
(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.
POWER OF ATTORNEY ----------------- Each person whose signature appears below under "SIGNATURES" hereby authorizes Henry C. Wolf and John S. Shannon, 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 John S. Shannon, or either of them, as attorneys-in-fact to sign on his behalf, individually and in each capacity stated below, and to file, any and all amendments to this report.
SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Norfolk Southern Railway Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 21st day of March, 1995.
NORFOLK SOUTHERN RAILWAY COMPANY
By /s/ David R. Goode ----------------------------------------- (David R. Goode, President and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 21st day of March, 1995, by the following persons on behalf of Norfolk Southern Railway Company and in the capacities indicated.
Signature Title --------- -----
/s/ David R. Goode -------------------------- President and Chief Executive (David R. Goode) Officer and Director (Principal Executive Officer)
/s/ John P. Rathbone -------------------------- Vice President and Controller (John P. Rathbone) (Principal Accounting Officer)
/s/ Henry C. Wolf -------------------------- Vice President-Finance (Henry C. Wolf) (Principal Financial Officer)
Signature Title --------- -----
/s/ John S. Shannon -------------------------- Director (John S. Shannon)
/s/ Stephen C. Tobias -------------------------- Director (Stephen C. Tobias)
/s/ John R. Turbyfill -------------------------- Director (John R. Turbyfill)
/s/ D. Henry Watts -------------------------- Director (D. Henry Watts)
/s/ Henry C. Wolf -------------------------- Director (Henry C. Wolf)
EXHIBIT INDEX -------------
Electronic Submission Exhibit Page Number Description Number ---------- ------------------------------------------- ------
21 Subsidiaries of Norfolk Southern Railway. 71
27 Financial Data Schedule (Required to be electronically submitted for use by the Securities and Exchange Commission only and not deemed part of this filing). 72