-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BrF/KD9Mn8JS8gSYiTYjhul+an34d8bLIp/pqLqHzhG+jmlzN1hJ6d+xcQ2LQFRX Z/To6TCSsDgASo5kOh+D2w== 0000092275-00-000015.txt : 20000307 0000092275-00-000015.hdr.sgml : 20000307 ACCESSION NUMBER: 0000092275-00-000015 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000306 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORFOLK SOUTHERN RAILWAY CO/VA CENTRAL INDEX KEY: 0000092275 STANDARD INDUSTRIAL CLASSIFICATION: RAILROADS, LINE-HAUL OPERATING [4011] IRS NUMBER: 536002016 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-00743 FILM NUMBER: 561843 BUSINESS ADDRESS: STREET 1: THREE COMMERCIAL PL CITY: NORFOLK STATE: VA ZIP: 23510 BUSINESS PHONE: 7576292682 FORMER COMPANY: FORMER CONFORMED NAME: SOUTHERN RAILWAY CO DATE OF NAME CHANGE: 19910117 10-K405 1 NORFOLK SOUTHERN RAILWAY CO 10-K405 FYE 12/31/99 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------- FORM 10-K405 (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR l5(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------------- ---------------- Commission file numbers 1-743; 1-3744; 1-4793; 1-5462 NORFOLK SOUTHERN RAILWAY COMPANY - ------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Virginia 53-6002016 - ------------------------------------------------ --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Three Commercial Place, Norfolk, Virginia 23510-2191 - ------------------------------------------------ --------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (757) 629-2680 ---------------------- Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS SO REGISTERED. EACH CLASS REGISTERED ON NEW YORK STOCK EXCHANGE: Norfolk and Western Railway Company 4.85% Subordinated Income Debentures, due November 15, 2015; Guarantee of Norfolk Southern Railway Company with respect to $1,754,900 principal amount of Norfolk and Western Railway Company 4.85% Subordinated Income Debentures due November 15, 2015; The Virginian Railway Company 6% Subordinated Income Debentures, due August 1, 2008; Guarantee of Norfolk Southern Railway Company with respect to $4,466,000 principal amount of The Virginian Railway Company 6% Subordinated Income Debentures due August 1, 2008; Norfolk Southern Railway Company $2.60 Cumulative Preferred Stock, Series A (No Par Value, $50 Stated Value). Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K405 or any amendment to this Form 10-K405. (X) The aggregate market value of the voting stock held by nonaffiliates as of January 31, 2000: $34,737,626. The number of shares outstanding of each of the registrant's classes of Common Stock, as of January 31, 2000: 16,668,997. PAGE 2 DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive proxy statement (to be dated April 14, 2000), to be filed electronically pursuant to Regulation 14A not later than 120 days after the end of the fiscal year, are incorporated by reference in Part III. PAGE 3 TABLE OF CONTENTS ----------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR) Page ---- Part I. 1. Business 4 2. Properties 4 3. Legal Proceedings 16 4. Submission of Matters to a Vote of Security Holders 16 Executive Officers of the Registrant 17 Part II. 5. Market for Registrant's Common Stock and Related Stockholder Matters 23 6. Selected Financial Data 24 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 25 7A. Quantitative and Qualitative Disclosures About Market Risk 39 8. Financial Statements and Supplementary Data 40 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 66 Part III.10. Directors and Executive Officers of the Registrant 67 11. Executive Compensation 67 12. Security Ownership of Certain Beneficial Owners and Management 67 13. Certain Relationships and Related Transactions 67 Part IV. 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 68 Index to Consolidated Financial Statement Schedule 68 Power of Attorney 73 Signatures 73 Exhibit Index 77 PAGE 4 PART I ------ NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR) Item 1. Business. - ------ -------- and Item 2. Properties. - ------ ---------- GENERAL - Norfolk Southern Railway Company (Norfolk Southern Railway) was incorporated in 1894 under the name Southern Railway Company (Southern) in the Commonwealth of Virginia and, together with its consolidated subsidiaries (collectively NS Rail), is primarily engaged in the transportation of freight by rail. On June 1, l982, Southern and Norfolk and Western Railway Company (N&W) became subsidiaries of Norfolk Southern Corporation (NS), a transportation holding company. Effective Dec. 31, 1990, NS transferred all the common stock of N&W to Southern, and Southern's name was changed to Norfolk Southern Railway Company. Effective Sept. 1, 1998, N&W was merged with and into Norfolk Southern Railway. 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 Dec. 31, 1999, 1,197,027 shares of Norfolk Southern Railway's $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of which 1,096,907 shares were held by other than subsidiaries. The Series A Stock is entitled to one vote per share, is nonconvertible and is traded on the New York Stock Exchange. As of Dec. 31, 1999, NS held a total of 176,705 shares of Series A Stock; consequently, as of the same date, NS held 94.8 percent of the voting stock of Norfolk Southern Railway. OPERATION OF A PORTION OF THE CONRAIL RAIL ASSETS - On June 1, 1999, Norfolk Southern Railway and CSX Corporation (CSX), through its railroad subsidiary, began operating separate portions of Conrail's rail routes and assets. Substantially all such assets are owned by two wholly owned subsidiaries of Consolidated Rail Corporation (CRC); one of those subsidiaries, Pennsylvania Lines LLC (PRR), has entered into various operating and leasing arrangements, more particularly described in Note 2 on Page 48, with Norfolk Southern Railway. Certain rail assets (Shared Assets Areas) still are owned by CRC, which operates them for joint and exclusive use by Norfolk Southern Railway and the rail subsidiary of CSX. PAGE 5 Operation of the PRR routes and assets increased the size of the system over which Norfolk Southern Railway provides service by nearly 50% and afforded access to the New York metropolitan area, to much of the Northeast and to most of the major East Coast ports north of Norfolk, Va. Also, the leasing arrangements with PRR augmented Norfolk Southern Railway's locomotive, freight car and intermodal fleet. OPERATIONS - As of Dec. 31, 1999, NS Rail operated approximately 21,800 miles of road in the states of Alabama, Delaware, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri, New Jersey, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Virginia and West Virginia, and in the Province of Ontario, Canada. Of this total, about 12,000 miles are owned with the balance operated under lease or trackage rights; most of this total is main line track. In addition, NS Rail operates almost 17,000 miles of passing, industrial, yard and side tracks. In addition to the lines leased from Conrail previously discussed, NS Rail has major leased lines between Cincinnati, Ohio, and Chattanooga, Tennessee, and operates over trackage owned by North Carolina Railway Company (NCRR). The Cincinnati-Chattanooga lease, covering about 335 miles, expires in 2026, and is subject to an option to extend the lease for an additional 25 years, at terms to be agreed upon. Operations over the approximately 330 miles of tracks of NCRR, previously under a 100-year lease which expired on Dec. 31, 1994, are now under a trackage rights agreement. The term of the agreement is 15 years with NS Rail having the right to renew for two additional 15-year periods. The new arrangement resolved all outstanding litigation between NS Rail and NCRR and settled a number of contested real property issues. The agreement also includes very broad dispute resolution provisions. NS Rail's lines carry raw materials, intermediate products and finished goods primarily in the Southeast, East 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, Virginia; Morehead City, North Carolina; Charleston, South Carolina; Savannah and Brunswick, Georgia; Jacksonville, Florida; Baltimore, Maryland; Philadelphia, Pennsylvania/Camden, New Jersey; Wilmington, Delaware; and the Ports of New York/New Jersey. Gulf Coast ports served include Mobile, Alabama, and New Orleans, Louisiana. NS Rail's lines reach most of the larger industrial and trading centers of the Southeast, East 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, Jacksonville, Cleveland, Newark, Pittsburgh, Philadelphia and Baltimore are among the leading centers originating and terminating freight traffic on the system. In addition, a haulage arrangement with Florida East Coast Railway Company allows NS Rail to provide single-line service to and PAGE 6 from south Florida, including the port cities of Miami, West Palm Beach and Fort Lauderdale. The system's lines also reach many individual industries, mines (in western Virginia, eastern Kentucky, southern and northern West Virginia and western Pennsylvania) and businesses located in smaller communities in its service area. The traffic corridors carrying the heaviest volumes of freight include those from the Appalachian coal fields of Virginia, West Virginia and Kentucky, to Norfolk and Sandusky, Ohio; Buffalo to Chicago and Kansas City; Chicago to Jacksonville (via Cincinnati, Chattanooga and Atlanta); and Washington, D.C./Hagerstown, Maryland, to New Orleans (via Atlanta and Birmingham); and the New Jersey area to Chicago (via Allentown and Pittsburgh). Buffalo, Chicago, Hagerstown, Jacksonville, Kansas City, Memphis, New Orleans and St. Louis are major gateways for interterritorial system traffic. RAILWAY OPERATING REVENUES - NS Rail's total railway operating revenues were $5.1 billion in 1999. Revenue, shipments and revenue yield by principal railway operating revenue sources for the past five years are set forth in the following table:
Year Ended December 31, Principal Sources of ------------------------------------------------ Railway Operating Revenues 1999 1998 1997 1996 1995 - -------------------- ---- ---- ---- ---- ---- (Revenues in millions, shipments in thousands, revenue yield in dollars per shipment) COAL Revenues $1,315 $1,252 $1,301 $1,305 $1,268 % of total revenues 26% 30% 31% 32% 32% Shipments 1,519 1,310 1,324 1,310 1,267 % of total shipments 25% 27% 28% 29% 29% Revenue Yield $ 866 $ 956 $ 983 $ 996 $1,001 AUTOMOTIVE Revenues $ 740 $ 566 $ 492 $ 489 $ 449 % of total revenues 14% 13% 11% 12% 11% Shipments 612 487 361 354 328 % of total shipments 10% 10% 8% 8% 7% Revenue Yield $1,209 $1,162 $1,364 $1,379 $1,368 CHEMICALS Revenues $ 720 $ 574 $ 585 $ 560 $ 541 % of total revenues 14% 13% 14% 14% 14% Shipments 475 401 405 385 374 % of total shipments 8% 8% 8% 8% 8% Revenue Yield $1,516 $1,431 $1,446 $1,456 $1,447 PAPER/CLAY/FOREST Revenues $ 575 $ 534 $ 539 $ 513 $ 537 % of total revenues 11% 13% 13% 12% 13% Shipments 465 445 457 438 459 % of total shipments 8% 9% 9% 10% 10% Revenue Yield $1,237 $1,200 $1,178 $1,171 $1,170 PAGE 7 Year Ended December 31, Principal Sources of ------------------------------------------------ Railway Operating Revenues 1999 1998 1997 1996 1995 - -------------------- ---- ---- ---- ---- ---- (Revenues in millions, shipments in thousands, revenue yield in dollars per shipment) METALS/CONSTRUCTION Revenues $ 562 $ 373 $ 368 $ 354 $ 349 % of total revenues 11% 9% 9% 9% 8% Shipments 587 372 374 359 367 % of total shipments 10% 8% 8% 8% 8% Revenue Yield $ 957 $1,003 $ 985 $ 986 $ 951 AGR./CONSUMER PRODUCTS/ GOVT. Revenues $ 453 $ 383 $ 391 $ 393 $ 394 % of total revenues 9% 9% 9% 9% 10% Shipments 407 355 366 376 391 % of total shipments 7% 8% 8% 8% 9% Revenue Yield $1,113 $1,079 $1,065 $1,045 $1,007 INTERMODAL (Trailers, Containers and RoadRailers) Revenues $ 749 $ 539 $ 547 $ 487 $ 474 % of total revenues 15% 13% 13% 12% 12% Shipments 1,896 1,443 1,472 1,331 1,263 % of total shipments 32% 30% 31% 29% 29% Revenue Yield $ 395 $ 374 $ 372 $ 366 $ 376 Total Railway Operating Revenues $5,114 $4,221 $4,223 $4,101 $4,012 Total Railway Shipments 5,961 4,813 4,759 4,553 4,449 Railway Revenue Yield $ 858 $ 877 $ 887 $ 901 $ 902
Note: Other railway revenues (principally switching and demurrage) have been allocated to revenues reported for each commodity group. Shipments include general merchandise and coal rail carloads and intermodal rail and RoadRailer(RT) units. PAGE 8 COAL TRAFFIC - Coal, coke and iron ore -- most of which is bituminous coal -- is NS Rail's largest commodity group as measured by revenues. NS Rail originated 138 million tons of coal, coke and iron ore in 1999 and handled a total of 158 million tons. Originated tonnage and total tons handled increased due to the commencement of operations in the Northern Region. Revenues from coal, coke and iron ore account for about 26 percent of NS Rail's total railway operating revenues. The following table shows total coal, coke and iron ore tonnage originated on line, received from connections and handled for the past five years: Tons of Coal, Coke and Iron Ore (Millions) ------------------------------------------
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Originated 138 119 119 117 114 Received 20 15 15 13 11 --- --- --- --- --- Handled 158 134 134 130 125 === === === === ===
Of the 138 million tons of coal, coke and iron ore originated on NS Rail's lines in 1999, the approximate breakdown by origin state was as follows:
Origin State Millions of Tons ------------ ---------------- West Virginia 45 Virginia 31 Kentucky 24 Pennsylvania 15 Indiana 7 Ohio 6 Alabama 4 Illinois 3 Tennessee 1 Other 2 --- 138 ===
Of the 158 million tons handled, approximately 18 million moved for export, principally through NS Rail's pier facilities at Norfolk (Lamberts Point), Virginia; 22 million moved to domestic and Canadian steel industries; 108 million of steam coal moved to electric utilities; and 10 million moved to other industrial and miscellaneous users. NS Rail moved 9 million tons of originated coal, coke and iron ore to various docks on the Ohio River, and 7 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. PAGE 9 Total coal handled through all system ports in 1999 was 38 million tons. Of this total, 53 percent, or 20 million tons (including coastwise traffic), moved through Lamberts Point, a 26 percent decrease compared with the 27 million tons handled in 1998. The quantities of NS Rail export coal handled through Lamberts Point for the past five years were as follows: Export Coal through Lamberts Point (Millions of tons) ----------------------------------
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- 17 24 28 26 25
See the discussion of coal traffic, by type of coal, in Part II, Item 7, "Management's Discussion and Analysis." MERCHANDISE TRAFFIC - The merchandise traffic group consists of intermodal and general merchandise, which consists of five major commodity groupings: automotive; chemicals; paper, clay and forest products; metals and construction; and agriculture, consumer products and government. Total merchandise revenues in 1999 were $3.9 billion, a 31 percent increase, compared with 1998. Merchandise carloads and intermodal units handled in 1999 were 4.44 million, compared with 3.50 million handled in 1998, an increase of 27 percent. The increases in revenues and carloads reflect the commencement of operations in the Northern Region. In 1999, 136 million tons of merchandise freight, or approximately 67 percent of total merchandise tonnage handled by NS Rail, originated online. The balance of merchandise traffic was received from connecting carriers, usually at interterritorial gateways. The principal interchange points for NS Rail-received traffic included Chicago, Memphis, New Orleans, Cincinnati, Kansas City, Detroit, Hagerstown, St. Louis/East St. Louis and Louisville. Revenues in all six market groups comprising merchandise traffic increased in 1999, due to the commencement of operations in the Northern Region. See the discussion of general merchandise rail traffic by commodity group and intermodal rail traffic in Part II, Item 7, "Management's Discussion and Analysis." PAGE 10 OPERATING STATISTICS - The following table sets forth certain statistics relating to NS Rail's operations for the past five years, including operations in the Northern Region that commenced June 1, 1999:
Year Ended December 31, -------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Revenue ton miles (billions) 165 133 136 130 127 Freight train miles traveled (millions) 61.5 53.0 49.7 49.4 48.5 Revenue per ton mile $0.0314 $0.0316 $0.0311 $0.0316 $0.0317 Revenue tons per train 2,691 2,517 2,732 2,625 2,611 Revenue ton miles per man-hour worked 2,560 2,635 2,905 2,764 2,679 Percentage ratio of railway operating expenses to railway operating revenues 86.2% 75.1% 71.3% 71.6% 73.5%
FREIGHT RATES - In 1999, NS Rail continued its reliance on private contracts and exempt price quotes as the predominant pricing mechanism. Thus, a major portion of NS Rail's freight business is not currently economically regulated by the government. In general, market forces have been substituted for government regulation and now are the primary determinant of rail service prices. In 1999, NS Rail was found by the STB not to be "revenue adequate" based on results for the year 1998. A railroad is "revenue adequate" under the applicable law when its return on net investment exceeds the rail industry's composite cost of capital. PASSENGER OPERATIONS - Regularly scheduled passenger operations on NS Rail's lines consist of Amtrak trains operating between Alexandria and New Orleans, and between Charlotte and Selma, North Carolina. Commuter trains are operated on the NS Rail line between Manassas and Alexandria under contract with two transportation commissions of the Commonwealth of Virginia. NS Rail also leases the Chicago to Manhattan, Illinois, line to the Commuter Rail Division of the Regional Transportation Authority of Northeast Illinois. Since June 1, 1999, Norfolk Southern Railway Company has operated former Conrail lines on which Amtrak conducts regularly scheduled passenger operations between Chicago, Illinois, and Detroit, Michigan, and between Chicago and Harrisburg, Pennsylvania. All of these services are under contracts providing for reimbursement of related expenses incurred by NS Rail. Also since June 1, 1999, Norfolk Southern Railway has been providing freight service over former Conrail lines with significant ongoing Amtrak and commuter passenger operations, and is conducting freight operations over some trackage owned by Amtrak or by New Jersey Transit, the Southeastern Pennsylvania Transportation Authority, Metro- North Commuter Railway Company and Maryland DOT. Finally, passenger operations are conducted either by Amtrak or by the commuter agencies over trackage owned by Pennsylvania Lines LLC, or by Conrail in the Shared Assets Areas. PAGE 11 In addition, through its operation of PRR's routes, Norfolk Southern Railway provides freight service over lines with significant ongoing Amtrak and commuter passenger operations, and conducts freight operations over some trackage owned by Amtrak or by commuter entities. RAILWAY PROPERTY: EQUIPMENT - As of December 31, 1999, NS Rail owned or leased the following units of equipment:
Number of Units ---------------------------- Capacity Owned* Leased** Total of Equipment ----- ------ ----- ------------ Type of Equipment - ----------------- Locomotives: (Horsepower) Multiple purpose 2,232 949 3,181 10,315,300 Switching 110 113 223 325,800 Auxiliary units 59 18 77 -- ------ ------ ------- ---------- Total locomotives 2,401 1,080 3,481 10,641,100 ====== ====== ======= ========== Freight Cars: (Tons) Hopper 20,605 5,796 26,401 2,773,704 Box 18,993 5,657 24,650 1,914,567 Covered Hopper 12,073 3,737 15,810 1,711,311 Gondola 28,591 12,534 41,125 4,380,293 Flat 4,181 1,035 5,216 392,663 Caboose 190 78 268 -- Other 793 -- 793 63,656 ------ ------ ------- ---------- Total freight cars 85,426 28,837 114,263 11,236,194 ====== ====== ======= ========== Other: Work equipment 6,005 2,151 8,156 Vehicles 3,685 1,720 5,405 Highway trailers and containers 1,871 5,319 7,190 Miscellaneous 1,497 6,404 7,901 ------ ------ ------- Total other 13,058 15,594 28,652 ====== ====== =======
* Includes equipment leased to outside parties and equipment subject to equipment trusts, conditional sale agreements and capitalized leases. ** Includes 1,020 locomotives, 20,351 freight cars and 3,880 units of other equipment leased from PRR. PAGE 12 In addition, NS Rail has leased locomotives to meet immediate needs. As of Dec. 31, 1999, NS Rail had 555 units under several short- term leases, most of which expire in the first quarter of 2000. The following table indicates the number and year built for locomotives and freight cars owned at Dec. 31, 1999:
Year Built ----------------------------------------------------------- 1989- 1983- 1982 & 1999 1998 1997 1996 1995 1994 1988 Before Total ---- ---- ---- ---- ---- ---- ---- ------ ----- Locomotives: Number of units 147 119 120 119 125 289 327 1,155 2,401 Percent of fleet 6 5 5 5 6 12 13 48 100% Freight cars: Number of units 438 1,167 531 787 1,036 6,610 1,335 73,522 85,426 Percent of fleet 1 1 1 1 1 8 1 86 100%
The average age of the freight car fleet at Dec. 31, 1999, was 24.4 years. During 1999, 423 freight cars were retired. As of Dec. 31, 1999, the average age of the locomotive fleet was 15.4 years. During 1999, 13 locomotives, the average age of which was 22.7 years, were retired. Since 1988, about 29,000 coal cars have been rebodied. As a result, the remaining serviceability of the freight car fleet is greater than may be inferred from the high percentage of freight cars built in earlier years. Ongoing freight car and locomotive maintenance programs are intended to ensure the highest standards of safety, reliability, customer satisfaction and equipment marketability. In past years, the freight car bad order ratio reflected the storage of certain types of cars which were not in high demand. The ratio has declined more recently as a result of a disposition program for underutilized, unserviceable and overage revenue cars. In this connection, an orderly disposition of 17,000 freight cars, begun in October 1994, was completed in 1997. The locomotive bad order ratio rose in 1997, particularly in the early months of the year, as older units required additional servicing and some new units were out-of-service related to warranty work. By year-end 1997, the locomotive bad order ratio had returned to a level nearer that of prior years. The increase in the locomotive bad order ratio in 1999 was primarily due to the maintenance requirements of units being rented to meet short-term needs and to weather-related failures. PAGE 13 Annual Average Bad Order Ratio --------------------------------
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Freight Cars (excluding cabooses): NS Rail 3.3% 4.1% 4.6% 4.8% 5.8% Locomotives: NS Rail 5.3% 4.3% 5.0% 4.5% 4.7%
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) ranges from 100 to 140 pounds per yard. Of the approximately 31,900 miles of track maintained as of Dec. 31, 1999, about 21,800 were laid with welded rail. The density of traffic on running tracks (main line trackage plus passing tracks) during 1999 was as follows:
Gross tons of freight carried per track mile Track miles of Percent (Millions) running tracks* of total --------------- -------------- -------- 0-4 9,070 39 5-19 6,561 29 20 and over 7,372 32 ------ --- 23,003 100 ====== ===
* Excludes trackage rights and includes track in the Northern Region, where operations commenced June 1, 1999. The following table summarizes certain information about track roadway additions and replacements during the past five years:
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Track miles of rail installed 403 429 451 401 403 Miles of track surfaced 5,087 4,715 4,703 4,686 4,668 New crossties installed (millions) 2.3 2.0 2.2 1.9 2.0
MICROWAVE SYSTEM - The NS Rail microwave system, consisting of 8,140 radio path miles, 430 active stations and 4 passive repeater stations, provides communications between most operating locations. The microwave system is used primarily 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. PAGE 14 TRAFFIC CONTROL - Of a total of 21,800 road miles operated by NS Rail, excluding trackage rights over foreign lines, 8,370 road miles are governed by centralized traffic control systems (of which 1,000 miles are controlled by data radio from 78 microwave site locations and 460 miles are cab-signal only) and 3,070 road miles are equipped for automatic block system operation. COMPUTERS - Data processing facilities connect the yards, terminals, transportation offices, rolling stock repair points, sales offices and other key system locations to the central computer complex in Atlanta, Georgia. Operating and traffic data are compiled and stored to provide customers with information on their shipments throughout the system. Data processing facilities are capable of providing current information on the location of every train and each car on line, as well as related waybill and other train and car movement data. Additionally, these facilities afford substantial capacity for, and are utilized to assist management in the performance of, a wide variety of functions and services, including payroll, car and revenue accounting, billing, material management activities and controls, and special studies. OTHER - The railroads have extensive facilities for support of operations, including freight depots, car construction shops, maintenance shops, office buildings, and signals and communications facilities. ENCUMBRANCES - Certain railroad equipment is subject to the prior lien of equipment financing obligations amounting to approximately $930 million as of Dec. 31, 1999, and $728 million at Dec. 31, 1998. CAPITAL EXPENDITURES - Capital expenditures for road, equipment and other property for the past five years were as follows (including capitalized leases): Capital Expenditures -------------------------------------------
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (In millions of dollars) Road $ 559 $ 583 $ 580 $ 428 $ 379 Equipment 356 419 304 326 333 Other property -- -- -- -- 1 ------ ------ ------ ------ ------ Total $ 915 $1,002 $ 884 $ 754 $ 713 ====== ====== ====== ====== ======
Capital spending and maintenance programs are and have been designed to assure the ability to provide safe, efficient and reliable transportation services. For 2000, NS Rail has budgeted approximately $747 million of capital spending. In addition, NS Rail plans to enter into a lease financing arrangement for 150 new locomotives, and NS Rail expects to lease 475 articulated bilevels for automotive service. PAGE 15 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" on Page 37 in Part II, Item 7, "Management's Discussion and Analysis," and in Note 15 to the Consolidated Financial Statements on Page 62. EMPLOYEES - NS Rail employed an average of 30,897 employees in 1999, compared with an average of 24,185 in 1998 (including Norfolk Southern Corporation's employees whose primary duties relate to rail operations). The increase reflects the substantial number of Conrail employees that became NS Rail employees on June 1, 1999. The approximate average cost per employee during 1999 was $48,600 in wages and $17,400 in employee benefits. Approximately 85 percent of NS Rail's employees are represented by labor unions under collective bargaining agreements with 14 different labor organizations. See the discussion of "Labor Agreements" on Page 38 in Part II, Item 7, "Management's Discussion and Analysis." GOVERNMENT REGULATION - In addition to environmental, safety, securities and other regulations generally applicable to all businesses, NS Rail is subject to regulation by the STB, which succeeded the ICC on Jan. 1, 1996. The STB has jurisdiction over some rates, routes, conditions of service and the extension or abandonment of rail lines. The STB also has jurisdiction over the consolidation, merger or acquisition of control of and by rail common carriers. The Department of Transportation regulates certain track and mechanical equipment standards. The relaxation of economic regulation of railroads, begun over a decade ago by the ICC under the Staggers Rail Act of 1980, has continued under the STB, and additional rail business could be exempted from regulation in the future. Significant exemptions are TOFC/COFC (i.e., "piggyback") business, rail boxcar traffic, lumber, manufactured steel, automobiles and certain bulk commodities such as sand, gravel, pulpwood and wood chips for paper manufacturing. Transportation contracts on regulated shipments effectively remove those shipments from regulation as well. About 80 percent of NS Rail's freight revenues come from either exempt traffic or traffic moving under transportation contracts. Efforts may be made in 2000 to re-subject the rail industry to unwarranted federal economic regulation. The Staggers Rail Act of 1980, which substantially reduced such regulation, encouraged and enabled rail carriers to innovate and to compete for business, thereby contributing to the economic health of the nation and to the revitalization of the industry. Accordingly, NS Rail and other rail carriers vigorously will oppose these counterproductive efforts to reimpose or to authorize reimposing such economic regulation. COMPETITION - There is continuing strong competition among rail, water and highway carriers. Price is usually only one factor of importance as shippers and receivers choose a transport mode and specific hauling company. Inventory carrying costs, service PAGE 16 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 rail competitor is the CSX system; both operate throughout much of the same territory. Other railroads also operate in parts of the territory. NS Rail also competes with motor carriers, water carriers and with shippers who have the additional option of handling their own goods in private carriage. Certain cooperative strategies between railroads and between railroads and motor carriers enable carriers to compete more effectively in specific markets. Item 3. Legal Proceedings. - ------ ----------------- None. Item 4. Submission of Matters to a Vote of Security Holders. - ------ --------------------------------------------------- There were no matters submitted to a vote of security holders during the fourth quarter of 1999. PAGE 17 Executive Officers of the Registrant. - ------------------------------------ Norfolk Southern Railway's officers are elected annually by the Board of Directors at its first meeting held after the annual meeting of stockholders, and they hold office until their successors are elected. There are no family relationships among the officers, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was selected. The following table sets forth certain information, as of February 1, 2000, relating to these officers: Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ------------------------------- David R. Goode, 59, Present position since September President and 1992. Also, Chairman, President, Chief Executive Officer and Chief Executive Officer of Norfolk Southern Corporation since September 1992. L. I. Prillaman, 56, Present position since August 1998. Vice President and Also, Vice Chairman and Chief Chief Marketing Officer Marketing Officer of Norfolk Southern Corporation since August 1998. Served as Vice President and Chief Traffic Officer of Norfolk Southern Railway and Executive Vice President-Marketing of Norfolk Southern Corporation from October 1995 to August 1998, and prior thereto was Vice President- Properties. Stephen C. Tobias, 55, Present position since August 1998. Vice President and Also, Vice Chairman and Chief Chief Operating Officer Operating Officer of Norfolk Southern Corporation since August 1998, and prior thereto was Vice President of Norfolk Southern Railway and Executive Vice President-Operations of Norfolk Southern Corporation. Henry C. Wolf, 57, Present position since August 1998. Vice President and Also, Vice Chairman and Chief Chief Financial Officer Financial Officer of Norfolk Southern Corporation since August 1998, and prior thereto was Vice President-Finance of Norfolk Southern Railway and Executive Vice President-Finance of Norfolk Southern Corporation. PAGE 18 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ------------------------------- Paul N. Austin, 56, Present position since September Vice President-Human Resources 1998. Also, Vice President and Assistant to Chairman, President and Chief Executive Officer of Norfolk Southern Corporation since November 1, 1999. Served as Vice President-Human Resources and Assistant to Chairman of Norfolk Southern Corporation from September 1998 to November 1999, and prior thereto was Vice President- Personnel and Assistant to Chairman. James C. Bishop, Jr., 63, Present position since March 1996. Vice President-Law Also, Executive Vice President-Law of Norfolk Southern Corporation since March 1996, and prior thereto was Vice President-Law. R. Alan Brogan, 59, Present position since April 1998. Vice President-Corporate Also, Executive President Norfolk Southern Intermodal since December 1, 1999, and prior thereto was Vice President-Transportation Logistics of Norfolk Southern Railway and Executive Vice President-Corporate of Norfolk Southern Corporation. David A. Cox, 64, Present position since December Vice President-Properties 1995. Also, Senior Vice President- Properties and Development of Norfolk Southern Corporation since October 1, 1999, and prior thereto was Vice President-Properties. Timothy P. Dwyer, 50, Present position since August 1998. Vice President-Marketing Services Also, Vice President-Marketing Services of Norfolk Southern Corporation since August 1998. Served as Senior Vice President- Operations of Conrail from June 1998 to August 1998, and prior thereto was Senior Vice President- Unit Train Service Group of Conrail. Nancy S. Fleischman, 52, Present position since August 1997. Vice President Also, Vice President of Norfolk Southern Corporation since August 1997, and prior thereto was Assistant Vice President-Strategic Planning. PAGE 19 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ------------------------------- Robert C. Fort, 55, Present position since December 1996. Vice President-Public Relations Also, Vice President-Public Relations of Norfolk Southern Corporation since December 1996, and prior thereto was Assistant Vice President-Public Relations. John W. Fox, Jr., 52, Present position since October 1995. Vice President-Coal Marketing Also, Senior Vice President-Coal Marketing of Norfolk Southern Corporation since December 1, 1999, and prior thereto was Vice President-Coal Marketing. William A. Galanko, 43 Present position since January 15, Vice President 2000. Also Vice President-Taxation of Norfolk Southern Corporation since November 1, 1999, and prior thereto was Tax Counsel. Lewis D. Hale, Jr., 53, Present position since August 1998. Vice President-Transportation Also, Vice President-Transportation of Norfolk Southern Corporation since August 1998. Served as Assistant Vice President-Mechanical from December 1995 to August 1998, and prior thereto was General Manager Western Region. James A. Hixon, 46, Present position since June 1993. Vice President-Taxation Also, Senior Vice President- Employee Relations of Norfolk Southern Corporation since November 1, 1999, and prior thereto was Vice President-Taxation. Thomas C. Hostutler, 63, Present position since August 1998. Vice President-Internal Audit Also, Vice President-Internal Audit of Norfolk Southern Corporation since August 1998, and prior thereto was Senior Assistant Vice President-Corporate Accounting. H. Craig Lewis, 55, Present position since August 1998. Vice President-Corporate Affairs Also, Vice President-Corporate Affairs of Norfolk Southern Corporation since August 1998. Served as Regional Vice President from August 1997 to August 1998, and prior thereto was a partner in a Pennsylvania law firm. PAGE 20 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ------------------------------- Jon L. Manetta, 61, Present position since June 2, 1999. Vice President-Operations Also, Senior Vice President- Operations of Norfolk Southern Corporation since August 1998. Served as Senior Vice President- Operations from August 1998 to June 2, 1999, of Norfolk Southern Railway and Vice President- Transportation & Mechanical of Norfolk Southern Corporation from December 1995 to August 1998, and prior thereto was Vice President- Transportation. Mark D. Manion, 47, Present position since August 1998. Vice President-Mechanical Also, Vice President-Mechanical of Norfolk Southern Corporation since August 1998. Served as General Manager Western Region from December 1995 to August 1998, and prior thereto was Assistant Vice President-Transportation. Harold C. Mauney, Jr., 61, Present position since August 1997. Vice President-Public Affairs Also, Vice President-Public Affairs of Norfolk Southern Corporation since August 1997. Served as Vice President-Operations Planning and Budget of Norfolk Southern Railway and Norfolk Southern Corporation from December 1996 to August 1997, and prior thereto was Vice President-Quality Management. Donald W. Mayberry, 56, Present position since December 1995. Vice President-Research and Tests Also, Vice President-Research and Tests of Norfolk Southern Corporation since December 1995, and prior thereto was Vice President-Mechanical. James W. McClellan, 60, Present position since June 2, 1999. Vice President-Planning Also, Senior Vice President- Planning of Norfolk Southern Corporation since August 1, 1998. Served as Senior Vice President- Planning of Norfolk Southern Railway from August 1998 to June 2, 1999, and prior thereto was Vice President-Strategic Planning. PAGE 21 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ------------------------------- Kathryn B. McQuade, 43, Present position since August 1998. Vice President-Financial Planning Also, Vice President-Financial Planning of Norfolk Southern Corporation since August 1998, and prior thereto was Vice President- Internal Audit. Charles W. Moorman, 48, Present position since October 1993. Vice President-Information Also, President Thoroughbred Technology Technology and Communications, Inc. of Norfolk Southern Corporation since October 1, 1999, and prior thereto was Vice President- Information Technology. Phillip R. Ogden, 59, Present position since June 2, 1999. Vice President-Engineering Also, Senior Vice President- Engineering of Norfolk Southern Corporation since August 1, 1998. Served as Senior Vice President- Engineering of Norfolk Southern Railway from August 1998 to June 2, 1999, and prior thereto was Vice President-Engineering. John P. Rathbone, 48, Present position since December 1992. Vice President and Controller Also, Vice President and Controller of Norfolk Southern Corporation since December 1992. Stephen P. Renken, 56, Present position since January 15, Vice President 2000. Also Vice President- Information Technology of Norfolk Southern Corporation since October 1, 1999. Served as Assistant Vice President-Program Management from January 1998 to October 1, 1999, and prior thereto was employed by Burlington Northern Santa Fe. William J. Romig, 55, Present position since December 1992. Vice President Also, Vice President and Treasurer of Norfolk Southern Corporation since December 1992. PAGE 22 Business Experience During Past Name, Age, Present Position Five Years - --------------------------- ------------------------------- John M. Samuels, 56, Present position since January 1998. Vice President-Operations Also, Vice President-Operations Planning and Budget Planning and Budget of Norfolk Southern Corporation since January 1998. Previously served as Vice President-Operating Assets of Conrail from January 1996 to January 1998, and prior thereto was Vice President-Mechanical of Conrail. Donald W. Seale, 47, Present position since August 1993. Vice President- Also, Senior Vice President- Merchandise Marketing Merchandise Marketing of Norfolk Southern Corporation since December 1, 1999, and prior thereto was Vice President-Merchandise Marketing. Rashe W. Stephens, Jr., 58, Present position since December Vice President-Quality Management 1996. Also, Vice President-Quality Management of Norfolk Southern Corporation since December 1996, and prior thereto was Assistant Vice President-Public Affairs. Charles J. Wehrmeister, 50, Present position since August 1998. Vice President- Also, Vice President-Safety and Safety and Environmental Environmental of Norfolk Southern Corporation since August 1998. Served as Assistant Vice President- Safety and Environmental from January 1995 to August 1998, and prior thereto was Division Superintendent, Virginia Division. William C. Wooldridge, 57, Present position since February 1997. Vice President Also, Vice President-Law of Norfolk Southern Corporation since March 1996, and prior thereto was General Counsel-Corporate. Sandra T. Pierce, 45, Present position since June 1995. Corporate Secretary Also, Assistant Corporate Secretary of Norfolk Southern Corporation since June 1995, and prior thereto was Assistant Corporate Secretary- Planning. Ronald E. Sink, 57, Present position since September 1987. Treasurer PAGE 23 PART II ------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR) Item 5. Market for the Registrant's Common Stock and Related - ------ ---------------------------------------------------- Stockholder Matters. ------------------- COMMON STOCK Since June 1, 1982, NS has owned all the common stock of Norfolk Southern Railway Company. The common stock is not publicly traded. PREFERRED STOCK INFORMATION There are 10,000,000 shares of no par value serial preferred stock authorized. This stock may be issued in series from time to time at the discretion of the Board of Directors with any series having such voting and other powers, designations, dividends and other preferences as deemed appropriate at the time of issuance. The $2.60 Cumulative Preferred Stock, Series A (Series A Stock), of which 1,197,027 shares were issued and 1,096,907 shares were held other than by subsidiaries, including 176,705 shares held by NS, as of Dec. 31, 1999, has no par value but has a $50 per share stated value. As indicated in the title, the stock pays a dividend of $2.60 per share annually, payable quarterly on March 15, June 15, Sept. 15 and Dec. 15. Dividends on this stock are cumulative and in preference to dividends on all other classes of stock. Except for any shares held by Norfolk Southern Railway Company subsidiaries and/or in a fiduciary capacity, each share is entitled to one vote per share on all matters, voting as a single class with holders of other stock. Should dividends become delinquent for six quarters, this class of stock, voting as a class, may elect two directors so long as any default in dividend payments continues. The stock is redeemable at the option of Norfolk Southern Railway Company at $50 per share plus accrued dividends. On liquidation, the stock is entitled to $50 per share plus accrued dividends before any amounts are paid on any other class of stock. PAGE 24 Item 6. Selected Financial Data. - ------ ----------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Five-Year Financial Review
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- ($ in millions) RESULTS OF OPERATIONS: Railway operating revenues $ 5,114 $ 4,221 $ 4,223 $ 4,101 $ 4,012 Railway operating expenses 4,611 3,178 3,010 2,936 2,949 ------- ------- ------- ------- ------- Income from railway operations 503 1,043 1,213 1,165 1,063 Other income (expense) - net 42 90 (49) 39 44 Interest expense on debt (39) (25) (30) (34) (33) ------- ------- ------- ------- ------- Income before income taxes 506 1,108 1,134 1,170 1,074 Provision for income taxes 174 383 380 401 372 ------- ------- ------- ------- ------- Net income $ 332 $ 725 $ 754 $ 769 $ 702 ======= ======= ======= ======= ======= FINANCIAL POSITION: Total assets $12,632 $12,017 $11,827 $11,053 $10,752 Total long-term debt, including current maturities $ 866 $ 760 $ 606 $ 598 $ 574 Stockholders' equity $ 5,385 $ 6,137 $ 6,392 $ 5,772 $ 5,645 OTHER: Capital expenditures $ 915 $ 1,002 $ 884 $ 754 $ 713 Number of stockholders at year-end 2,109 2,317 2,519 2,763 3,025 Average number of employees (1) 30,897 24,185 23,323 23,361 24,488
(1) The employee count includes NS' employees whose primary duties relate to rail operations. PAGE 25 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. ----------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes beginning on Page 41 and the Five-Year Financial Review on Page 24. COMMENCEMENT OF OPERATIONS OVER CONRAIL'S LINES On June 1, 1999 (the "Closing Date"), NS Rail began operating a substantial portion of Conrail's properties (NS Rail's new "Northern Region") under various agreements with Pennsylvania Lines LLC (PRR), a wholly owned subsidiary of Consolidated Rail Corporation (CRC) (see Note 2 on Page 48). As a result, both the railroad route miles operated by NS Rail and the number of its employees increased by approximately 50% on that date. Results for 1999 reflect five months (January through May) of operating the former NS Rail system and seven months (June through December) of operations that include the Northern Region. Difficulties encountered in the assimilation of the Northern Region into NS Rail's existing system resulted in system congestion, an increase in cars on line, increased terminal dwell time and reduced system velocity. These service issues and actions taken to address them increased operating expenses, primarily labor costs and equipment costs, including car hire and locomotive rentals. Moreover, revenues were lower than expected as some customers diverted traffic to other modes of transportation. Income from railway operations is expected to continue to be adversely affected until these revenue and expense issues have been resolved. A prolonged continuation of these operational difficulties could have a substantial adverse impact on NS Rail's financial position, results of operations and liquidity. SUMMARIZED RESULTS OF OPERATIONS 1999 Compared with 1998 - ----------------------- Net income in 1999 was $332 million, a decrease of 54%. The decline was largely the result of a 52% decrease in income from railway operations, which reflected the difficulties in integrating the Northern Region and a sharp decline in export coal traffic. In addition, railway operating expenses included $168 million ($103 million after taxes) of costs incurred on the Closing Date for contractual obligations, principally to former Conrail employees, and expenses arising from the license of intangible assets owned by NS (see Note 2 on Page 48). Lower nonoperating income (see Note 3 on Page 52) and higher interest expense on debt (a result of increased debt and lower capitalized interest) also contributed to the decline in net income. 1998 Compared with 1997 - ----------------------- Net income in 1998 was $725 million, a decrease of 4%, compared with 1997. The decline was principally due to a 14% decline in income from railway operations, somewhat offset by higher nonoperating income (see Note 3 on Page 52). RAILWAY OPERATING REVENUES AND EXPENSES (Shown as a graph in the Annual Report to Stockholders)
($ in millions) 1999 1998 1997 1996 1995 --------------- ---- ---- ---- ---- ---- Revenues $5,114 $4,221 $4,223 $4,101 $4,012 Expenses 4,611 3,178 3,010 2,936 2,949
PAGE 26 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- DETAILED RESULTS OF OPERATIONS Railway Operating Revenues - -------------------------- Railway operating revenues were $5.1 billion in 1999, compared with $4.2 billion in both 1998 and 1997. Revenues in 1999 reflect the commencement of operations in the Northern Region on June 1. Revenues were lower than expected because of service issues associated with the expansion of the network and a sharp decline in export coal traffic. The following table presents a three-year comparison of revenues by market group. RAILWAY OPERATING REVENUES BY MARKET GROUP
($ in millions) 1999 1998 1997 --------------- ---- ---- ---- Coal $ 1,315 $ 1,252 $ 1,301 General merchandise: Automotive 740 566 492 Chemicals 720 574 585 Paper/clay/forest 575 534 539 Metals/construction 562 373 368 Agriculture/consumer products/government 453 383 391 ------- ------- ------- General merchandise 3,050 2,430 2,375 Intermodal 749 539 547 ------- ------- ------- Total $ 5,114 $ 4,221 $ 4,223 ======= ======= =======
In 1999, revenues increased for all market groups as a result of traffic handled in the Northern Region. Prior to the Closing Date, revenues for all commodity groups, except automotive, were below or even with those of the prior year. As shown in the following table, the full- year volume gains attributable to expanded operations produced the revenue increase. Revenue per unit improved for most market groups principally due to the effects of the Northern Region traffic; however, the effects of changes in the mix of traffic, most notably the reduced export coal traffic, more than offset the effects of the revenue-per-unit improvements. In 1998, revenue increases in the automotive and metals and construction groups were offset by revenue decreases in the other market groups. Volume gains were more than offset by lower revenue per unit. However, almost all of the volume increase and revenue per unit decrease were mixing-center related (see the discussion under the "Automotive" caption, below). Revenues for the remaining market groups declined $76 million, $60 million of which resulted from lower traffic volume and $16 million of which resulted from lower revenue per unit that was mitigated by favorable effects from changes in traffic mix. RAILWAY OPERATING REVENUE VARIANCE ANALYSIS Increases (Decreases)
($ in millions) 1999 vs. 1998 1998 vs. 1997 --------------- ------------- ------------- Volume $ 1,007 $ 48 Revenue per unit/mix (114) (50) ------- ------- Total $ 893 $ (2) ======= =======
PAGE 27 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- COAL tonnage increased 18% in 1999, but revenues increased by only 5%. The positive revenue effects of tonnage handled in the Northern Region were largely offset by significantly lower export coal tonnage. In addition, a larger proportion of the Northern Region traffic is shorter- haul (lower average revenue) traffic. Coal revenues represented 26% of total railway operating revenues in 1999, and 88% of coal shipments originated on lines operated by NS Rail. In 1998, coal tonnage was unchanged compared with 1997, but revenues decreased 4%. An increase in utility tonnage, especially shorter-haul traffic, helped offset decreases in longer-haul (higher average revenue) export and domestic metallurgical traffic. TOTAL COAL, COKE AND IRON ORE TONNAGE
(In millions of tons) 1999 1998 1997 --------------------- ---- ---- ---- Utility 108 83 76 Export 18 25 29 Domestic metallurgical 22 18 21 Other 10 8 8 --- --- --- Total 158 134 134 === === ===
Utility coal traffic increased 30% in 1999, due to the expansion of operations into the Northern Region. In 1998, utility coal traffic increased 9%, due to rising electricity production, the return of some traffic to rail and increased business from several customers. The near-term outlook for utility coal remains positive. U.S. demand for electricity continues to increase at a rate greater than generation capacity is being added, and coal-fired generation continues to be the cheapest marginal source of electricity. Many underutilized coal-fired power plants are making the transition from peak-only generation to full- time generation. NS Rail also could benefit from access to several utility coal customers not now receiving coal by rail. However, competitive pressures on utilities to reduce costs could put price pressure on generation source fuels, including NS Rail-delivered coal. NS Rail continues to work with utility customers to reduce the delivered price of coal by developing more efficient coal handling facilities, which lead to more efficient train operations. Many of the mines served by NS Rail produce coals that satisfy the Phase II requirements of the Clean Air Act Amendments. In the Northern Region, NS Rail now has access to high-quality, low-cost coal that can be blended with coal from the Powder River Basin to meet the Phase II requirements. In addition, substantial banks of sulfur dioxide allowances held by many NS Rail-served utilities should continue to provide a market for other NS Rail-served mines for nearly a decade. However, more stringent environmental rules have been promulgated and are scheduled to be implemented during the next decade, some as early as 2003. Most of these rules are being challenged in court; but, if they survive and are implemented, they could increase the cost of coal-fired generation. Also, the Kyoto Protocol, if ratified and implemented, could put additional cost pressures on some coal-fired generation. A recent decision by a federal district court judge in West Virginia holds that some common mountaintop mining practices in the coal industry are illegal. There are a small number of mountaintop mining operations on NS Rail's lines; however, if sustained, the decision could have an adverse effect on these coal mining operations and on NS Rail's coal traffic and revenues. PAGE 28 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Export coal tonnage decreased 28% in 1999, despite additional traffic handled in the Northern Region. The lower traffic resulted from reduced demand for U.S. coking coal (in part, the result of a strong U.S. dollar), productivity gains made by foreign producers, lower ocean transportation rates and lower foreign royalties. Steam coal exports continued to be noncompetitive on price, making domestic markets more attractive for U.S. producers. In 1998, export coal tonnage decreased 14%, due to weak economies in Asia and a strong U.S. dollar. The dollar gained 20% or more compared with the currencies of other countries (such as Australia, South Africa and Indonesia) that provide the primary competition for U.S. export coal. A significant decline in Asian demand for coal created supplies that competed at deeply discounted prices with U.S. export coal in Europe and South America. Steam coal exports declined to 0.4 million tons in 1998, compared with 1.7 million tons in 1997. U.S. low-sulfur coals were not price-competitive due to lower-cost foreign production and the strength of the dollar. Export coal tonnage is expected to continue to suffer from the effects of strong global competition. Despite rising steel production, continued pricing pressure from foreign producers is expected to keep demand for U.S. coking coal weak. In addition, the Kyoto Protocol, if implemented, could increase pressure to reduce the use of carbon-based fuels. Domestic metallurgical coal, coke and iron ore traffic increased 22% in 1999, as the addition of Northern Region traffic more than offset the effects of reduced U.S. steel production. Lower-priced steel imports led to reduced production levels at integrated steel manufacturers, especially through the first three quarters of 1999, thereby dampening demand for raw materials. In 1998, domestic metallurgical coal, coke and iron ore traffic declined 14%, due to plant closures, reduced blast furnace operations and the continuation of aggressive producer pricing of high-volatile metallurgical coals not located on NS Rail's lines. Domestic metallurgical coal, coke and iron ore traffic is expected to benefit from recent strengthening of domestic and foreign steel markets. Several domestic blast furnaces are expected to resume production in 2000. However, long-term demand is expected to continue to decline, due to advanced technologies that allow production of steel using less coal. Other coal traffic, primarily steam coal shipped to manufacturing plants, increased 25% in 1999, due to the expansion of operations in the Northern Region, and was flat in 1998. GENERAL MERCHANDISE traffic volume (carloads) increased 24%, and revenues increased 26%, in 1999, due to the addition of Northern Region traffic. Service issues resulted in traffic diversions in all market groups. In 1998, traffic volume increased 5%, and revenues increased 2%, driven by higher automotive revenues. Automotive traffic volume increased 26%, and revenues increased 31%, in 1999, largely reflecting the expansion of operations in the Northern Region and record vehicle production. The new NS Rail-served Toyota plant in Princeton, Ind., and the new vehicle parts distribution center in Dayton, Ohio, also contributed to the increase. NS Rail's mixing center network is not yet fully utilized due to network design and service issues and equipment shortages caused by extended cycle times. In addition, service issues after the Closing Date resulted in significant traffic diversions. In 1998, automotive carloads increased 35%, and revenues increased 15%. Finished vehicles led the growth, as carloads increased 54% and revenues increased 19%, primarily due to new business through the Ford mixing centers. Full production volume at the Mercedes-Benz plant in Vance, Ala., and the Toyota minivan line at Georgetown, Ky., also contributed to the increases. Vehicle parts traffic volume and revenues remained steady despite the effects of the mid-year strike at General Motors. PAGE 29 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- A substantial portion of the 1998 increase in carloads resulted from the nature of the mixing centers. Previously, carloads of vehicles went from plant to distribution center, where vehicles were classified and loaded onto trucks for transport to dealers. Now, carloads of vehicles, mostly in unit-train service, go from plant to the mixing centers, where vehicles are sorted by destination and loaded onto other trains in a mix suitable for direct transport to dealers. As a result, carload counts have increased; each vehicle that is handled through the centers arrives on one carload and departs on another carload. This hub-and-spoke method of distribution is intended to improve Ford's delivery logistics and reduce its inventory costs and order-to-delivery times. Light vehicle production in 2000 is expected to decline 3% from the record level of 1999. However, NS Rail expects to recapture diverted traffic as its service improves and to benefit from increased shipments of finished vehicles from Ford's Norfolk, Va., assembly plant and from the introduction of new sport utility vehicles at BMW's Greer, S.C., assembly plant and at Toyota's second plant in Princeton, Ind., and increased parts business from General Motors. Chemicals traffic volume increased 18%, and revenues increased 25%, in 1999, due to the addition of Northern Region traffic. Chemical production increased slightly during the year, but fertilizer production declined. In addition, significant production cutbacks at plants served by NS Rail affected shipments of both sulfur and fertilizer. Shipments of chlorine, caustic soda and PVC plastics rebounded from 1998 levels, benefiting from an improved Asian economy. The location of new and expanded processing plants on lines NS Rail serves improved shipments of plastic pellets. Chemicals shipments also increased through NS Rail's Thoroughbred Bulk Transfer (TBT) facilities that handle chemicals and bulk commodities for customers not located on lines it serves. In 1998, chemicals traffic volume decreased 1%, and revenues decreased 2%, the first decline since 1989. The weak economies in Asia and softness in certain domestic markets adversely affected shipments of products for the vinyl, polyester and pulp markets. In addition, nationwide rail service issues, particularly early in the year, caused some customers to divert traffic to truck and barge. However, several NS Rail-served facilities with new and expanded plant capacity increased shipments of plastics and petroleum products, somewhat offsetting these reductions. NS Rail also increased traffic through its TBT facilities. Chemicals revenues in 2000 are expected to benefit from plant expansions, increases in U.S. chemical production and extended market reach through the TBT facilities. Paper, clay and forest products traffic volume increased 4%, and revenues increased 8%, in 1999, principally due to the expansion of operations into the Northern Region. The closure of four major paper mills and some chip mills late in 1998, coupled with the effects of continued consolidation and weak demand within the paper industry, had a negative impact on 1999 traffic volume. In 1998, paper, clay and forest products traffic volume decreased 3%, and revenues declined 1%. Traffic volume increases in the first three quarters were offset by a sudden and pronounced weakness in the paper industry in the fourth quarter, adversely affecting shipments of paper, wood fiber and kaolin clay. Decreased domestic and foreign demand resulted in both widespread paper mill downtime late in the year and indefinite closure of several NS Rail-served paper mills. Record carloads and revenues from shipments of lumber and wood products to meet demand in the housing construction industry partially offset the effects of these declines. The paper industry is expected to continue to experience weak demand during 2000. Metals and construction traffic volume increased 57%, and revenues increased 51%, in 1999, due to the addition of Northern Region traffic. NS Rail's expanded operations give it access to numerous steel mills, processors and distribution facilities. Continued growth from new mini- mills and steel processors locating in NS Rail's service territory offset PAGE 30 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- the effects of a weaker scrap market. Construction traffic benefited from continued strength in housing starts and highway construction in the Southeast. Agricultural limestone shipments were higher in the first half of the year, due to an early planting season as a result of the mild winter. In addition, new cement terminals on NS Rail's lines generated additional traffic. In 1998, metals and construction traffic volume was unchanged, and revenues increased 1%. The strong performance in the metals market during 1997 was repeated in the first half of 1998, due to improved efficiency at integrated mills and the continued growth of new mini-mills and steel processors in NS Rail's service territory. However, the domestic metals market weakened in the second half of 1998, due to an increase in the supply of lower-priced, imported steel. Construction traffic and revenues increased, due to increased highway and housing construction activity in the Southeast. Metals revenues are expected to show the benefits of continued strength in the steel and construction industries. Agriculture, consumer products and government traffic volume increased 15%, and revenues increased 18%, in 1999, reflecting new access to the large Northeast consumer markets. Service issues that arose early in the year due to harsh weather conditions and continued during efforts to integrate the Northern Region had an adverse effect on traffic volume. In addition, soybean traffic was negatively affected by low-priced imports from South America. In 1998, agriculture, consumer products and government traffic volume decreased 3%, and revenues declined 2%. Weak export and soybean meal markets adversely affected shipments. Sweeteners volume and revenues declined, as a strong beet sugar crop negatively affected cane sugar shipments out of the South. Increased revenues from grain, soybeans and feed ingredients from the longer-haul Southeast feed and corn processing markets somewhat offset the effects of the declines. Moderate growth is expected in 2000 as service levels improve and more benefits are realized from NS Rail's expanded operations. Continued low prices and abundant supply are expected to increase consumption of corn for feed and processing. However, the export market for other grain products is expected to remain weak. INTERMODAL traffic volume increased 31%, and revenues increased 39%, in 1999, due to the addition of Northern Region traffic. NS was awarded the majority of Conrail's postal business, and NS Rail provides the rail service related to that business. Intermodal traffic volume declined in the first five months of 1999, reflecting the network redesign implemented in August 1998 which pared a significant number of lanes and associated volumes. Service issues following the integration of the Northern Region also negatively affected volume and revenues. In 1998, intermodal traffic volume decreased 2%, and revenues decreased 1%. The decline, the first in 12 years, was due to the service network redesign that was implemented in August. As a result, trailer traffic volume declined 16%, but this decrease was largely offset by increases in both container traffic volume and revenues (respectively, 2% and 5%) and TCS traffic volume and revenues (respectively, 5% and 9%). Intermodal revenues are expected to continue to benefit from the expansion of operations in the Northeast, as well as terminal and line capacity expansions and equipment additions. However, APL, which generated 247,000 units of annualized volume on NS Rail, moved almost all of this volume to CSX after their strategic alliance. Most of this traffic had been shifted by December 1999. PAGE 31 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Railway Operating Expenses - -------------------------- Railway operating expenses increased 45% in 1999, while carloadings increased 24%. The expense increase was principally attributable to the commencement of operations in the Northern Region, and includes significant costs arising from the service issues experienced after the Closing Date and the contractual obligations incurred on the Closing Date. In addition, a licensing fee for the use of certain intangible assets owned by NS that became effective Nov. 1, 1998, also contributed to the increase in expenses (see Note 2, "General," on Page 48). Railway operating expenses increased 6% in 1998, while carloadings increased 1%. The expense increase was mostly attributable to Conrail- related integration expenses, and additional expenses, including start-up costs, related to the Ford mixing centers. As a result, the railway operating ratio, which measures the percentage of railway revenues consumed by railway expenses, was 90.2% in 1999, compared with 75.3% in 1998 and the record-low 71.3% in 1997. Management estimates that the integration-related service issues in the Northern Region, including estimated traffic diversions, resulted in almost half of the increase in the railway operating ratio in 1999. The $168 million of contractual obligations incurred on the Closing Date increased the railway operating ratio by 3.3 percentage points. The remaining increase was attributable to: (1) the change in traffic mix (more resource-intensive traffic, such as automotive and intermodal) and the new traffic in the Northern Region, coupled with the decrease in export coal traffic; and (2) the NS licensing fee. In 1998, the railway operating ratio was adversely affected by Conrail-related integration expenses and a change in traffic mix related to the growth in automotive traffic coupled with the change in coal traffic mix. Automotive traffic includes some of NS Rail's most time- sensitive and resource-intensive business, requiring more trains, increased handling costs and higher equipment rents. The railway operating ratio is not expected to return to pre-Closing Date levels in the near term, due to changes in NS Rail's traffic mix and the higher cost structure of the Conrail properties it now operates. However, the railway operating ratio is expected to show favorable year- to-year comparisons after the first quarter of 2000. RAILWAY OPERATING RATIO (Shown as a graph in the Annual Report to Stockholders)
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- 90.2% 75.3% 71.3% 71.6% 73.5%
The following table shows the changes in railway operating expenses summarized by major classifications. RAILWAY OPERATING EXPENSES Increases (Decreases)
($ in millions) 1999 vs. 1998 1998 vs. 1997 --------------- ------------- ------------- Compensation and benefits $ 475 $ 87 Materials, services and rents 373 118 Conrail rents and services 279 -- Depreciation 29 18 Diesel fuel 81 (53) Casualties and other claims 43 (28) Other 153 26 ------- ------- Total $ 1,433 $ 168 ======= =======
PAGE 32 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Compensation and benefits, which represented 43% of total railway operating expenses, increased 32% in 1999 and 6% in 1998. In 1999, the increase resulted largely from the almost 50% increase in the railroad work force following commencement of operations in the Northern Region. The service issues encountered after the expansion of operations also contributed to the increase, including $49 million for the Special Work Incentive Program available to union employees during much of the third quarter. In addition, the contractual obligations incurred in employing a substantial portion of Conrail's work force also contributed to the increase. These increases were mitigated by reduced stock-based incentive compensation, the absence of bonus accruals and reduced pension and other postretirement benefits expenses. NS has substantial unrecognized gains relating to its over-funded pension plan; amortization of these gains will continue to be included in NS Rail's "Compensation and benefits" expenses (see Note 13 on Page 58). In 1998, higher wages and salaries -- results of additional staffing in anticipation of the Closing Date and union wage increases, including the effect of an increase in the bonus fund for locomotive engineers -- were offset somewhat by lower expenses for pension benefits, due to favorable investment returns on pension plan assets. Also contributing to the increase were new FRA train inspection requirements and a higher Railroad Unemployment Tax rate. In January 2000, NS announced a voluntary early retirement program that included enhancements to pension benefits for eligible nonunion employees. Approximately 1,180 employees, or 20% of NS' nonunion work force, were eligible for the program; and 916 accepted and retired effective March 1. Benefits will be paid out of NS' over-funded pension plan. Actions also were taken in the first quarter of 2000 to reduce the size of the union work force. These work force reduction efforts were taken to resize employment levels and reduce operating expenses in response to changes in NS Rail's business. The cost of these work force reductions will be reflected in NS Rail's expenses in the first quarter of 2000. Materials, services and rents expenses include items used for the maintenance of the railroads' lines, structures and equipment; the costs of services purchased from outside contractors, including the net costs of operating joint (or leased) facilities with other railroads; and the net cost of equipment rentals. This category of expenses increased 46% in 1999 and 17% in 1998. The 1999 increase reflected the expanded operations in the Northern Region and additional costs attributable to the service issues, including costs for alternate transportation to meet the needs of customers. The 1998 increase was principally due to Conrail-related integration costs and higher-than-anticipated mixing center costs associated with the increase in automotive traffic. Higher equipment rents and locomotive repair expenses also contributed to the increase. Equipment rents, which represent the cost to NS Rail of using equipment (mostly freight cars) owned by other railroads or private owners, less the rent paid to NS Rail for the use of its equipment, increased 93% in 1999 and 18% in 1998. The 1999 increase principally was due to: (1) increased volume attributable to expanded operations; (2) higher rental costs for freight cars, as service issues increased car cycle times; and (3) costs for short-term locomotive leases to improve system fluidity. In addition, Conrail historically rented a higher percentage of its freight cars than has NS Rail, resulting in higher equipment rents in the Northern Region. The 1998 increase was due to: (1) rents for equipment needed to support the increase in automotive traffic; (2) reduced rents received from the leasing of owned locomotives; and (3) increased lease expenses for equipment obtained to meet anticipated demand after the Closing Date. These 1998 increases were somewhat offset by higher receipts on NS Rail-owned freight cars and auto racks. PAGE 33 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Locomotive and car repair costs increased in 1999 due to the expansion of operations and to the higher repair costs associated with the leased locomotives. Locomotive repair costs increased in 1998 due to the higher traffic levels and an increase in the average number of locomotives in service, reflecting the retention of older units. Conrail rents and services, a new category of expense arising from the expansion of operations on June 1, amounted to $279 million in 1999. This item includes amounts due to PRR and CRC for: (1) use of their operating properties and equipment; (2) CRC's operation of the Shared Assets Areas; and (3) CRC's operation of certain transition facilities. Depreciation expense (see Note 1, "Properties," on Page 48 for NS Rail's depreciation policy) was up 7% in 1999 and 4% in 1998. Increases in both years were due to property additions, reflecting recent substantial levels of capital spending. Diesel fuel expenses increased 47% in 1999, but declined 23% in 1998. The increase in 1999 resulted from a 19% increase in the average price per gallon, due to a sharp rise in the last half of the year, and higher consumption, primarily the result of the additional Northern Region traffic. The 1998 decrease was due to a 26% drop in the average price per gallon, which was the lowest since 1988, somewhat offset by a 3% increase in consumption. Casualties and other claims expenses (including the estimates of costs related to personal injury, property damage and environmental matters) increased 45% in 1999, but decreased 23% in 1998. The 1999 increase principally resulted from higher personal injury accruals related to the increased size of the work force as well as higher environmental expenses. The 1998 decrease was due to cost recoveries from third parties and lower accruals for environmental remediation costs and to reduced personal injury expenses. The largest component of casualties and other claims expense is personal injury costs. Costs related to so-called "occupational" injuries continued to increase. Within the past decade, there has been a dramatic increase in the number of these types of claims. In 1999, about two- thirds of the total employee injury cases settled and one-quarter of settlement payments made were related to occupational claims. These claims generally do not relate to a specific accident or event, but rather result from a claimed exposure over time to some condition of employment. As a result, many of these claims are asserted by former or retired employees. NS Rail continues to work actively to eliminate all accidents and exposure risks and to control associated costs. The rail industry remains uniquely susceptible to litigation involving job-related accidental injury and occupational claims because of an outmoded law, the Federal Employers' Liability Act (FELA), originally passed in 1908 and applicable only to railroads. This law, which covers employee claims for job-related injuries, promotes an adversarial claims environment and produces results that are unpredictable and inconsistent, at a far greater cost to the rail industry than the no-fault workers' compensation system to which nonrail competitors and other employers are universally subject. The railroads have been unsuccessful so far in efforts to persuade Congress to replace FELA with a no-fault workers' compensation system. NS Rail maintains substantial amounts of commercial insurance for potential third-party liability and property damage claims. It also retains reasonable levels of risk through self-insurance. PAGE 34 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Other expenses increased 87% in 1999 and 17% in 1998. The 1999 increase resulted from: (1) a licensing fee for the use of certain intangible assets owned by NS that became effective Nov. 1, 1998 (see Note 2, "General," on Page 48); (2) the expansion of operations, including property and other taxes related to the Northern Region; and (3) costs arising from the service issues. The 1998 increase principally resulted from: (1) the licensing fee charged by NS; (2) higher property and other taxes, due to the effects of favorable adjustments in prior years resulting from settlements with taxing authorities; and (3) increased travel expenses, mostly attributable to planning for the Conrail transaction. Income Taxes - ------------ Income tax expense in 1999 was $174 million, for an effective rate of 34%, compared with an effective rate of 35% in 1998 and 34% in 1997. The effective rates in all three years were below the statutory federal and state rates -- results of favorable adjustments upon filing the prior year tax returns and favorable adjustments to state tax liabilities. In addition, 1998 and 1997 benefited from investments in corporate-owned life insurance, and 1998 benefited from favorable adjustments resulting from settlement of federal income tax years 1993 and 1994. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities, NS Rail's principal source of liquidity, decreased $821 million, or 59%, in 1999, and $30 million, or 2%, in 1998. Both declines reflected the reductions in income from operations, mitigated somewhat by lower income tax payments. In addition, 1999 was affected by NS Rail's dividend of accounts receivable to NS (see Note 2, "Noncash Dividends," on Page 50). The large changes in "Accounts receivable" and "Other short-term liabilities" in the 1999 cash flow statement reflect the commencement of operations in the Northern Region. Cash used for investing activities in 1999 decreased 19%, but increased slightly in 1998. Investing activities in 1999 included approximately $160 million more of borrowings against the net cash surrender value of company-owned life insurance, compared with 1998. In addition, 1999 included $60 million in proceeds from the sale of certain licensing arrangements and the sale of NS Rail's signboard business. Property additions account for most of the spending in this category. The following tables show capital spending, track and equipment statistics for the past five years. Capital expenditures include amounts relating to capitalized leases, which are excluded from the Consolidated Statements of Cash Flows (see Note 8, "Capital Lease Obligations," on Page 56). CAPITAL EXPENDITURES (Also shown as a graph in the Annual Report to Stockholders)
($ in millions) 1999 1998 1997 1996 1995 --------------- ---- ---- ---- ---- ---- Road $ 559 $ 583 $ 580 $ 428 $ 379 Equipment 356 419 304 326 333 Other property -- -- -- -- 1 ------- ------- ------- ------- ------- Total $ 915 $ 1,002 $ 884 $ 754 $ 713 ======= ======= ======= ======= =======
PAGE 35 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Capital expenditures decreased 9% in 1999, but increased 13% in 1998. Both variances were largely attributable to significant outlays in 1998 for roadway projects and equipment in anticipation of the Closing Date. In addition, 1997 and 1998 included significant expenditures for automotive-related projects. TRACK STRUCTURE STATISTICS (CAPITAL AND MAINTENANCE)
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Track miles of rail installed 403 429 451 401 403 Miles of track surfaced 5,087 4,715 4,703 4,686 4,668 New crossties installed (millions) 2.3 2.0 2.2 1.9 2.0 AVERAGE AGE OF OWNED RAILWAY EQUIPMENT (In years) 1999 1998 1997 1996 1995 ---------- ---- ---- ---- ---- ---- Freight cars 24.4 23.6 23.0 22.3 22.0 Locomotives 15.4 15.4 15.3 15.4 15.7 Retired locomotives 22.7 20.6 23.3 24.4 22.6
In addition to NS Rail-owned equipment, approximately 20% of the freight car fleet and 30% of the locomotive fleet is leased from PRR (see Note 2 on Page 48). The 1998 decrease in the average age of retired locomotives resulted from a disproportionate share of early retirements due to casualties and service failures and retention of older units in anticipation of the Closing Date. Since 1988, NS Rail has rebodied about 29,000 coal cars, and plans to continue that program at least through the first half of 2000. This work, performed at NS Rail's Roanoke Car Shop, converts hopper cars into high-capacity steel gondolas or hoppers. As a result, the remaining service life of the freight car fleet is greater than may be inferred from the increasing average age shown in the table, above. For 2000, NS Rail has budgeted $747 million for capital expenditures. In addition, NS Rail plans to enter into a lease financing arrangement for 150 new locomotives. The anticipated spending includes $576 million for roadway projects, of which $284 million is for track and bridge program work. Also included are projects to increase track and terminal capacity. Equipment spending includes the rebodying of coal and coke hoppers, the purchase of 255 multilevel automobile racks, the upgrading of existing locomotives and the modification of open coil steel cars. NS Rail also plans to lease 475 articulated bilevels for automobile service. Cash flows from financing activities in 1999 were significantly affected by NS Rail's dividend of accounts receivable to NS: absent this dividend, NS Rail likely would have advanced to NS the cash received for collection of those receivables. "Advances to NS" typically account for most of the cash used for financing activities and reflect NS' requirements (see Note 2 on Page 48). Proceeds from borrowings included amounts received in 1999 and 1998 from the sale of equipment trust certificates and $149 million of borrowings in 1999 from a PRR subsidiary (see Note 2 on Page 48). NS is subject to various financial covenants with respect to its debt and under its credit agreement, including a minimum net worth requirement, a maximum leverage ratio restriction and certain restrictions on issuance of further debt. As the major NS subsidiary, NS Rail is subject to certain of those covenants. PAGE 36 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- OTHER MATTERS Proposed CN-BNSF Combination - ---------------------------- On Dec. 20, 1999, Canadian National Railway Company and Burlington Northern Santa Fe Corporation announced plans to combine their companies under common control, thereby forming the largest railroad in North America. NS Rail and other Class I railroads have expressed strong concerns about both the timing and the implications for the railroad industry of the proposed combination; moreover, the Surface Transportation Board (which would have to approve the combination) has indicated that the carriers will be expected to address the "cumulative impacts and crossover effects" of the transaction. Management will monitor developments and take appropriate actions. Market Risks and Hedging Activities - ----------------------------------- NS Rail does not engage in the trading of derivatives. NS Rail manages its overall exposure to fluctuations in interest rates by issuing both fixed- and floating-rate debt instruments and by entering into interest-rate hedging transactions to achieve a targeted mix within its debt portfolio. Of NS Rail's total debt outstanding (see Note 8 on Page 55), all is fixed-rate debt, except for most capital leases. As a result, NS Rail's debt subject to interest rate exposure was $281 million on Dec. 31, 1999. A 1% increase in interest rates would increase NS Rail's total annual interest expense related to all its variable debt by approximately $3 million. Management considers it unlikely that interest rate fluctuations applicable to these instruments will result in a material adverse effect on NS Rail's financial position, results of operations or liquidity. The capital leases, which carry an average fixed rate of 7.1%, were effectively converted to variable rate obligations using interest rate swap agreements. On Dec. 31, 1999, the average pay rate under these agreements was 6.3%, and the average receive rate was 7.1%. During 1999, the effect of the swaps was to reduce interest expense by $4 million. A portion of the lease obligations is payable in Japanese yen. NS Rail hedged the associated exchange rate risk at the inception of each lease with a yen deposit sufficient to fund the yen-denominated obligation. Most of these deposits are held by Japanese banks. As a result, NS Rail is exposed to financial market risk relative to Japan. Counterparties to the interest rate swaps and Japanese banks holding yen deposits are major financial institutions believed by Management to be creditworthy. Accounting Changes and New Pronouncements - ----------------------------------------- As discussed in Note 1 under "Required Accounting Changes" on Page 48, NS Rail adopted AICPA Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" in 1999. During 1999, the Financial Accounting Standards Board deferred the effective date of Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." NS Rail expects to adopt SFAS No. 133 effective Jan. 1, 2001. This adoption is not expected to have a material effect on NS Rail's consolidated financial statements. Lawsuits - -------- Norfolk Southern Railway Company and certain subsidiaries are defendants in numerous lawsuits relating principally to railroad operations. On Sept. 8, 1997, a state court jury in New Orleans returned a verdict awarding $175 million in punitive damages against The Alabama Great Southern Railroad Company (AGS), a subsidiary of Norfolk Southern Railway Company. The verdict was returned in a class action suit PAGE 37 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- involving some 8,000 individuals who claim to have been damaged as the result of an explosion and fire that occurred in New Orleans on Sept. 9, 1987, when a chemical called butadiene leaked from a tankcar. The jury verdict awarded a total of nearly $3.2 billion in punitive damages against four other defendants in the same case: two rail carriers, the owner of the car and the shipper. Previously, the jury had awarded nearly $2 million in compensatory damages to 20 of the more than 8,000 individual plaintiffs. Prior to the trial court's ruling on the post trial motions, AGS and four other defendants agreed to settle their liability in this case for a total payment of approximately $150 million, of which AGS' share was $15 million. The settlement has been given preliminary approval by the trial court, and the money has been paid into an escrow account maintained by Bank One Trust Company in New Orleans. Final approval of the settlement and distribution of the settlement proceeds to qualified members of the class are subject to a fairness hearing scheduled for March 22, 2000. While it is possible that the trial court will decline to give final approval to the settlement, or that the settlement may be overturned on appeal, Management believes that the settlement is a fair resolution of this controversy and that disapproval by the courts is unlikely. While the final outcome of this matter and other lawsuits cannot be predicted with certainty, it is the opinion of Management, based on known facts and circumstances, that the amount of NS Rail's ultimate liability is unlikely to have a material adverse effect on NS Rail's financial position, results of operations or liquidity. 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 its amount can be estimated reasonably. Claims, if any, against third parties for recovery of cleanup costs incurred by NS Rail are reflected as receivables (when collection is probable) in the balance sheet and are not netted against the associated NS Rail liability. Environmental engineers regularly participate in ongoing evaluations of all identified sites and in determining any necessary adjustments to initial liability estimates. NS Rail also has established an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy. Operating expenses for environmental matters totaled approximately $12 million in 1999, $4 million in 1998 and $21 million in 1997, and capital expenditures totaled approximately $8 million in 1999, $7 million in 1998 and $6 million in 1997. The increase in operating expenses in 1999 compared with 1998 was principally due to a combination of unfavorable development experience on identified sites during 1999, and higher recoveries in 1998 from third parties of amounts paid by NS Rail in prior years for environmental cleanup and remediation. Capital expenditures in 2000 are expected to be comparable with 1999. As of Dec. 31, 1999, NS Rail's balance sheet included a reserve for environmental exposures in the amount of $41 million (of which $8 million is accounted for as a current liability), which is NS Rail's estimate of the probable cleanup and remediation costs based on available information at 126 identified locations. On that date, 12 sites accounted for $20 million of the reserve, and no individual site was considered to be material. NS Rail anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period. At some of the 126 locations, certain NS Rail subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs. PAGE 38 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- 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 in NS Rail's traffic mix, particularly those classified as hazardous materials, can pose special risks that NS Rail and its subsidiaries work diligently to minimize. In addition, several NS Rail subsidiaries own, or have owned, land used as operating property, or which is leased or may have been leased and operated by others, or held for sale. Because environmental problems that are latent or undisclosed may exist on these properties, there can be no assurance that NS Rail will not incur environmentally related liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and other now-unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial condition, results of operations or liquidity in a particular year or quarter. However, based on its assessments of the facts and circumstances now known, Management believes that it has recorded the probable costs for dealing with those environmental matters of which the Corporation is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in the aggregate, will have a material adverse effect on NS Rail's financial position, results of operations or liquidity. Labor Agreements - ---------------- Approximately 85% of NS Rail's employees are represented by labor unions under collective bargaining agreements with 14 different labor organizations. Moratorium provisions of the agreements currently in force expired Dec. 31, 1999; however, the agreements remain in effect until amendments are agreed to or until the Railway Labor Act's procedures are exhausted. In late 1999, negotiations began at the national level on agreements with major labor organizations. The outcome of these negotiations is uncertain at this time. However, a tentative agreement was reached with the Brotherhood of Locomotive Engineers which represents approximately 5,000 of NS Rail's locomotive engineers. The settlement requires ratification by the members before acceptance. Negotiations with the other unions are progressing. Inflation - --------- Generally accepted accounting principles require the use of historical cost in preparing financial statements. This approach disregards the effects of inflation on the replacement cost of property. NS Rail, a capital-intensive company, has most of its capital invested in such assets. The replacement cost of these assets, as well as the related depreciation expense, would be substantially greater than the amounts reported on the basis of historical cost. PAGE 39 Item 7. Management's Discussion and Analysis of Financial - ------ ------------------------------------------------- Condition and Results of Operations. (continued) ----------------------------------- Trends - ------ - Federal Economic Regulation -- Efforts may be made in 2000 to re- subject the rail industry to unwarranted federal economic regulation. The Staggers Rail Act of 1980, which substantially reduced such regulation, encouraged and enabled rail carriers to innovate and to compete for business, thereby contributing to the economic health of the nation and to the revitalization of the industry. Accordingly, NS Rail and other rail carriers vigorously will oppose these counterproductive efforts to reimpose or to authorize reimposing such economic regulation. - Reduction of "Greenhouse" Gases -- In December 1997, international environmental officials meeting in Kyoto, Japan, agreed to reduce substantially the emission of so-called "greenhouse" gases by 2010. Agreement on such reductions was reached on the basis of questionable scientific evidence and in spite of the fact that the burden of the reduction regimen will be borne disproportionally by developed nations such as the United States. NS Rail, the rail industry and a wide variety of other affected constituencies in the United States expect to assure that, prior to a Senate vote on the proposed treaty, the public and governmental authorities have available to them additional scientific information and data concerning other effects that are likely to result from implementation. - Utility Deregulation -- Deregulation of the electrical utility industry is expected to increase competition among electric power generators; deregulation over time would permit wholesalers and possibly retailers of electric power to sell or purchase increasing quantities of power to or from far-distant parties. The effects of deregulation on NS Rail and on its customers cannot be predicted with certainty; however, NS Rail serves a number of efficient power producers and is working diligently to assure that its customers remain competitive in this evolving environment. Forward-Looking Statements - -------------------------- This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Annual Report contain forward-looking statements that are based on current expectations, estimates and projections. Such forward-looking statements reflect Management's good-faith evaluation of information currently available. However, because such statements are based upon and, therefore, can be influenced by, a number of external variables over which Management has no, or incomplete, control, they are not, and should not be read as being, guarantees of future performance or of actual future results; nor will they necessarily prove to be accurate indications of the times at or by which any such performance or result will be achieved. Accordingly, actual outcomes and results may differ materially from those expressed in such forward-looking statements. This caveat has particular importance in the context of all such statements that relate to the resolution of the service issues, the recapture of diverted business, the addition of new business, and the ability to reduce expenses. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. - ------- ---------------------------------------------------------- The information required by this item is included in Part II, Item 7, "Management's Discussion and Analysis of Financial Conditions and Results of Operations," on Page 36 under the heading "Market Risks and Hedging Activities." PAGE 40 Item 8. Financial Statements and Supplementary Data. - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Quarterly Financial Data (Unaudited)
March 31 June 30 Sept. 30 Dec. 31 -------- ------- -------- ------- ($ in millions, except per share amounts) 1999 ---- Railway operating revenues $1,030 $1,181 $1,467 $1,436 Income from railway operations 222 22 137 122 Net income 146 13 84 89 Dividends per serial preferred share $ 0.65 $ 0.65 $ 0.65 $ 0.65 1998 ---- Railway operating revenues $1,066 $1,079 $1,048 $1,028 Income from railway operations 251 294 258 240 Net income 168 206 167 184 Dividends per serial preferred share $ 0.65 $ 0.65 $ 0.65 $ 0.65
Index to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1999, 1998 and 1997 41 Consolidated Balance Sheets As of December 31, 1999 and 1998 42 Consolidated Statements of Cash Flows Years ended December 31, 1999, 1998 and 1997 44 Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1999, 1998 and 1997 46 Notes to Consolidated Financial Statements 47 Independent Auditors' Report 65 The Index to Consolidated Financial Statement Schedule appears in Item 14 on Page 68. PAGE 41 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Consolidated Statements of Income
Years ended December 31, 1999 1998 1997 ---- ---- ---- ($ in millions) RAILWAY OPERATING REVENUES $ 5,114 $ 4,221 $ 4,223 RAILWAY OPERATING EXPENSES: Compensation and benefits 1,967 1,492 1,405 Materials, services and rents 1,181 808 690 Conrail rents and services (Note 2) 279 -- -- Depreciation 463 434 416 Diesel fuel 255 174 227 Casualties and other claims 138 95 123 Other 328 175 149 ------- ------- ------- Railway operating expenses 4,611 3,178 3,010 ------- ------- ------- Income from railway operations 503 1,043 1,213 Charge for credit facility costs -- -- (77) Other income - net (Note 3) 42 90 28 Interest expense on debt (Note 6) (39) (25) (30) ------- ------- ------- Income before income taxes 506 1,108 1,134 Provision for income taxes (Note 4) 174 383 380 ------- ------- ------- NET INCOME $ 332 $ 725 $ 754 ======= ======= =======
See accompanying Notes to Consolidated Financial Statements. PAGE 42 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Consolidated Balance Sheets
As of December 31, 1999 1998 ---- ---- ($ in millions) ASSETS Current assets: Short-term investments $ 12 $ 44 Accounts receivable net of allowance for doubtful accounts of $5 million and $4 million, respectively 681 508 Due from Conrail (Note 2) 77 -- Materials and supplies 98 59 Deferred income taxes (Note 4) 124 110 Other current assets 144 130 ------- ------- Total current assets 1,136 851 Due from NS - net (Note 2) -- 43 Investments (Notes 5 and 14) 624 990 Properties less accumulated depreciation (Note 6) 10,390 9,985 Other assets 482 148 ------- ------- TOTAL ASSETS $12,632 $12,017 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable (Note 7) $ 787 $ 577 Income and other taxes 132 139 Due to NS - net (Note 2) 483 -- Notes and accounts payable to Conrail (Note 2) 184 -- Other current liabilities (Note 7) 152 73 Current maturities of long-term debt (Note 8) 85 141 ------- ------- Total current liabilities 1,823 930 Long-term debt (Note 8) 781 619 Other liabilities (Note 10) 1,044 909 Minority interests 3 2 Deferred income taxes (Note 4) 3,596 3,420 ------- ------- TOTAL LIABILITIES 7,247 5,880 ------- ------- PAGE 43 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Consolidated Balance Sheets (continued) As of December 31, 1999 1998 ---- ---- ($ in millions) Stockholders' equity: Serial preferred stock (Note 11) 55 55 Common Stock (Note 11) 167 167 Additional paid-in capital 673 548 Accumulated other comprehensive income (Note 12) 259 414 Retained income 4,231 4,953 ------- ------- TOTAL STOCKHOLDERS' EQUITY 5,385 6,137 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $12,632 $12,017 ======= =======
See accompanying Notes to Consolidated Financial Statements. PAGE 44 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Consolidated Statements of Cash Flows
Years ended December 31, 1999 1998 1997 ---- ---- ---- ($ in millions) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 332 $ 725 $ 754 Reconciliation of net income to net cash provided by operating activities: Depreciation 465 435 417 Deferred income taxes 5 100 70 Charge for credit facility costs -- -- 77 Nonoperating gains on properties and investments (44) (31) (9) Accounts receivable dividend to NS (Note 2) (491) -- -- Changes in assets and liabilities affecting operations: Accounts receivable (173) 31 (23) Materials and supplies (40) (1) 3 Other current assets and due from Conrail (49) (15) (8) Income tax liabilities 162 208 180 Other short-term liabilities 269 (11) (1) Other - net 130 (54) (43) ------ ------ ------ Net cash provided by operating activities 566 1,387 1,417 CASH FLOWS FROM INVESTING ACTIVITIES: Property additions (915) (898) (838) Property sales and other transactions 65 54 54 Investments, including short-term (105) (97) (175) Investment sales and other transactions 311 143 165 ------ ------ ------ Net cash used for investing activities (644) (798) (794) CASH FLOWS FROM FINANCING ACTIVITIES: Dividends (Note 2) (3) (3) (3) Credit facility costs paid -- -- (72) Advances to NS (Note 2) (105) (603) (760) Advances and repayments from NS (Note 2) 17 6 101 Proceeds from borrowings 337 67 2 Debt repayments (168) (63) (56) ------ ------ ------ Net cash provided by (used for) financing activities 78 (596) (788) ------ ------ ------ Net increase (decrease) in cash and cash equivalents -- (7) (165) CASH AND CASH EQUIVALENTS: At beginning of year -- 7 172 ------ ------ ------ At end of year $ -- $ -- $ 7 ====== ====== ====== (continued) PAGE 45 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Consolidated Statements of Cash Flows (continued) Years ended December 31, 1999 1998 1997 ---- ---- ---- ($ in millions) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest (net of amounts capitalized) $ 70 $ 61 $ 60 Income taxes $ 5 $ 74 $ 169
See accompanying Notes to Consolidated Financial Statements. PAGE 46 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Consolidated Statements of Changes in Stockholders' Equity
Accumu- Addi- lated Other Serial tional Compre- Preferred Common Paid-In hensive Retained Stock Stock Capital Income Income Total -------- ------ ------- ---------- -------- ----- ($ in millions) BALANCE DECEMBER 31, 1996 $ 55 $ 167 $ 525 $ 398 $4,627 $5,772 Comprehensive income- 1997 Net income 754 754 Other comprehensive income (Note 12) 16 16 ------ Total comprehensive income 770 Serial preferred stock, $2.60 per share cash dividend (3) (3) Noncash dividends on Common Stock (Note 2) (147) (147) ------ ------ ------ ------ ------ ------ BALANCE DECEMBER 31, 1997 55 167 525 414 5,231 6,392 Comprehensive income- 1998 Net income 725 725 Other comprehensive income (Note 12) -- -- ------ Total comprehensive income 725 Serial preferred stock, $2.60 per share cash dividend (3) (3) Noncash dividends on Common Stock (Note 2) (1,000) (1,000) Capital contribution (Note 2) 23 23 ------ ------ ------ ------ ------ ------ BALANCE DECEMBER 31, 1998 55 167 548 414 4,953 6,137 Comprehensive income- 1999 Net income 332 332 Other comprehensive income (Note 12) (155) (155) ------ Total comprehensive income 177 Serial preferred stock, $2.60 per share cash dividend (3) (3) Noncash dividends on Common Stock (Note 2) (1,051) (1,051) Capital contribution (Note 2) 125 125 ------ ------ ------ ------ ------ ------ BALANCE DECEMBER 31, 1999 $ 55 $ 167 $ 673 $ 259 $4,231 $5,385 ====== ====== ====== ====== ====== ======
See accompanying Notes to Consolidated Financial Statements. PAGE 47 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (A Majority-Owned Subsidiary of Norfolk Southern Corporation) Notes to Consolidated Financial Statements The following Notes are an integral part of the Consolidated Financial Statements. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business - ----------------------- Norfolk Southern Railway Company (NSR), together with its consolidated subsidiaries (collectively NS Rail), is engaged principally in the transportation of freight by rail, operating approximately 21,800 route miles, primarily in the East and Midwest (see Note 2). These financial statements include NSR and its majority-owned and controlled subsidiaries on a consolidated basis. All significant intercompany balances and transactions have been eliminated in consolidation. NS Rail transports raw materials, intermediate products and finished goods classified in the following market groups: coal; automotive; chemicals; paper/clay/forest products; metals/construction; agriculture/consumer products/government; and intermodal. Except for coal, all groups are approximately equal in size based on revenues; coal accounts for about 26% of total railway operating revenues. Ultimate points of origination or destination for some of the freight (particularly coal bound for export and intermodal containers) are outside of the United States. Use of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents - ---------------- "Cash equivalents" are highly liquid investments purchased three months or less from maturity. Investments - ----------- Marketable equity and debt securities are reported at amortized cost or fair value, depending upon their classification as securities "held-to- maturity," "trading," or "available-for-sale." On Dec. 31, 1999 and 1998, all "Short-term investments," consisting primarily of United States government and federal agency securities and all marketable equity securities consisting principally of NS Common Stock, were designated as "available-for-sale." Accordingly, unrealized gains and losses, net of taxes, are recognized in "Accumulated Other Comprehensive Income" (see Note 12). Investments where NS Rail has the ability to exercise significant influence over, but does not control, the entity are accounted for using the equity method in accordance with APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock." Materials and Supplies - ---------------------- "Materials and supplies," consisting mainly of fuel oil and items for maintenance of property and equipment, are stated at the lower of average cost or market. The cost of materials and supplies expected to be used in capital additions or improvements is included in "Properties." PAGE 48 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Properties - ---------- "Properties" are stated principally at cost and are depreciated using group depreciation. Rail is depreciated primarily on the basis of use measured by gross ton-miles. Other properties are depreciated generally using the straight-line method over estimated service or lease lives. NS Rail capitalizes interest on major capital projects during the period of their construction. Additions to properties, including those under lease, are capitalized. Maintenance expense is recognized when repairs are performed. When properties other than land and nonrail assets are sold or retired in the ordinary course of business, the cost of the assets, net of sale proceeds or salvage, is charged to accumulated depreciation rather than recognized through income. Gains and losses on disposal of land and nonrail assets are included in "Other Income - Net" (see Note 3). NS Rail reviews the carrying amount of properties whenever events or changes in circumstances indicate that such carrying amount may not be recoverable based on future undiscounted cash flows or estimated net realizable value. Assets that are deemed impaired as a result of such review are recorded at the lower of carrying amount or fair value. Revenue Recognition - ------------------- Revenue is recognized proportionally as a shipment moves from origin to destination. Derivatives - ----------- NS Rail does not engage in the trading of derivatives. NS Rail has entered into a limited number of derivative agreements to hedge interest rate exposures on certain components of its debt portfolio. All of these derivative instruments are designated as hedges, have high correlation with the underlying exposure and are highly effective in offsetting underlying price movements. Accordingly, payments made or received under interest rate swap agreements are recorded in the income statement with the corresponding interest expense. Required Accounting Changes - --------------------------- Effective Jan. 1, 1999, NS Rail adopted AICPA Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Adoption of this pronouncement had no material effect on NS Rail's consolidated financial statements. Reclassifications - ----------------- Certain amounts in the financial statements and Notes thereto have been reclassified to conform to the 1999 presentation. 2. RELATED PARTIES General - ------- Norfolk Southern Corporation (NS) is the parent holding company of NSR. The costs of functions performed by NS are charged to NS Rail. In addition, effective Nov. 1, 1998, NS charges NS Rail a revenue-based licensing fee (which totaled $77 million for 1999) for use of certain intangible assets owned by NS. Rail operations are coordinated at the holding company level by the NS Vice Chairman and Chief Operating Officer. NS Rail owns 21,627,902 shares of NS common stock. PAGE 49 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. RELATED PARTIES (continued) Operations Over Conrail's Lines - ------------------------------- Overview -- NS and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primary subsidiary is Consolidated Rail Corporation (CRC), the major railroad in the Northeast. From May 23, 1997, the date NS and CSX completed their acquisition of Conrail stock, until June 1, 1999, Conrail's operations continued substantially unchanged while NS and CSX awaited regulatory approvals and prepared for the integration of the respective Conrail routes and assets to be leased to their railroad subsidiaries, NSR and CSX Transportation, Inc. (CSXT). Commencement of Operations -- On June 1, 1999 (the "Closing Date"), NSR and CSXT began operating as parts of their rail systems the separate Conrail routes and assets leased to them pursuant to operating and lease agreements. The Operating Agreement between NSR and Pennsylvania Lines LLC (PRR), a wholly owned subsidiary of CRC, governs substantially all nonequipment assets to be operated by NSR and has an initial 25-year term, renewable at the option of NSR for two five-year terms. Payments under the Operating Agreement are subject to adjustment every six years to reflect changes in values. NSR also has leased or subleased for varying terms from PRR a number of equipment assets. Costs necessary to operate and maintain the PRR assets, including leasehold improvements, are borne by NSR. CSXT has entered into comparable arrangements, for the operation and use of certain other CRC routes and assets, with another wholly owned CRC subsidiary. NSR and CSXT also have entered into agreements with CRC governing other Conrail properties that continue to be owned and operated by Conrail (the "Shared Assets Areas"). NSR and CSXT pay CRC a fee for joint and exclusive access to the Shared Assets Areas. In addition, NSR and CSXT pay, based on usage, the costs incurred by CRC to operate the Shared Assets Areas. Future minimum lease payments due to PRR under the Operating Agreement and lease agreements and to CRC under the Shared Assets Areas (SAA) agreements are as follows:
PRR Oper. PRR Lease SAA ($ in millions) Agmt. Agmts. Agmts. --------------- -------- -------- -------- 2000 $ 166 $ 154 $ 22 2001 178 129 24 2002 196 122 27 2003 217 110 30 2004 238 92 32 2005 and subsequent years 5,022 367 687 ------- ------- ------- Total $ 6,017 $ 974 $ 822 ======= ======= =======
Operating lease expense related to the agreements, which is included in "Conrail rents and services," amounted to $273 million in 1999. On the Closing Date, both NS Rail's route miles and its employees increased by approximately 50 percent. NS Rail and CSXT now provide substantially all rail freight services on Conrail's route system, perform or are responsible for performing most services incident to customer freight contracts and employ the majority of Conrail's former work force. Consequently, NS Rail began to receive all freight revenues and incur all expenses on the PRR lines. Since June 1, 1999, difficulties in integrating the PRR routes and assets have affected adversely both NS Rail's revenues and expenses. These higher expenses included the cost of a special incentive program available to unionized employees for much of the third quarter, higher labor costs and equipment rents and service alteration costs to meet the PAGE 50 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. RELATED PARTIES (continued) needs of shippers. A long-term failure by NS Rail to integrate successfully these PRR properties could have a substantial adverse impact on NS Rail's financial position, results of operations and liquidity. NS Rail's railway operating expenses in 1999 included $168 million ($103 million after taxes) for contractual obligations, principally to former Conrail employees. Most of these costs are expected to be paid in the two years following the Closing Date, and $42 million of such is classified on NS Rail's balance sheet as "Current liabilities." However, certain contractual obligations by their terms will be paid out over a longer period and are classified as "Other liabilities" on NS Rail's balance sheet. Through Dec. 31, 1999, NS Rail has paid $24 million of these costs. In addition, NS Rail has incurred $9 million and expects to incur an additional $10 million of costs for relocations of former Conrail employees. As definitive plans are determined and communicated, costs, if any, for severing or relocating NS Rail employees and for disposing of NS Rail facilities also will be charged to operating expenses. Until the Closing Date, NS Rail and CRC had transactions with each other in the customary course of handling interline traffic. As of Dec. 31, 1999, most of the amounts receivable or payable related to these transactions have been satisfied. NS Rail provides certain general and administrative support functions to Conrail, the fees for which are billed in accordance with several service-provider arrangements. "Conrail rents and services," a new line on the income statements beginning June 1, 1999, includes expenses for amounts due to PRR and CRC for use by NS Rail of operating properties and equipment, operation of the Shared Assets Areas and continued operation of certain facilities during a transition period. "Due from Conrail" includes $39 million for vacation liability related to the portion of CRC's work force that became NS Rail employees on the Closing Date. NS Rail increased its vacation liability accordingly, and will pay these employees as they take vacation. "Notes and accounts payable to Conrail" includes $123 million of interest-bearing loans made to NS Rail by a PRR subsidiary, payable on demand. The interest rate for these loans is variable and was 5.6% at Dec. 31, 1999. Also included is $61 million due to PRR and CRC related to expenses included in "Conrail rents and services," as discussed above. Noncash Dividends - ----------------- NSR declared and issued to NS noncash dividends of $1.1 billion in 1999, $1.0 billion in 1998 and $147 million in 1997. The 1999 amount included a $491 million dividend of accounts receivable declared December 1. The remainder of the 1999 dividends and all of the 1998 and 1997 dividends were settled by reduction of NSR's interest-bearing advances due from NS. Noncash dividends are excluded from the Consolidated Statements of Cash Flows. Sale of Accounts Receivable - --------------------------- Effective Dec. 1, 1999, NS Rail sells its rail accounts receivable to NS. The sales are accounted for as secured borrowings, and the liability is included in "Due to NS - net" in the Consolidated Balance Sheet. As of Dec. 31, 1999, "Accounts receivable" included $388 million of such sold receivables. NS Rail services the receivables on behalf of NS for a fee that approximates the costs of servicing. The fee is reflected in the discount applied to receivables sold. The discount is included in "Other income - net" in the Consolidated Statement of Income and is a component of "Other interest expense" in Note 3. PAGE 51 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 2. RELATED PARTIES (continued) Intercompany Accounts - --------------------- December 31, ------------ 1999 1998 ---- ----
Average Average Interest Interest ($ in millions) Balance Rate Balance Rate --------------- ------- -------- ------- -------- Due from NS: Advances $ 75 4% $ 354 5% Due to NS: Advances (234) 5% -- Notes (324) 7% (311) 7% ------ ------ Due (to) from NS - net $ (483) $ 43 ====== ======
Interest is applied to certain advances at the average NS yield on short-term investments and to the notes at specified rates. "Interest income" includes interest on amounts due from NS of $13 million in 1999, $48 million in 1998 and $15 million in 1997. "Other interest expense" includes interest on amounts due to NS of $31 million in 1999, $23 million in 1998 and $17 million in 1997. 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. NS Rail had long-term intercompany federal income tax payables (which are included in "Deferred income taxes" in the Consolidated Balance Sheets) of $809 million at Dec. 31, 1999, and $633 million at Dec. 31, 1998. Capital Contributions - --------------------- In 1999, NS Rail recognized capital contributions for a transfer of pension assets NS received from the Conrail pension plan and for benefits NS Rail received related to tax credits generated by a nonrail subsidiary of NS. In 1998, NS Rail recognized a capital contribution for benefits it received related to tax credits generated by a nonrail subsidiary of NS. Cash Required for NS Debt - ------------------------- To finance the cost of the Conrail transaction, NS issued and sold commercial paper and $4.3 billion of unsecured notes. A significant portion of the funding for the interest and repayments on this and other NS debt is expected to be provided by NS Rail. NS is subject to various financial covenants with respect to its debt and under its credit agreement, including a minimum net worth requirement, a maximum leverage ratio restriction and certain restrictions on issuance of further debt. As a major NS subsidiary, NS Rail is subject to certain of those covenants. PAGE 52 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 3. OTHER INCOME - NET
($ in millions) 1999 1998 1997 --------------- ---- ---- ---- Gains from sales of properties and investments $ 44 $ 31 $ 9 Rental income 32 24 22 Interest income (Note 2) 20 58 31 Dividends from NS 17 17 17 Other interest expense (Note 2) (58) (45) (45) Corporate-owned life insurance - net (3) 11 7 Taxes on nonoperating property (3) (2) (2) Other - net (7) (4) (11) ------- ------- ------- Total $ 42 $ 90 $ 28 ======= ======= =======
4. INCOME TAXES Provision for Income Taxes - --------------------------
($ in millions) 1999 1998 1997 --------------- ---- ---- ---- Current: Federal $ 159 $ 269 $ 279 State 10 14 31 ------- ------- ------- Total current taxes 169 283 310 ------- ------- ------- Deferred: Federal 8 87 75 State (3) 13 (5) ------- ------- ------- Total deferred taxes 5 100 70 ------- ------- ------- Provision for income taxes $ 174 $ 383 $ 380 ======= ======= =======
Reconciliation of Statutory Rate to Effective Rate - -------------------------------------------------- Total income taxes as reflected in the Consolidated Statements of Income differ from the amounts computed by applying the statutory federal corporate tax rate as follows:
1999 1998 1997 ($ in millions) Amount % Amount % Amount % --------------- ------ --- ------ --- ------ --- Federal income tax at statutory rate $ 177 35 $ 388 35 $ 397 35 State income taxes, net of federal tax benefit 4 1 18 2 17 2 Corporate-owned life insurance -- -- (12) (1) (10) (1) Other - net (7) (2) (11) (1) (24) (2) ----- --- ----- --- ----- --- Provision for income taxes $ 174 34 $ 383 35 $ 380 34 ===== === ===== === ===== ===
PAGE 53 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 4. INCOME TAXES (continued) Inclusion in Consolidated Return - -------------------------------- NS Rail is included in the consolidated federal income tax return of NS. The provision for current income taxes in the Consolidated Statements of Income reflects NS Rail's portion of NS' consolidated tax provision. Tax expense or tax benefit is recorded on a separate company basis. Deferred Tax Assets and Liabilities - ----------------------------------- Certain items are reported in different periods for financial reporting and income tax purposes. Deferred tax assets and liabilities were recorded in recognition of these differences. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
December 31, ------------ ($ in millions) 1999 1998 --------------- ---- ---- Deferred tax assets: Reserves, including casualty and other claims $ 168 $ 158 Employee benefits 95 124 Retiree health and death benefit obligation 125 126 Taxes, including state and property 160 157 Other 2 -- -------- -------- Deferred tax assets 550 565 -------- -------- Deferred tax liabilities: Property (3,029) (2,975) Unrealized holding gains (153) (237) Other (31) (30) -------- -------- Deferred tax liabilities (3,213) (3,242) Intercompany federal tax payable - net (809) (633) -------- -------- Net deferred tax liability (3,472) (3,310) Net current deferred tax assets 124 110 -------- -------- Net long-term deferred tax liability $ (3,596) $ (3,420) ======== ======== Except for amounts for which a valuation allowance has been provided, Management believes the other deferred tax assets will be realized. Internal Revenue Service (IRS) Reviews - -------------------------------------- Consolidated federal income tax returns have been examined and Revenue Agent Reports have been received for all years up to and including 1994. The consolidated federal income tax returns for 1995 and 1996 are being audited by the IRS. Management believes that adequate provision has been made for any additional taxes and interest thereon that might arise as a result of IRS examinations. PAGE 54 Item 8. Financial Statements and Supplementary Data. (continued) - ------ -------------------------------------------
5. INVESTMENTS
December 31, ------------ ($ in millions) 1999 1998 --------------- ---- ---- Marketable equity securities at fair value (Note 14) $ 445 $ 687 Corporate-owned life insurance at net cash surrender value 150 282 Other 29 21 ----- ----- Total $ 624 $ 990 ===== =====
6. PROPERTIES
December 31, Depreciation ($ in millions) 1999 1998 Rate for 1999 --------------- ---- ---- ------------- Railway property: Road $ 9,620 $ 9,228 2.8% Equipment 5,395 5,117 4.1% Other property 83 77 2.5% ------- ------- 15,098 14,422 Less: Accumulated depreciation 4,708 4,437 ------- ------- Net properties $10,390 $ 9,985 ======= ======= Equipment includes $593 million at Dec. 31, 1999 and 1998 of assets recorded pursuant to capital leases. Capitalized Interest - -------------------- Total interest cost incurred on debt in 1999, 1998 and 1997 was $54 million, $46 million and $47 million, respectively, of which $15 million, $21 million and $17 million was capitalized. PAGE 55 Item 8. Financial Statements and Supplementary Data. (continued) - ------ -------------------------------------------
7. CURRENT LIABILITIES
December 31, ------------ ($ in millions) 1999 1998 --------------- ---- ---- Accounts payable: Accounts and wages payable $ 324 $ 260 Casualty and other claims 180 143 Equipment rents payable - net 135 72 Vacation liability 123 80 Other 25 22 ------- ------- Total $ 787 $ 577 ======= ======= Other current liabilities: Accrued Conrail-related costs (Note 2) $ 42 $ -- Interest payable 38 13 Liabilities for forwarded traffic 37 27 Retiree health and death benefit obligation (Note 13) 24 24 Other 11 9 ------- ------- Total $ 152 $ 73 ======= =======
8. DEBT Long-Term Debt - --------------
December 31, ------------ ($ in millions) 1999 1998 --------------- ---- ---- Equipment obligations at an average rate of 6.8% maturing to 2014 $ 450 $ 377 Capitalized leases at an average rate of 6.3% maturing to 2015 382 349 Other debt at an average rate of 5.4% maturing to 2015 34 34 ------- ------- Total long-term debt 866 760 ------- ------- Current maturities (85) (141) ------- ------- Long-term debt less current maturities $ 781 $ 619 ======= =======
PAGE 56 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 8. DEBT (continued)
Long-term debt matures as follows: 2001 $ 80 2002 75 2003 78 2004 76 2005 and subsequent years 472 ------ Total $ 781 ======
The equipment obligations and the capitalized leases are secured by liens on the underlying equipment. Capital Lease Obligations - ------------------------- During 1998 and 1997, NSR entered into capital leases covering new locomotives. The related capital lease obligations, totaling $127 million in 1998 and $64 million in 1997, were reflected in the Consolidated Balance Sheets as debt and, because they were noncash transactions, were excluded from the Consolidated Statements of Cash Flows. These and certain other lease obligations carry an average stated interest rate of 7.1%, but were effectively converted to variable rate obligations using interest rate swap agreements. The interest rates on the swap obligations are based on the six-month London Interbank Offered Rate and are reset every six months with changes in interest rates accounted for as an adjustment of interest expense over the terms of the leases. As of Dec. 31, 1999, the notional amount of the swap agreements was $281 million, and the average interest rate was 6.3%. As a result, NS Rail is exposed to the market risk associated with fluctuations in interest rates. To date, the effects of the rate fluctuations have been favorable and not material. Counterparties to the interest rate swap agreements are major financial institutions believed by Management to be creditworthy. 9. LEASE COMMITMENTS NS Rail is committed under long-term lease agreements, which expire on various dates through 2067, for equipment, lines of road and other property. The following amounts do not include payments to PRR under the Operating Agreement and lease agreements or to CRC under the SAA agreements (see Note 2). Future minimum lease payments other than to PRR and CRC are as follows: PAGE 57 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 9. LEASE COMMITMENTS (continued)
Operating Capital ($ in millions) Leases Leases --------------- --------- ------- 2000 $ 96 $ 47 2001 74 47 2002 62 47 2003 58 46 2004 50 46 2005 and subsequent years 553 245 ------ ------ Total $ 893 478 ====== Less imputed interest on capital leases at an average rate of 7.1% 96 ------ Present value of minimum lease payments included in debt $ 382 ======
Operating Lease Expense - -----------------------
($ in millions) 1999 1998 1997 --------------- ---- ---- ---- Minimum rents $ 117 $ 75 $ 68 Contingent rents 61 40 43 ------ ------ ------ Total $ 178 $ 115 $ 111 ====== ====== ======
10. OTHER LIABILITIES
December 31, ------------ ($ in millions) 1999 1998 --------------- ---- ---- Casualty and other claims $ 275 $ 271 Retiree health and death benefit obligation (Note 13) 256 264 Accrued Conrail-related costs (Note 2) 102 -- Net pension obligation (Note 13) 74 72 Other 337 302 ------- ------- Total $ 1,044 $ 909 ======= =======
PAGE 58 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 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, designations, dividends and other preferences as deemed appropriate at the time of issuance. On Dec. 31, 1999 and 1998, 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, including 176,705 shares held by NS. 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. Preference - ---------- There are 10,000,000 shares of no par value serial preference stock authorized. None of these shares has been issued. Common - ------ There are 50,000,000 shares of no par value common stock with a stated value of $10 per share authorized. NS owned all 16,668,997 shares issued and outstanding at Dec. 31, 1999 and 1998. 12. ACCUMULATED OTHER COMPREHENSIVE INCOME "Accumulated other comprehensive income" reported in "Stockholders' equity" included unrealized gains, net of taxes, on securities of $272 million at Dec. 31, 1999, and $428 million at Dec. 31, 1998, (see Note 14) and minimum pension liability of $13 million at Dec. 31, 1999, and $14 million at Dec. 31, 1998. "Other comprehensive income" reported in the Consolidated Statements of Changes in Stockholders' Equity consisted of the following:
($ in millions) 1999 1998 1997 --------------- ---- ---- ---- Unrealized gains on securities $ (242) $ 22 $ 25 Minimum pension liability 2 (23) -- Income taxes 85 1 (9) ------ ------ ------ Other comprehensive income $ (155) $ -- $ 16 ====== ====== ======
"Unrealized gains on securities" included reclassification adjustments for gains realized in income from the sale of the securities of less than $1 million in 1999, $2 million in 1998 and less than $1 million in 1997. 13. PENSIONS AND OTHER POSTRETIREMENT BENEFITS NS Rail provides defined pension benefits, principally for salaried employees, through participation in NS' funded and defined benefit pension plans. NS Rail also provides specified health care and death benefits to eligible retired employees and their dependents by participating in welfare benefit plans sponsored by NS. Under the present plans, which may be amended or terminated at NS' option, a defined PAGE 59 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued) percentage of health care expenses is covered, reduced by any deductibles, co-payments, Medicare payments and, in some cases, coverage provided under other group insurance policies. The following data relate to the combined NS plans:
Pension Benefits Other Benefits ($ in millions) 1999 1998 1999 1998 --------------- ---- ---- ---- ---- CHANGE IN BENEFIT OBLIGATIONS Benefit obligation at beginning of year $ 1,063 $ 956 $ 362 $ 360 Increase related to former Conrail employees 68 -- -- -- Service cost 17 13 11 10 Interest cost 73 67 23 24 Amendment -- 40 -- -- Actuarial (gains) losses (92) 61 (33) (9) Benefits paid (71) (74) (23) (23) ------- ------- ------- ------- Benefit obligation at end of year 1,058 1,063 340 362 ------- ------- ------- ------- CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year 1,544 1,360 139 111 Transfer of assets from Conrail plan 352 -- -- -- Actual return on plan assets 250 253 21 28 Employer contribution 4 5 15 23 401(h) account transfer (7) -- -- -- Benefits paid (71) (74) (23) (23) ------- ------- ------- ------- Fair value of plan assets at end of year 2,072 1,544 152 139 ------- ------- ------- ------- Funded status 1,014 481 (188) (223) Unrecognized initial net asset (10) (16) -- -- Unrecognized (gain) loss (799) (517) (97) (57) Unrecognized prior service cost (benefit) 40 44 -- (12) ------- ------- ------- ------- Net amount recognized $ 245 $ (8) $ (285) $ (292) ======= ======= ======= ======= Amounts recognized in the Consolidated Balance Sheets consist of: Prepaid benefit cost $ 298 $ 41 $ -- $ -- Accrued benefit liability (74) (72) (285) (292) Accumulated other comprehensive income 21 23 -- -- ------- ------- ------- ------- Net amount recognized $ 245 $ (8) $ (285) $ (292) ======= ======= ======= =======
PAGE 60 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued) Of the pension plans included above, the nonqualified pension plans were the only plans with an accumulated benefit obligation in excess of plan assets. These plans' accumulated benefit obligations were $74 million at Dec. 31, 1999, and $72 million at Dec. 31, 1998. These plans' projected benefit obligations were $76 million at Dec. 31, 1999, and $77 million at Dec. 31, 1998. Because of the nature of such plans, there are no plan assets. During 1999, a Section 401(h) account transfer of $7 million was made, transferring a portion of pension assets to fund 1999 medical payments for retirees. As a result of the commencement of operations over Conrail's lines (see Note 2), NS hired a substantial portion of Conrail's former work force. In August 1999, NS assumed certain pension obligations related to those employees. These obligations, along with pension plan assets in excess of the obligations, were transferred to the NS plans in 1999. NS has amended its qualified pension plan to conform certain provisions of its plan with the Conrail plan and to provide prior service credit to Conrail employees for benefits under the NS plan. The amendment, as it relates to NS employees, increased the pension benefit obligation at Dec. 31, 1998, by $40 million. In January 2000, NS announced a voluntary early retirement program that included enhancements to pension benefits for eligible nonunion employees. Approximately 1,180 employees, or 20% of NS' nonunion work force, were eligible for the program. Benefits will be paid out of NS' over-funded pension plan. Pension and other postretirement benefit costs are determined based on actuarial valuations that reflect appropriate assumptions as of the measurement date, ordinarily the beginning of each year. The funded status of the plans is determined using appropriate assumptions as of each year end. During 1999, NS received assets from the Conrail pension plan and assumed certain related liabilities. As a result, the measurement dates for determining pension costs were Jan. 1, 1999, and Aug. 31, 1999, and reflect discount rates of 6.75% and 7.75%, respectively, and other assumptions appropriate at those dates. A summary of the major assumptions follows:
1999 1998 1997 ---- ---- ---- Funded status: Discount rate 7.75% 6.75% 7.25% Future salary increases 5% 5% 5.25% Pension cost: Discount rate 6.75% 7.25% 7.75% Return on assets in plans 10% 9% 9% Future salary increases 5% 5.25% 5.25%
PAGE 61 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued) Pension and Other Postretirement Benefit Costs - ----------------------------------------------
($ in millions) 1999 1998 1997 --------------- ---- ---- ---- PENSION BENEFITS Service cost $ 17 $ 13 $ 11 Interest cost 73 67 66 Expected return on plan assets (152) (106) (90) Amortization of prior service cost 4 1 1 Amortization of initial net asset (7) (7) (6) Recognized net actuarial (gain) loss (22) (12) (7) ------ ------ ------ Net cost (benefit) $ (87) $ (44) $ (25) ====== ====== ====== OTHER POSTRETIREMENT BENEFITS Service cost $ 11 $ 10 $ 9 Interest cost 23 24 25 Expected return on plan assets (12) (9) (7) Amortization of prior service cost (12) (12) (12) Recognized net actuarial (gain) loss (2) (2) -- ------ ------ ------ Net cost $ 8 $ 11 $ 15 ====== ====== ======
For measurement purposes, increases in the per capita cost of covered health care benefits were assumed to be 7.5% for 2000 and 8.0% for 1999. The rate was assumed to decrease gradually to an ultimate rate of 5.0% for 2003 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported in the financial statements. To illustrate, a one- percentage-point change in assumed health care cost trend would have the following effects:
One percentage point ($ in millions) Increase Decrease --------------- -------- -------- Increase (decrease) in: Total service and interest cost components $ 4 $ (3) Postretirement benefit obligation $ 28 $ (24)
Under collective bargaining agreements, NS Rail participates in a multi-employer benefit plan, which provides certain postretirement health care and life insurance benefits to eligible agreement employees. Premiums under this plan are expensed as incurred and amounted to $5 million in 1999, $5 million in 1998 and $4 million in 1997. 401(k) Plans - ------------ NS Rail provides 401(k) savings plans for employees. Under the plans, NS Rail matches a portion of employee contributions, subject to applicable limitations. In 1999, NS issued shares of its Common Stock to fund NS Rail's contributions. NS Rail's expenses under these plans were $12 million in 1999, $10 million in 1998 and $9 million in 1997. PAGE 62 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 13. PENSIONS AND OTHER POSTRETIREMENT BENEFITS (continued) In November 1999, NS issued and contributed to eligible participants' accounts approximately 2 million shares of its Common Stock in connection with a temporary special work incentive program available to NS Rail's unionized employees during much of the third quarter. The cost of the program, which was charged to compensation and benefits expenses, was $49 million. Contributions funded with NS Common Stock were excluded from the Consolidated Statements of Cash Flows because they were noncash transactions. 14. FAIR VALUES OF FINANCIAL INSTRUMENTS The fair values of "Cash and cash equivalents," "Accounts receivable," "Short-term debt," and "Accounts payable" approximate carrying values because of the short maturity of these financial instruments. The fair value of corporate-owned life insurance approximates carrying value. The carrying amounts and estimated fair values for the remaining financial instruments, excluding investments accounted for under the equity method in accordance with APB No. 18, consisted of the following at December 31:
1999 1998 ---- ---- Carrying Fair Carrying Fair ($ in millions) Amount Value Amount Value --------------- -------- ----- -------- ----- Investments $ 502 $ 507 $ 777 $ 782 Long-term debt 866 867 760 779 Interest rate swaps -- 4 -- 20
Quoted market prices were used to determine the fair value of marketable securities; underlying net assets were used to estimate the fair value of other investments. The fair values of debt were estimated based on quoted market prices or discounted cash flows using current interest rates for debt with similar terms, company rating and remaining maturity. The fair value of interest rate swaps were estimated based on discounted cash flows, reflecting the difference between estimated future variable-rate payments and future fixed-rate receipts. Carrying amounts of marketable securities, which consist almost entirely of shares of NS Common Stock, reflect unrealized holding gains of $424 million on Dec. 31, 1999, and $666 million on Dec. 31, 1998. Sales of "available-for-sale" securities were immaterial for years ended Dec. 31, 1999 and 1998. 15. COMMITMENTS AND CONTINGENCIES Lawsuits - -------- NSR and certain subsidiaries are defendants in numerous lawsuits relating principally to railroad operations. While the final outcome of these lawsuits cannot be predicted with certainty, it is the opinion of Management, based on known facts and circumstances, that the amount of NS Rail's ultimate liability is unlikely to have a material adverse effect on NS Rail's financial position, results of operations or liquidity. Environmental Matters - --------------------- NS Rail is subject to various jurisdictions' environmental laws and regulations. It is NS Rail's policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably. Claims, if any, against third parties for recovery of cleanup costs incurred by NS Rail are reflected as receivables in the balance sheet PAGE 63 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 15. COMMITMENTS AND CONTINGENCIES (continued) and are not netted against the associated NS Rail liability. Environmental engineers regularly participate in ongoing evaluations of all identified sites and in determining any necessary adjustments to initial liability estimates. NS Rail also has established an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy. As of Dec. 31, 1999, NS Rail's balance sheet included a reserve for environmental exposures in the amount of $41 million (of which $8 million is accounted for as a current liability), which is NS Rail's estimate of the probable cleanup and remediation costs based on available information at 126 identified locations. On that date, 12 sites accounted for $20 million of the reserve, and no individual site was considered to be material. NS Rail anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period. At some of the 126 locations, certain NS Rail subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for 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 in NS Rail's traffic mix, particularly those classified as hazardous materials, can pose special risks that NS Rail and its subsidiaries work diligently to minimize. In addition, several NS Rail subsidiaries own, or have owned, land used as operating property, or which is leased or may have been leased and operated by others, or held for sale. Because environmental problems may exist on these properties that are latent or undisclosed, there can be no assurance that NS Rail will not incur environmentally related liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time. Moreover, lawsuits and claims involving these and other now-unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial condition, results of operations or liquidity in a particular year or quarter. However, based on its assessments of the facts and circumstances now known, Management believes that it has recorded the probable costs for dealing with those environmental matters of which the Corporation is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in the aggregate, will have a material adverse effect on NS Rail's financial position, results of operations or liquidity. Tax Benefit Leases - ------------------ In January 1995, the United States Tax Court issued a preliminary decision that disallowed some of the tax benefits a predecessor of NSR purchased from a third party pursuant to a safe harbor lease agreement in 1981. The Tax Court finalized this decision in February 1997, and all avenues of appeal have been exhausted. NS Rail has requested payment and filed suit to collect from the third party in accordance with indemnification provisions of the lease agreement, and Management believes that this receivable will be collected. PAGE 64 Item 8. Financial Statements and Supplementary Data. (continued) - ------ ------------------------------------------- 15. COMMITMENTS AND CONTINGENCIES (continued) Change-in-Control Arrangements - ------------------------------ NS has compensation agreements with officers and certain key employees that become operative only upon a change in control -- as defined in those agreements -- of that corporation. The agreements provide generally for payments based on compensation at the time of a covered individual's involuntary or other specified termination and for certain other benefits. Debt Guarantees - --------------- As of Dec. 31, 1999, NSR and certain of its subsidiaries are contingently liable as guarantors with respect to $104 million of indebtedness of related entities. PAGE 65 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors Norfolk Southern Railway Company: We have audited the consolidated financial statements of Norfolk Southern Railway Company and subsidiaries as listed in the index in Item 8. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule listed in Item 14(a)2. These consolidated financial statements and this consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and this consolidated financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norfolk Southern Railway Company and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. Also in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Norfolk, Virginia January 25, 2000 PAGE 66 Item 9. Changes in and Disagreements with Accountants on Accounting - ------ ----------------------------------------------------------- and Financial Disclosure. ------------------------ None. PAGE 67 PART III -------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR) Item 10. Directors and Executive Officers of the Registrant. - ------- -------------------------------------------------- Item 11. Executive Compensation. - ------- ---------------------- Item 12. Security Ownership of Certain Beneficial Owners and - ------- --------------------------------------------------- Management. ---------- and Item 13. Certain Relationships and Related Transactions. - ------- ---------------------------------------------- In accordance with General Instruction G(3), the information called for by Part III is incorporated herein by reference from Norfolk Southern Railway's definitive Proxy Statement, to be dated April 14, 2000, for the Norfolk Southern Railway Annual Meeting of Stockholders to be held on May 11, 2000, which definitive Proxy Statement will be filed electronically with the Commission pursuant to Regulation 14A. The information regarding executive officers called for by Item 401 of Regulation S-K is included in Part I hereof beginning on Page 17 under "Executive Officers of the Registrant." PAGE 68 PART IV ------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR) Item l4. Exhibits, Financial Statement Schedule and - ------- ------------------------------------------ Reports on Form 8-K. ------------------- (A) The following documents are filed as part of this report: 1. Index to Consolidated Financial Statements: Page ------------------------------------------ ---- Consolidated Statements of Income Years ended December 31, 1999, 1998 and 1997 41 Consolidated Balance Sheets As of December 31, 1999 and 1998 42 Consolidated Statements of Cash Flows Years ended December 31, 1999, 1998 and 1997 44 Consolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1999, 1998 and 1997 46 Notes to Consolidated Financial Statements 47 Independent Auditors' Report 65 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 75 Schedules other than the one listed above are omitted either because they are not required or are inapplicable, or because the information is included in the consolidated financial statements or related notes. PAGE 69 Item l4. Exhibits, Financial Statement Schedule and - ------- ------------------------------------------ Reports on Form 8-K. (continued) ------------------- 3. Exhibits Exhibit Number Description - ------- -------------------------------------------------------- 3 Articles of Incorporation and Bylaws - 3(i) The 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. 3(ii) The Bylaws of Norfolk Southern Railway Company, as last amended March 3, 1993, are incorporated herein by reference from Exhibit 3(b) of Norfolk Southern Railway's 1992 Annual Report on Form 10-K. 4 Instruments Defining the Rights of Security Holders, Including Indentures - In accordance with Item 601(b)(4)(iii) of Regulation S-K, copies of instruments of Norfolk Southern Railway and its subsidiaries with respect to the rights of holders of long-term debt are not filed herewith, or incorporated by reference, but will be furnished to the Commission upon request. 10 Material Contracts - (a) The Transaction Agreement, dated as of June 10, 1997, by and among CSX, CSX Transportation, Inc., NS, Registrant, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC, with certain schedules thereto, is incorporated herein by reference from Exhibit 10 to Norfolk Southern Railway Company's Form 8-K filed electronically on June 30, 1997. (b) Amendment No. 1, dated as of August 22, 1998, to the Transaction Agreement, dated as of June 10, 1997, by and among CSX Corporation, CSX Transportation, Inc., Norfolk Southern Corporation, Norfolk Southern Railway Company, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC is incorporated herein by reference from Exhibit 10.1 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. PAGE 70 Item l4. Exhibits, Financial Statement Schedule and - ------- ------------------------------------------ Reports on Form 8-K. (continued) ------------------- 3. Exhibits (continued) Exhibit Number Description - ------- -------------------------------------------------------- 10 Material Contracts (continued) - (c) Amendment No. 2, dated as of June 1, 1999, to the Transaction Agreement, dated June 10, 1997, by and among CSX Corporation, CSX Transportation, Inc., Norfolk Southern Corporation, Norfolk Southern Railway Company, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC is incorporated herein by reference from Exhibit 10.2 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. (d) Operating Agreement, dated as of June 1, 1999, by and between Pennsylvania Lines LLC and Norfolk Southern Railway Company is incorporated herein by reference from Exhibit 10.3 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. (e) Shared Assets Area Operating Agreement for North Jersey, dated as of June 1, 1999, by and among Consolidated Rail Corporation, CSX Transportation, Inc. and Norfolk Southern Railway Company, with exhibit thereto, is incorporated herein by reference from Exhibit 10.4 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. (f) Shared Assets Area Operating Agreement for South Jersey/Philadelphia, dated as of June 1, 1999, by and among Consolidated Rail Corporation, CSX Transportation, Inc. and Norfolk Southern Railway Company, with exhibit thereto, is incorporated herein by reference from Exhibit 10.5 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. (g) Shared Assets Area Operating Agreement for Detroit, dated as of June 1, 1999, by and among Consolidated Rail Corporation, CSX Transportation, Inc. and Norfolk Southern Railway Company, with exhibit thereto, is incorporated herein by reference from Exhibit 10.6 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. PAGE 71 Item l4. Exhibits, Financial Statement Schedule and - ------- ------------------------------------------ Reports on Form 8-K. (continued) ------------------- 3. Exhibits (continued) Exhibit Number Description - ------- -------------------------------------------------------- 10 Material Contracts (continued) - (h) Monongahela Usage Agreement, dated as of June 1, 1999, by and among CSX Transportation, Inc., Norfolk Southern Railway Company, Pennsylvania Lines LLC and New York Central Lines LLC, with exhibit thereto, is incorporated herein by reference from Exhibit 10.7 to Norfolk Southern Railway Company's Form 10-Q Report for the period ended June 30, 1999. (i) The Agreement, entered into as of July 27, 1999, between North Carolina Railroad Company and Norfolk Southern Railway Company, is filed herewith. (j) 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 Company) - extending and amending a Lease, dated as of October 11, 1881 (both the Lease and Supplementary Agreement, formerly incorporated by reference with Exhibit 10(b) to Southern's 1987 Annual Report on Form 10-K) - is incorporated herein by reference from Exhibit 10(a) to Norfolk Southern Railway's 1994 Annual Report on Form 10-K. 21 Subsidiaries of the Registrant. 27 Financial Data Schedule. (B) Reports on Form 8-K. No reports on Form 8-K were filed for the three months ended December 31, 1999. (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. PAGE 72 Item l4. Exhibits, Financial Statement Schedule and - ------- ------------------------------------------ Reports on Form 8-K. (continued) ------------------- Exhibit Number Description - ------- -------------------------------------------------------- (D) Financial Statement Schedules. Financial statement schedules and separate financial statements specified by this Item are included in Item 14(a)2 or are otherwise not required or are not applicable. PAGE 73 POWER OF ATTORNEY ----------------- Each person whose signature appears below under "SIGNATURES" hereby authorizes Henry C. Wolf and J. Gary Lane, 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 J. Gary Lane, 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 6th day of March, 2000. 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 6th day of March, 2000, 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 (Henry C. Wolf) and Chief Financial Officer and Director (Principal Financial Officer) PAGE 74 Signature Title - --------- ----- /s/ James C. Bishop, Jr. - -------------------------- Director (James C. Bishop, Jr.) /s/ Jon L. Manetta - -------------------------- Director (Jon L. Manetta) /s/ L. I. Prillaman - -------------------------- Director (L. I. Prillaman) /s/ Stephen C. Tobias - -------------------------- Director (Stephen C. Tobias) PAGE 75 Schedule II Page 1 of 2 Norfolk Southern Railway Company and Subsidiaries ------------------------------------------------- Valuation and Qualifying Accounts Years Ended December 31, 1997, 1998 and 1999 (In millions of dollars)
Additions charged to -------------------- Beginning Other Ending Balance Expenses Accounts Deductions Balance --------- -------- -------- ---------- ------- Year ended December 31, 1997 - ---------------------------- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 1 $ -- $ -- $ -- $ 1 Casualty and other claims included in other liabilities $247 $108 $ 2 (1) $105 (2) $252 Current portion of casualty and other claims included in accounts payable $165 $ 14 $170 (1) $178 (3) $171 Year ended December 31, 1998 - ---------------------------- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 1 $ -- $ -- $ -- $ 1 Casualty and other claims included in other liabilities $252 $ 86 $ 22 (1) $ 89 (2) $271 Current portion of casualty and other claims included in accounts payable $171 $ 11 $149 (1) $188 (3) $143 (1) Includes revenue overcharges provided through charges to operating revenues and transfers from other accounts. (2) Payments and reclassifications to/from accounts payable. (3) Payments and reclassifications to/from other liabilities. (continued) PAGE 76 Schedule II Page 2 of 2 Norfolk Southern Railway Company and Subsidiaries ------------------------------------------------- Valuation and Qualifying Accounts Years Ended December 31, 1997, 1998 and 1999 (continued) (In millions of dollars) Additions charged to -------------------- Beginning Other Ending Balance Expenses Accounts Deductions Balance --------- -------- -------- ---------- ------- Year ended December 31, 1999 - ---------------------------- Valuation allowance (included net in deferred tax liability) for deferred tax assets $ 1 $ -- $ -- $ -- $ 1 Casualty and other claims included in other liabilities $271 $114 $ 9 (1) $119 (2) $275 Current portion of casualty and other claims included in accounts payable $143 $ 19 $191 (1) $173 (3) $180
(1) Includes revenue overcharges provided through charges to operating revenues and transfers from other accounts. (2) Payments and reclassifications to/from accounts payable. (3) Payments and reclassifications to/from other liabilities. PAGE 77 EXHIBIT INDEX ------------- NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NSR) Electronic Submission Exhibit Number Description Page - ---------- ---------------------------------------------------- ---- 10 (i) The Agreement, entered into as of July 27, 1999, between North Carolina Railroad Company and Norfolk Southern Railway Company. 78 21 Subsidiaries of Norfolk Southern Railway. 122 27 Financial Data Schedule. 123 (Required to be electronically submitted for use by the Securities and Exchange Commission only and not deemed part of this filing.) EX-21 2 NSR SUBSIDIARIES PAGE 122 EXHIBIT 21, Page 1 of 1 NAME AND STATE OF INCORPORATION OF SUBSIDIARIES OF NORFOLK SOUTHERN RAILWAY COMPANY AS OF MARCH 1, 2000 Airforce Pipeline, Inc., North Carolina Alabama Great Southern LLC, Virginia Alabama Great Southern Railroad Company, The; Alabama Atlantic and East Carolina Railway Company, North Carolina Camp Lejeune Railroad Company, North Carolina Central of Georgia LLC, Virginia Central of Georgia Railroad Company, Georgia Chesapeake Western Railway, Virginia Cincinnati, New Orleans and Texas Pacific Railway Company, The; Ohio Citico Realty Company, Virginia Georgia Southern and Florida Railway Company, Georgia High Point, Randleman, Asheboro and Southern Railroad Company, North Carolina Interstate Railroad Company, Virginia Lamberts Point Barge Company, Inc., Virginia Memphis and Charleston Railway Company, Mississippi Mobile and Birmingham Railroad Company, Alabama Norfolk and Portsmouth Belt Line Railroad Company, Virginia Norfolk Southern International, Inc., Virginia North Carolina Midland Railroad Company, The; North Carolina Rail Investment Company, Delaware Shenandoah-Virginia Corporation, Virginia South Western Rail Road Company, The; Georgia Southern Rail Terminals, Inc., Georgia Southern Rail Terminals of North Carolina, Inc., North Carolina Southern Region Coal Transport, Inc., Alabama Southern Region Materials Supply, Inc., Georgia Southern Region Motor Transport, Inc., Georgia State University Railroad Company, North Carolina Tennessee, Alabama & Georgia Railway Company, Delaware Tennessee Railway Company, Tennessee Virginia and Southwestern Railway Company, Virginia Yadkin Railroad Company, North Carolina EX-27 3 YEAR END 1999 EX-27 NSR FINANCIAL DATA SCHEDULE
5 1,000,000 YEAR DEC-31-1999 DEC-31-1999 0 12 686 5 98 1,136 15,098 4,708 12,632 1,823 781 167 0 55 5,163 12,632 0 5,114 0 4,611 (42) 0 39 506 174 332 0 0 0 332 0 0
EX-10.I 4 AGREEMENT BETWEEN NORTH CAROLINA RAILROAD COMPANY AND NORFOLK SOUTHERN RAILWAY COMPANY PAGE 78 EXHIBIT 10(i), Page 1 of 44 AGREEMENT --------- THIS AGREEMENT (hereinafter "Agreement" or "Master Agreement") dated the 27th day of July, 1999, by and between NORTH CAROLINA RAILROAD COMPANY (hereinafter "NCRR"), a North Carolina corporation, and NORFOLK SOUTHERN RAILWAY COMPANY (hereinafter "NSR"), a Virginia corporation: WHEREAS, NCRR and Southern Railway Company (hereinafter "Southern") entered into a lease dated August 16, 1895 ("the 1895 agreement"); WHEREAS, NCRR and Southern entered into certain supplements or amendments to the 1895 agreement; WHEREAS, Atlantic and North Carolina Railroad Company (hereinafter "ANC"), as lessor, a North Carolina corporation, and Atlantic & East Carolina Railway Company ("A&EC"), now a wholly owned subsidiary of NSR, as lessee, entered into a Lease and Indenture dated August 30, 1939 ("the 1939 agreement"); WHEREAS, ANC and A&EC entered into certain supplements or amendments to the 1939 agreement, the last of which supplements provided A&EC the option to continue the 1939 agreement through the end of 1994, and that option was properly exercised; WHEREAS, effective September 29, 1989, ANC was merged into NCRR; WHEREAS, effective December 31, 1990, Southern changed its name to NSR; WHEREAS, the 1895 agreement and the 1939 agreement (together, as supplemented and amended, referred to herein as the "Old Leases") were to expire on January 1, 1995 and December 31, 1994, respectively, and have not been and will not be renewed and NSR has continued to operate the property of NCRR under the provisions of federal and/or state law; WHEREAS, while the parties had negotiated an agreement to extend the Old Leases (the Lease Extension Agreement or "LEA"), the LEA was declared to be invalid by the U.S. District Court for the Eastern District of North Carolina for want of a quorum at the NCRR shareholders meeting called for the purpose of approving the LEA on December 15, 1995 and the Court entered an order enjoining the LEA. Before the LEA had been enjoined, NSR made certain payments to NCRR under the terms of the LEA consisting of payments as consideration for a release of certain claims for return of personalty (the "Release Payment"), and payments of rental under the LEA (the "Rental Payments"), and NSR has made additional payments to NCRR pursuant to an order of the U.S. Surface Transportation Board (the "Interim Payments"); WHEREAS, NCRR and NSR desire by these terms to provide for NSR's continued use of the property of NCRR which was the subject of the Old Leases for the operation of freight rail services thereon; PAGE 79 EXHIBIT 10(i), Page 2 of 44 NOW THEREFORE, in consideration of the commitments and undertakings recited below, the parties hereto do hereby covenant and agree as follows: Section 1. INDEX OF TERMS TERM SECTION ---- ------- (a) NCRR-inclusive Preamble (b) NSR-inclusive Preamble (c) CSXT 2 (d) Old Leases 6 (e) Release Payment 6 (f) Rental Payments 6 (g) Interim Payments 6 (h) Cap 4 (i) Line of Road 24 (j) High Speed Passenger Trains 13 (k) Amtrak/NSR Direct Service Agreement 2 (l) Effective Date 27 (m) Period of Continued Occupancy 4 (n) Right of Way 15 (o) Return Date 18 (p) Designated Returned Property 18 (q) Designated NSR Facility Property 18 (r) Environmental Occurrence 24 (s) Contaminating Substance 24 (t) Leased Properties 24 (u) Trackage Rights Agreement 2 GENERAL PRINCIPLES OF INTERPRETATION The following general principles will apply throughout this Agreement unless specifically stated to the contrary: (a) Safety considerations will be paramount; (b) For any operating scenario, NCRR and NSR intend to jointly work to make changes in a manner that will: (1) minimize capital and operating costs, and (2) minimize disruption to existing service so as to maximize the value of both freight and passenger services; (c) Cross subsidization of costs will not occur between passenger and freight operations or between NSR freight and third-party freight operations, including but not limited to operating and maintenance expenses and capital expenditures; (d) All costs, including but not limited to operating and maintenance expenses and capital expenditures, will be borne by the party hereto who requests the expenditure or the addition to capacity; and (e) "Costs" or "expenses" will be defined by the PPC/Dispute Resolution provisions hereof. PAGE 80 EXHIBIT 10(i), Page 3 of 44 Section 2. RIGHTS GRANTED BY NCRR (a) Subject to any applicable regulatory approval, NCRR hereby grants to NSR, under the terms set forth in the attached Trackage Rights Agreement of even date herewith, exclusive freight trackage rights over the lines and properties of NCRR owned by NCRR as of the date hereof, thereby extending to NSR the exclusive right to conduct freight operations over the NCRR lines and properties, including performance of local freight service on those lines and properties. NCRR hereby also grants to NSR such operating rights over the lines of NCRR as will permit continuation of the existing operations of National Railroad Passenger Corporation ("Amtrak") over the lines of NCRR pursuant to the "Basic Agreement" between Southern Railway Company and The Alabama Great Southern Railroad Company and National Railroad Passenger Corporation dated January 2, 1979, as amended (hereinafter referred to as the "Amtrak/NSR Direct Service Agreement" or the "Basic Agreement"), together with such additional operating rights over lines of NCRR operated by NSR as may from time to time during the term of this Agreement be required for the continuation or modification of Amtrak's intercity rail passenger service over the NCRR lines pursuant to the Basic Agreement and Amtrak's franchise under federal law. It is the intent of the parties, with respect to the operational facilities of NCRR operated by NSR, that Amtrak and NSR shall continue to enjoy and be able to fulfill their respective rights and obligations to each other under the Basic Agreement (including the duty to make and the right to receive payments thereunder) and under federal law for the term of this Agreement. NCRR shall be consulted in advance of any proposed extensions or modifications to the Basic Agreement that could have a material effect upon the dispatching or maintenance of the lines of NCRR operated by NSR or upon the facilities of NCRR operated by NSR. (b) NSR will fulfill freight common carrier duties of NCRR on the NCRR segments for which NSR holds the exclusive freight trackage rights from NCRR until such time as NSR's exclusive freight trackage rights over the line or any segment thereof are terminated, and until the federal Surface Transportation Board or any successor agency has granted any approval that may be required by law for any cessation of NSR's common carrier duties pursuant to Section 17 hereof. (c) The exclusive freight trackage rights shall continue unless and until there is initiation of service by a qualified third-party freight operator on segments over which NSR ceases operations pursuant to the terms and provisions set forth in Section 17 hereof. (d) That interest in the portion of the "R" Line in Charlotte, North Carolina which lies between the point of connection between said "R" Line and CSX Transportation, Inc. ("CSXT") near 12th Street and the easterly line of Second Street which remained a part of the Old Leases upon their expiration will not be operated by NSR. Either NSR or NCRR may seek discontinuance of its common carrier obligation imposed by federal and state laws regulating the PAGE 81 EXHIBIT 10(i), Page 4 of 44 operation of a railroad on such portion and each party will cooperate with the other in any such proceedings. Nothing in this Agreement shall be construed to affect the terms and obligations of the agreement dated December 31, 1968 between NCRR and Southern regarding certain property in Charlotte, North Carolina. (e) The rights granted to NSR do not eliminate, modify or diminish the rights of CSXT to operate and to serve customers between Fetner and Raleigh (Boylan) or NSR's and CSXT's reciprocal operating rights and obligations to each other relating thereto. (f) Except as provided in Section 2(a), NCRR does not grant to NSR the right to grant trackage or other rights to any carrier not at the time of grant affiliated with NSR over the lines or property of NCRR, and NCRR will not grant to others such rights on lines or property over which NSR maintains the status of exclusive freight operator without NSR's approval. Any grant of trackage or other rights by NSR to a carrier affiliated with NSR shall not be effective beyond the expiration of this Agreement, including extensions or renewals, or with respect to segments over which NSR ceases freight services hereunder the date of any cessation of NSR service pursuant to Section 17 hereof. NSR will provide NCRR with copies of any such proposed trackage or other rights documents not less than 15 days prior to execution by NSR and its affiliate. Section 3. TERM (a) The term of the Agreement shall commence on the Effective Date and end on December 31, 2014. (b) NSR shall have the option to renew the Agreement for two additional fifteen-year terms, provided NSR notifies NCRR in writing of its intention to renew at least two years prior to the expiration of the Agreement or, with respect to the second renewal period, two years prior to the expiration of the first renewal period. Section 4. COMPENSATION (a) Beginning on January 1, 2000, and during the term of this Agreement and any renewal thereof, or during any Period of Continued Occupancy (as defined in this Section), NSR shall pay to NCRR an "Annual Trackage Rights Fee." For the period January 1, 2000, through December 31, 2000, the Annual Trackage Rights Fee payable to NCRR shall be ELEVEN MILLION DOLLARS ($11,000,000). (b) For each calendar year thereafter the Agreement continues in effect and during any Period of Continued Occupancy, the Annual Trackage Rights Fee shall be adjusted in accordance with the following formula except that in no event will any increase or decrease in such Annual Trackage Rights Fee for any year exceed an amount equal PAGE 82 EXHIBIT 10(i), Page 5 of 44 to four-and-one-half percent (4-1/2%) of the Annual Trackage Rights Fee applicable to the previous year (hereinafter the "Cap"). The formula is: For 2001 and subsequent calendar years the Annual Trackage Rights Fee shall be an amount calculated by multiplying the prior year's Annual Trackage Rights Fee by the "Factor" obtained by dividing the Implicit Price Deflator for Gross Domestic Product ("IPD-GDP") for the calendar year preceding the prior calendar year by the IPD-GDP for the calendar year preceding that calendar year. For any given calendar year, the denominator of the fraction used to calculate the Factor will be the same as the numerator of the fraction used to calculate the immediately prior year's Factor. The calculation of the Factor to be applied to the immediately prior year's Annual Trackage Rights Fee shall be carried out to five places to the right of the decimal and rounded. Presently, IPD-GDP is developed by the United States Department of Commerce, Bureau of Economic Analysis and is reported in the publication of ECONOMIC INDICATORS prepared for the Joint Economic Committee by the Council of Economic Advisors. The denominator of the initial Factor will utilize the IPD-GDP for 1998, as published in the December 1999 issue of ECONOMIC INDICATORS. The numerator will be the IPD-GDP for 1999 as published in the December 2000 issue of ECONOMIC INDICATORS. (c) If during the term of this Agreement, including any renewal period, the IPD-GDP is no longer published, the parties will attempt in good faith to agree upon a replacement index, using the PPC/Dispute Resolution procedures herein if necessary. (d) The parties will renegotiate the Cap if over any seven consecutive year period the average rate of inflation as measured by the IPD- GDP exceeds four and one-half percent (4-1/2%) with the matter to be resolved through the PPC/Dispute Resolution procedures herein if the parties are unable to agree on a new cap. (e) In no event will the Annual Trackage Rights Fee, through deflationary adjusters, as applicable to the entirety of the NCRR, go below ELEVEN MILLION DOLLARS ($11,000,000). In the event that the Annual Trackage Rights Fee is adjusted under the provisions of Section 17(d) of this Agreement, the $11,000,000 minimum Annual Trackage Rights Fee set forth in the preceding sentence will be adjusted by the same percentage used to adjust the Annual Trackage Rights Fee pursuant to Section 17(d) hereof. (f) In the event NSR does not extend the Agreement or at the end of the extended terms, the payment provisions of the Agreement at that time will continue to apply and payments may not be withheld by NSR so long as NSR continues to operate over any portion of the NCRR lines (other than the line between Pomona and Elm described in Section 21(b) hereof) (referred to herein as a "Period of Continued Occupancy"). PAGE 83 EXHIBIT 10(i), Page 6 of 44 (g) The Annual Trackage Rights Fee will be paid by NSR to NCRR, without set-off or reduction, in monthly installments not later than the 15th day of each month. If any such payment is not paid within a grace period of seven (7) days after such due date, a late payment penalty charge shall be charged to NSR. The late payment penalty charge shall be in the amount of one and one-half percent (1-1/2%) per month (simple interest) for each month, or part thereof, after such grace period as the Annual Trackage Rights Fee shall remain unpaid. If owed, NSR will pay such late payment penalty charge together with the Annual Trackage Rights Fee due. Nothing in this Section 4 pertaining to or calling for the payment of the late payment penalty charge or for an overdue payment of the Annual Trackage Rights Fee shall be construed to be a waiver or acceptance by NCRR for such payment to be overdue, and NCRR retains all rights it has for payment of trackage rights fees. Section 5. INTERIM COMPENSATION Within three business days of the execution of this Agreement, NSR will pay to NCRR one-half of the remaining compensation to be paid to NCRR as back rental for the period ending December 31, 1999, pursuant to the Memorandum of Understanding dated April 27, 1999, and shall pay the remainder of such back rental not later than December 31, 1999. Section 6. RELEASE (a) For and in consideration of the receipt and retention of the Release Payment by NCRR, NCRR hereby agrees that each and every obligation NSR or A&EC may have under the Old Leases with respect to or in any manner connected with the use, depreciation, maintenance, repair, renewal, replacement or return to NCRR of (i) locomotives and railroad cars and (ii) any other items of personal property which are not customarily located or used on property owned or determined to be owned by NCRR during any part of at least 10 months of any consecutive 12 month period during the 10 years preceding the termination of this Agreement and any renewal will be of no further force or effect, and NCRR hereby releases and discharges NSR from all such claims relating to such property. (b) For and in consideration of the receipt and retention of the Rental Payments, the Interim Payments and the payments by NSR set forth in this Agreement, NCRR hereby agrees that each and every obligation NSR or A&EC may have to pay rent or other forms of periodic compensation to NCRR for the use of NCRR's property under the Old Leases and from January 1, 1995 through December 31, 1999 has been fully satisfied and paid, and NCRR hereby releases and discharges NSR from all claims for the payment of rent or other forms of periodic compensation under the Old Leases. PAGE 84 EXHIBIT 10(i), Page 7 of 44 Section 7. DISPATCHING (a) NSR will dispatch all NCRR lines except for the segment between Boylan and Fetner presently dispatched by CSXT and any segments for which NCRR and NSR subsequently agree in writing that NSR will not dispatch. NSR will dispatch the NCRR lines with the same diligence and safety considerations as it dispatches lines of its ownership with similar train densities and operating characteristics. (b) NSR will exercise operational control over NCRR line segments which NSR dispatches, including controlling all access to the property within 25 feet of the tracks over which it has trackage rights. In accessing such property, NCRR and those accessing such property with permission from NCRR will be required by NCRR to comply with all NSR safety, access, and insurance processes and procedures. Except with respect to any access by NCRR in the ordinary course of the management of its property, NSR may charge reasonable costs to accommodate requests for such access. (c) NSR will not dispatch any NCRR line segment on which a third-party operator begins operations in accordance with the provisions of this Agreement. (d) NSR will not provide dispatching services on lines where passenger speeds exceed 90 mph. (e) NSR will give priority to scheduled passenger trains over freight trains, and will establish priority protocols to be applied between scheduled passenger trains as requested by NCRR. (f) Should any dispute arise over NSR's dispatching of passenger trains, or the priority they are given, NCRR will describe in writing the method by which it seeks to have the passenger trains, or freight trains affecting passenger trains, dispatched. If NSR does not agree with the proposed method requested by NCRR, any unresolved issues shall be resolved pursuant to PPC/Dispute Resolution procedure herein. (g) NCRR reserves the right to terminate NSR's contract hereunder to perform dispatching for failure by NSR to abide by the PPC/Dispute Resolution procedures herein or any decision made pursuant to such procedures. NSR shall have 30 days from the date of any final decision or award made pursuant to the PPC/Dispute Resolution procedure to remedy such dispatching deficiencies and to document such remedy to NCRR in writing. If the time periods are not adequate for NSR to make the changes, such schedule shall be reviewed and addressed pursuant to the PPC/Dispute Resolution procedure herein. PAGE 85 EXHIBIT 10(i), Page 8 of 44 Section 8. MAINTENANCE (a) NSR will maintain the lines of NCRR over which it serves as the exclusive freight operator. (b) The standard of maintenance of any line segment shall be the FRA track classifications as of July 1, 1999, consistent with timetable and track profile speed restrictions and any other restrictions therein that affect the speed of operation. The effective timetables and track profiles are attached hereto as EXHIBIT A. (c) Any routine slow orders in effect on January 1, 2000 will be eliminated by October 1, 2000, and any routine slow orders subsequently imposed will be eliminated within 90 days of imposition. A list of show orders in effect will be provided on or about January 1, 2000. (d) In the event of slow orders necessitated by unusual events or requiring major construction or capital expenditure, the PPC/Dispute Resolution procedure will be employed to establish a reasonable time frame for NSR to make the necessary repairs. (e) NCRR will bear all initial and future costs for any upgrades it requests. (f) NSR will not maintain any NCRR line segment on which a third-party operator begins operations under the provisions of the Agreement. (g) NSR will not maintain any line on which passenger speeds exceed 90 mph. (h) NSR will submit to NCRR in writing not less than 30 days in advance a description of any changes it intends to make to the maintenance levels affecting the lines of NCRR; if NCRR objects to such changes the PPC/Dispute Resolution procedure described herein will be utilized to review such proposed changes wherein such changes may be approved as submitted by NSR or modified. (i) NCRR reserves the right to terminate NSR's contract hereunder to perform maintenance for failure by NSR to abide by the PPC/Dispute Resolution procedures herein or any decision made pursuant to such procedures. NSR shall have 270 days from the date of any final decision or award made pursuant to the PPC/Dispute Resolution procedure set forth herein to remedy such maintenance deficiencies and to document such remedy to NCRR in writing. If the time periods are not adequate for NSR to make the changes, such schedule shall be reviewed and addressed pursuant to the PPC/Dispute Resolution procedure herein. PAGE 86 EXHIBIT 10(i), Page 9 of 44 Section 9. CAPITAL IMPROVEMENTS (a) Capital Improvements at the Request of NSR: (i) NSR may, at its sole cost, make capital improvements to the property of NCRR to render the property more amenable to its freight railroad operations. (ii) Such improvements will not be made without the prior approval of NCRR, which approval will not be unreasonably withheld. (iii) NCRR shall own all capital improvements made by NSR to the property of NCRR hereunder upon expiration or termination of the Agreement, or with regard to improvements made to any segment which NSR ceases to operate, upon the cessation of service by NSR on such segment pursuant to Section 17 hereof. (b) Capital Improvements at the Request of NCRR: (i) NCRR (or NCRR on behalf of passenger operators) may, at its sole cost, make capital improvements to the NCRR property. (ii) All such capital improvements on lines over which NSR operates or will operate shall be performed by NSR unless NSR has expressly agreed to the contrary. However, if a shortage of available manpower would delay implementation beyond a reasonable completion date, NSR and NCRR agree to cooperate to jointly seek concurrence from the appropriate labor organizations representing NSR's employees, if such concurrence is required, for such work to be done by qualified contractors selected in accordance with the PPC/Dispute Resolution procedure and to be engaged by NSR. (iii) Payments required of NCRR under the terms of this Agreement may be paid by NCDOT or by other passenger service operators. (iv) NSR will not be required to begin construction on any such project(s) until all necessary capital funds are set aside for the project, and mechanisms are in place to pay other costs or expenses associated with the project identified in the separate agreement required by the provisions of paragraph (f) below. (c) Any track, signal, bridge, or structure constructed on the lines of NCRR, whether by NCRR (on its own behalf or on behalf of a passenger operator) or NSR, must be built, maintained and operated consistent with the following goals: (i) Such construction must not interfere with or disadvantage NSR freight operations or the utility or capacity of the line for freight operations; PAGE 87 EXHIBIT 10(i), Page 10 of 44 (ii) Such construction must not preclude eventual double-tracking of the line between Greensboro and Raleigh; (iii) Such construction must not preclude capacity expansion to accommodate growth of intercity/regional passenger and freight traffic; and (iv) Access by NSR to its present and future customers on both sides of the tracks on which NSR has or will have trackage rights will be maintained at no cost to NSR. (d) Should one party determine it has a need for additional capacity, the additional capacity shall be added in consultation with the other party utilizing the PPC/Dispute Resolution procedure, at the cost and expense of the party that needs the capacity. (e) Should NSR and NCRR mutually determine that each needs additional capacity, the parties shall jointly plan, through the PPC/Dispute Resolution procedure, for the necessary additional capacity to meet the needs. The costs of such additional joint capacity will be prorated on the relative additional capacity needs of the parties. Best efforts shall be made in the planning process to achieve economies of scale in the addition of such improvements, such that both parties receive maximum value for their capacity investments through capacity sharing. (f) If NCRR adds shared trackage under the provisions hereof, or if NCRR approves, makes or funds any other improvements which increase freight or passenger utility/capacity or passenger speeds, including but not limited to improvements to track, signals, structures or the adding of super-elevation under provisions hereof and including but not limited to the "Rail Impact" program described in Section 12 hereof, NCRR, NSR (and any other appropriate parties, including NCDOT) will enter into a separate written agreement prior to the commencement of any construction. NSR will dispatch and maintain the line segment as improved and NCRR will reimburse NSR for any and all additional dispatching and maintenance costs, including but not limited to costs of additional employees required to dispatch and maintain the line on account of such improvements, incurred by NSR, except as provided in Section 10 hereof. Any disputes over the causal relationship between such construction projects and such additional dispatching and maintenance costs billed to NCRR by NSR will be referred to the PPC/Dispute Resolution procedure. (g) NCRR and NSR will develop the design and phasing of double-tracking and other investments for the line between Greensboro and Charlotte, the cost of preparing such plans to be at NCRR expense, so that freight and passenger services can both be accommodated and so that any intermediate investments made will conform with a long- term infrastructure plan. PAGE 88 EXHIBIT 10(i), Page 11 of 44 (h) In advance of installing double track or other investments made by NCRR, NCRR and NSR, at NCRR expense, will jointly conduct a study to determine the additional capacity provided by such investments. Should NCRR determine that additional passenger trains and/or increased train speeds are desirable and that the funds are available to make the necessary investments to increase passenger train speed or capacity, NCRR will plan for the additional capacity necessary to support more passenger service and/or greater speeds, in conjunction with NSR through the PPC/Dispute Resolution procedure. (i) If NCRR adds dedicated separate infrastructure on the right-of-way for passenger operations above 90 mph as required by Section 13 hereof, NCRR shall have such dedicated separate facilities dispatched and maintained by a party other than NSR. (j) NCRR and NSR will each keep the other informed of matters involving present and prospective passenger and freight traffic on the line, the operation of the line, or any other matter relating to the NCRR lines with which they may be involved during the term of the Agreement. In all matters involving NCDOT or regulatory bodies where the parties' interests are in common, the parties shall work cooperatively to accomplish the purposes of this Agreement in a timely fashion. (k) Any capital expenses or other improvements will abide by and be subject to the principle of no cross subsidization between the services operated on the lines. Section 10. EASTERN SEGMENT TRACK IMPROVEMENTS In order to promote economic development along the NCRR corridor and greatly improve the current track condition of the line, the parties agree to implement a project to upgrade the Raleigh to Morehead City line segment in order to improve the condition of the segment closer to the condition of other segments of the NCRR line. NSR (under contract to NCDOT utilizing NCRR dividend proceeds from NCRR interim compensation), agrees to perform work, such as a timber and surfacing project, of up to $10 million on such segments of the NCRR line between Boylan (Raleigh) to the Port Terminal (at Morehead City, including the tracks maintained by NSR at the Port Terminal) as are determined by NCRR to be most effective. Notwithstanding the provisions of Section 9(f) hereof, to the extent that such work increases the FRA classification of the following NCRR track segments, NCRR shall not be responsible for reimbursing NSR for any additional dispatching or maintenance costs, including any costs of any additional employees required on account of such work: PAGE 89 EXHIBIT 10(i), Page 12 of 44 Milepost EC 1.5 to EC 9.0; Milepost EC 71.0 to EC 94.0; Milepost H 119.7 to H 120.0; Milepost H 126.0 to H 126.8. NSR will begin implementation of the project within 60 days of the finalization of the project scope and the availability of funding and will complete the project as expeditiously as possible, with a date certain for completion to be established by the PPC/Dispute Resolution provisions herein. Section 11. PROCESS FOR REVIEWING ADDITIONAL PASSENGER CAPACITY ON NCRR LINES (a) The NCRR trackage will be operated on a shared-use basis with passenger operations for passenger or commuter trains with speeds of 90 mph or less. NSR will present to NCRR its analysis of the number of additional freight trains that could be operated on the line as of January 1, 2000, without adding capacity to the NCRR line. If NCRR does not concur, the issue will be resolved pursuant to the PPC/Dispute Resolution procedure herein. (b) NSR will have use of the freight capacity as determined above. (c) NCRR will pay for any increased costs for operations, maintenance or capital expenditures necessary to accommodate increasing the number of passenger trains above that currently operated on NCRR tracks, or to permit increased passenger speeds above the present passenger train speeds, except for the additional passenger train set permitted pursuant to Section 12(e) hereof. (d) If any passenger service or any third-party passenger operations are added to the NCRR line, the passenger service operator or other third-party passenger operator will be required to make and pay for capital improvements on the line adequate to assure that none of NSR's capacity, either the capacity NSR is currently using or unused capacity that is available to NSR, determined as described above, is diminished or disadvantaged. (e) All FRA regulations must be complied with in advance of initiating any passenger operations in excess of 79 mph. The administrative costs of obtaining such regulatory approval, including but not limited to any expense of performing an environmental impact statement or environmental assessment, if required to comply with environmental regulations, shall be borne by NCRR. (f) NCRR and NSR agree to cooperate in the following long range planning studies, at NCRR's expense, to determine whether additional capacity would be required to handle additional passenger or commuter trains proposed on segments of NCRR: PAGE 90 EXHIBIT 10(i), Page 13 of 44 (i) Passenger Train Studies: NCRR and NSR agree to several studies that are designed to allow NCRR to plan more effectively for the long-term utilization of the valuable asset NCRR has in the NCRR right- of-way: (A) Passenger Train Transit Time Improvement: These studies will include the following considerations in its analysis of potential passenger service related expenditures: (I) Reduced passenger train stops and reduced duration of stops; (II) Reduced highway grade crossings, whether equipped with active or passive warning devices; (III) Increased speeds through towns and localities with speed restriction ordinances; (IV) Improvements to increase speed at various restrictions, such as crossings with railroads at grade; (V) Improvements to reduce the required safety margins or clearing times for passenger/freight and passenger/passenger meets or passes; (VI) Revisions to passenger train and freight train schedules; (VII) Reductions in transit times by using FRA-approved tilt train equipment; (VIII) Improvements to dispatching systems; (IX) Improvements to signal systems; and (X) Track improvements such as adding double track, sidings, double power crossovers, turnouts and curve improvements including super elevation of curves. NCRR will request NCDOT, not at NSR's expense, to jointly work with appropriate NSR operations and engineering staff to determine which investments yield the highest returns in terms of speed and capacity. PAGE 91 EXHIBIT 10(i), Page 14 of 44 (B) Passenger Train Operating Speed Study (79 to 90 mph): The study will address the safety and other issues related to increasing maximum passenger speeds from 79 mph to 90 mph and the economic issues related to installing cab signals and operating trains in cab signal territory. (C) High Speed Study (maximum speeds in excess of 90 mph): The study will address what will be needed to safely and economically transition toward separate freight and passenger operations at the point when passenger train speeds exceed 90 mph; the study will address interim capital investments to assure that the investments are made in conjunction with a long-term transition plan and will continue to be useful in the ultimate plan; the study will address safety issues related to migrating from shared-use operations to separate operations for passenger services operated in excess of 90 mph. The study will also investigate whether it is possible and desirable that incremental improvements may proceed in such a way that portions of the Raleigh - Charlotte route may achieve greater than 90 mph, with the required separate track structure, while other segments remain at less than 90 mph and continue as shared-use segments. (ii) Alternative Routing Study: NCRR and NSR will perform a joint study of the operational and economic considerations involved in operating through freight trains between Greensboro and Raleigh over other NSR routes rather than over the NCRR route. NCRR will study, at NCRR expense, the differences in the investment required, the maintenance expenses, and the operations if the NCRR line between Greensboro and Raleigh were operated with or without through freight trains. NSR will determine, at NSR expense, the capital investment required to upgrade any alternate route to accommodate the through freight trains operated on the NCRR route between Greensboro and Raleigh. Any decision by NCRR or NCDOT to cooperate and/or participate in the cost of NSR's use of the alternative route would be based on producing the lowest net capital cost to the NCDOT and Triangle Transit Authority (TTA) run passenger trains while still affording to NSR existing levels of freight service capacity, and would take into account community impacts on both lines. It is understood that in the event that through freight trains are operated over an alternate route, NSR will need to be able to continue to serve present and future customers on the NCRR line, including those which might be accessible only by PAGE 92 EXHIBIT 10(i), Page 15 of 44 crossing TTA tracks. However, nothing in the Agreement will serve to cause any delay in TTA and NSR continuing to work together in making final plans and implementation of TTA facilities and service. (g) In connection with the studies referred to herein, NCRR and NSR will employ analytical techniques to: (1) determine the impact of passenger trains on the operations and capacity of NSR, and (2) to determine the capital improvements that would be necessary to avoid adverse impacts on NSR's freight operations or capacity. Any capital improvements or other costs or expenses will abide by and be subject to the principle of no cross subsidization between the services operated on the lines. (h) NCRR and NSR may engage consultants and outside experts to analyze construction, maintenance or dispatching issues. Consultants may be involved in data gathering, data analysis, and presentation of recommendations, but NSR agrees that senior level NSR officers will be involved in the decision-making process. (i) Intercity passenger operations may use equipment such as tilt-train equipment as long as the use of such equipment on NCRR commingled with NSR operations is approved by FRA or FRA grants a specific waiver or approval allowing operation of such equipment commingled with NSR operations on the NCRR. Section 12. IMPLEMENTATION OF THE NCDOT'S UPDATED "RAIL IMPACT" PROGRAM (a) NSR agrees to implement the NCDOT's updated "Rail IMPACT" program. (b) NSR and NCRR will reevaluate with NCDOT the elements included in NCDOT's original Rail Impact program, to develop an updated program of rail improvements totaling $20 million which will provide increased passenger speeds while at the same time not adversely impacting the freight operations of NSR. (c) When funds for the updated Rail Impact program are available to NCRR or NCDOT, NSR agrees to then implement as expeditiously as possible. (d) If a shortage of available manpower would delay implementation beyond a reasonable completion date, NSR and NCRR agree to cooperate to jointly seek concurrence from the appropriate labor organizations representing NSR's employees, if such concurrence is required, for such work to be done by qualified contractors selected in accordance with the PPC/Dispute Resolution procedure and to be engaged by NSR. (e) NCDOT may add one daily passenger train set to operate at or below a maximum speed of 79 mph to the line between Raleigh and Charlotte subsequent to the completion of the construction of the updated Rail Impact program. PAGE 93 EXHIBIT 10(i), Page 16 of 44 Section 13. HIGH SPEED PASSENGER OPERATIONS (a) NCRR may grant operating authority within the NCRR corridor for intercity passenger trains to be operated in excess of 90 miles per hour ("high speed passenger trains") only if such trains or systems are operated on a dedicated separate new infrastructure. (b) After approval by FRA, high speed passenger trains may use the shared-use tracks for low speed access to and from stations and/or for operations at conventional passenger train speeds in areas in which adequate right-of-way for separate tracks is not available. Section 14. OTHER PASSENGER OPERATIONS OVER NSR LINES NSR will negotiate in good faith with NCDOT regarding passenger service to Asheville, N.C., it being understood that NSR will not be responsible for any capital and operating costs and/or expenses associated with or related to such operations, and the addition of passenger trains to the line will be accompanied by sufficient State investment to maintain NSR's current or future freight capacity/utility and service standards on the route, as determined by NSR. Section 15. REGIONAL RAIL OPERATIONS WITHIN NCRR RIGHT OF WAY (a) NCRR reserves the right to allow rail service such as that proposed by the Triangle Transit Authority or other light rail operations on separately dedicated infrastructure within NCRR's right-of-way, consistent with the terms of this Agreement. (b) If any FRA approvals or plan reviews are necessary, the passenger operator would be responsible for obtaining such approvals or reviews. (c) NCRR will require the service provider to assure that reasonable and efficient access by NSR to its present and future customers on both sides of the track(s) over which NSR has trackage rights is maintained at no cost to NSR. (d) NCRR will require the service provider to have in place before beginning operations, and to maintain at all times while such operations are conducted, indemnity agreements and liability insurance as described in Section 23 hereof. (e) The proximity of light rail operations to NCRR tracks and the related maintenance and operation issues shall be addressed under the PPC/Dispute Resolution provisions herein and in conformity with all federal regulations. PAGE 94 EXHIBIT 10(i), Page 17 of 44 Section 16. TRAFFIC INFORMATION AND FORECASTS Subject to the confidentiality provisions of Section 34 hereof, NSR and NCRR will jointly examine traffic information and develop and share near- and long-term traffic forecasts of freight and passenger traffic volumes to evaluate safety, capacity and speed issues relating to the use of the various segments for freight and passenger operations. Section 17. CESSATION OF FREIGHT SERVICE ON ANY SEGMENT (a) At any time during the term of this Agreement or any renewal period, NSR may seek to abandon its operation over the segment between Charlotte and Greensboro, or the segment between Greensboro and Raleigh, or the segment between Raleigh and Morehead City, or any two of those segments, or all three of those segments. (b) No subdivision of the segments will be permitted, i.e., NSR may seek to abandon its operations on the entire segment between Charlotte and Greensboro or on the entire segment between Greensboro and Raleigh or the entire segment between Raleigh and Morehead City, or combinations of those segments, but it cannot abandon service on any sub-segments of those segments unless agreed to by NCRR, in NCRR's sole discretion. (c) In the event of such abandonment of service on such segment or segments, the following transition provisions shall apply to the segment or segments being abandoned by NSR: (i) NSR will continue to operate, dispatch, and maintain the line until initiation of service by a qualified operator. A qualified operator is one with demonstrated successful experience in operation of railroad lines previously operated by Class I railroads. (ii) NSR will assure that if operation of the line is handed over to a third-party operator, the line must retain for at least a six-month period its maintenance level to then-current FRA track classifications consistent with current timetable and current track profile speed restrictions and any other restrictions therein that affect the speed of operation, consistent with any FRA track classification increases and/or elimination of timetable or track profile speed restrictions or other restrictions that affect the speed of operation resulting from work performed pursuant to Section 10 hereof. (iii) All conditions requiring routine slow orders will be corrected in advance of the line being handed over to a third- party operator. In the event of slow orders necessitated by unusual events or requiring major construction or capital expenditures which occur prior to the line being handed over PAGE 95 EXHIBIT 10(i), Page 18 of 44 to a third-party operator, the PPC/Dispute Resolution process will be employed to establish a reasonable time frame for NSR to make the necessary repairs. (iv) NSR will not be responsible for correcting slow orders resulting from unusual events that occur subsequent to the line being handed over to a third-party operator. (v) NSR will assist NCRR in securing a qualified third party operator. NSR's assistance to NCRR shall include but shall not be limited to the following: (1) identify qualified operators from previous experience with other operators, (2) assist in preparation and review of the Request for Proposal, and (3) assist in preparation of an operating agreement with the third party. (vi) Any business package offered to potential third-party operators will be developed in consultation with significant customers on the line and significant customers not on the NCRR line which would be substantially affected (positively or negatively) by a change in operators. (vii) The third party operator will provide all service on the line. NSR shall be entitled to negotiate haulage rights with such third party for all or portions of the line at standard eastern region haulage agreement rates and conditions applicable at the time of haulage. (viii) NSR will assist in seeking shipper satisfaction for any transition to third party operation. NSR will provide railroad cars to customers of the third-party operator on the same basis it does for other third-party operators connected to its line. (ix) Prior to initiation of service by a third-party operator, NSR will operate a rail flaw detector car over the line and will replace any rails or rail segments determined to have defects. (ix) Each party shall cooperate with the other in obtaining any necessary regulatory approval to accomplish any termination of NSR trackage rights and initiation of trackage rights by a third party operator. (d) Should NSR cease operations over either the Charlotte/Greensboro segment or the Greensboro/Raleigh segment, the annual trackage rights fee will be subject to adjustment through the PPC/Dispute Resolution procedures. The adjustment will be based on the percentage of total car miles operated on each of the two segments. PAGE 96 EXHIBIT 10(i), Page 19 of 44 Section 18. RETURN OF REAL PROPERTY (a) Non-operating Property (i) NCRR and NSR hereby agree that the term "Designated Returned Property" as used herein means those non-operating properties owned by NCRR and described on EXHIBIT B attached hereto and incorporated herein by reference. (ii) The Designated Returned Property will be released by NSR and A&EC to NCRR as of January 1, 2000 or the date such property is accepted by NCRR, whichever date is later, or a date as otherwise agreed between the parties (the "Return Date"). NSR shall continue to have use of the Designated Returned Property until the Return Date. (iii) For each such parcel the Return Date of which is within 9 months of the date NSR provides NCRR with the information described in Section 19 (e) hereof, NSR shall pay to NCRR within thirty business days of the Return Date one-half (1/2) of all rents received by NSR or A&EC for such parcel of Designated Returned Property from January 1, 1995, through the Return Date, subtracting any property taxes, assessments of any type and normal maintenance paid or to be paid by NSR, its parents or any affiliate and/or A&EC with respect to Designated Returned Property applicable to the period from January 1, 1995 to the Return Date. (iv) Any parcel of Designated Returned Property that is released by NSR or A&EC to NCRR shall be returned to NCRR free of any obligation of NCRR, NSR or A&EC to operate that parcel as a part of its or their line(s) of railroad unless otherwise agreed between the parties. (b) Operating Property: (i) Operating property will be considered by the parties to have been released from the leasehold or other interest of NSR or A&EC to NCRR and to be subject to this Agreement and the Trackage Rights Agreement as of the Effective Date. (ii) From and after the Effective Date, NSR and A&EC will have no ownership or leasehold interest in the properties of NCRR or the right-of-way of NCRR, and will look solely to this Agreement and to its rights and obligations under federal and/or state law for its authority to operate upon or to enter or remain upon the properties of NCRR. (iii) On or before October 1, 2000, NCRR and NSR, through the ad hoc property committee described in Section 19 hereof, shall determine the properties (except the property discussed in Section 7(b) hereof) which are necessary for NSR, by itself PAGE 97 EXHIBIT 10(i), Page 20 of 44 or through an affiliate of NSR, to fulfill NSR's obligations as operator of exclusive freight trackage rights under this Agreement (the "Designated NSR Facility Property"). Upon such determination, NSR shall provide to NCRR drawings of Designated NSR Facility Property that depict the shape and dimensions in feet of each such parcel of Designated NSR Facility Property, and shall note, in feet, the distance of the parcel to the nearest railroad milepost and also to the center line of the main track. NCRR and NSR shall then enter into a non-assignable (except as provided in Section 31) license or other written agreement for the continued NSR possession of such property for so long as (a) NSR has exclusive freight trackage rights under this Agreement or any renewal thereof, and (b) such property continues to be needed by NSR for its identified purpose. Such license or other written agreement shall be entered into consistent with and subject to the terms and conditions of this Agreement and the Trackage Rights Agreement as consideration for this Agreement and without additional consideration to be paid to NCRR by NSR. NSR shall be responsible for the management and condition of such property and any ad valorem taxes, assessments, and any other costs related directly or indirectly to such property. (iv) The parties acknowledge that there may be parcels which are subject to leases to third parties which are located within the limits of the right of way ( "3PL Parcels"). The parties intend that 3PL Parcels be treated in a manner similar to the Designated Returned Properties with respect to the allocation of rentals, both those received between January 1, 1995 and the date such parcels are returned to NCRR and those received after such parcels are returned to NCRR, and with respect to the duties of the parties regarding the return of such parcels to the management of NCRR and the obligations to pay property taxes and assume environmental responsibility, except that the parties agree that the indemnity provisions of Section 24(c) will not apply to such parcels. Section 19. AGREEMENTS WITH USERS, LICENSEES AND/OR THIRD PARTIES REGARDING THE RIGHT OF WAY (a) NSR and NCRR shall cooperate with each other in the transition of responsibility to NCRR, or shared responsibility between NCRR and NSR, as outlined herein and in EXHIBIT C, of the management, administration, and control of new and existing third party license, lease and other agreements that concern NCRR-owned property or right of way previously subject to the Old Leases. (b) NCRR and NSR shall appoint an ad hoc property committee (the "Committee" for purposes of this section) to address the orderly transition of the management of such agreements, with a target date of October 1, 2000 for completion of such transition. PAGE 98 EXHIBIT 10(i), Page 21 of 44 (c) The Committee shall address the following types of existing NSR agreements and any other agreements the parties agree must be addressed: (i) leases, licenses, wire line agreements, pipeline agreements, and other longitudinal or perpendicular encroachments; (ii) private and public grade crossing agreements and agreements concerning public projects; (iii) track lease agreements; (iv) spur tracks owned by third parties; (v) real property matters relating to trackage rights and other operating agreements with other railroad companies (other than with Amtrak and the agreement covering CSXT's operations between Fetner and Raleigh (Boylan)), including operations between Goldsboro and the CP&L lead; (vi) agreements with Amtrak for stations, parking, or other passenger facilities and related properties (other than tracks, platforms, and signals). (d) Within nine (9) months of receipt of the information from NSR described in section (e) below, NCRR will request an assignment from NSR of management of any active third party agreement, terminate any such agreement, request NSR or A&EC to terminate such agreement, substitute new agreements for existing agreements, or request that NSR retain management responsibility for such agreement for the remaining term of such agreement. If NSR declines to accept such responsibility for a particular matter at a particular time, the matter shall be addressed by the PPC/Dispute Resolution procedure herein. It is the intention of the parties that NCRR will assume responsibility for the management of all properties of NCRR not needed by NSR in its freight operations, but that the timing of such assumption will be subject to the agreement of the parties on a case by case basis. It is understood that it may be that parties to certain agreements can no longer be readily located, and that such agreements may be terminated by NSR by mailing notice to the last known address, if any, of the party. The parties shall work cooperatively and in good faith in reviewing the existing agreements. Rentals from third party agreements other than rentals of Designated Returned Properties or 3PL Parcels received by NSR from January 1, 1995 shall be divided as agreed by the Committee or if the Committee fails to agree, the matter shall be resolved pursuant to the PPC/Dispute Resolution procedure herein. As a general rule, the parties agree that the party entitled to the rental of Designated Returned Properties or 3PL Parcels shall from the date of such entitlement be responsible for the management of such property, for PAGE 99 EXHIBIT 10(i), Page 22 of 44 payment of any ad valorem taxes (if taxed as non-system property or separately assessed as set forth in Section 26 hereof) and, as between the parties, for any environmental harm to such property not caused by the other party occurring after the Return Date and any environmental reporting, if any, for such property. (e) NSR shall be responsible for providing to NCRR file documents or copies of the following records, if any, relating to Designated Returned Property and 3PL parcels: (1) photocopies of all applicable leases, licenses, or agreements relating to such property, including supplements and assignments, correspondence, and indexes or lists relating thereto; (2) the status of the rental for any such property, including billing statements or rental notice records for such rent; (3) the status of property taxes and all other expenses for such property, (4) photocopies of non- privileged materials found in the paper files of NSR's Environmental Protection Department; and (5) photocopies of non- privileged materials found in the paper files of the NSR Real Estate and Contract Services Department for all such property. NSR shall be responsible for providing to NCRR file documents or copies of the above described records to the extent they are available for all other agreements under Section 19(c) above. NSR shall use its best efforts not to destroy such records of third party agreements and records relating to any agreements. Neither NCRR nor NSR, including their affiliates, shall be required to provide any proprietary or licensed application software, including without limitation any such software dealing with real estate. (f) With respect to properties used by Amtrak, NSR and NCRR will work together to seek Amtrak's acquiescence in any change of management and control. Amtrak passenger station platforms shall be included in Designated NSR Facility Property as set forth above unless otherwise agreed between NCRR and NSR. (g) Any dispute arising under this section if not resolved within 60 days of first being raised by either party shall be addressed pursuant to the PPC/Dispute Resolution provision of this Agreement. (h) If any agreement covers both NCRR property and properties owned by NSR and/or A&EC, and NCRR determines that the agreement is to be assigned, terminated or substituted with respect to the NCRR portion of the property, the action taken by NCRR will only cover the portion of the property owned by NCRR and rents, taxes and other costs or services will be prorated appropriately. (i) NSR and NCRR in contacts with third parties will make referrals to the other party in a manner that is consistent with this Section 19 and in such a manner as to encourage timely and efficient handling. PAGE 100 EXHIBIT 10(i), Page 23 of 44 Section 20. VERTICAL AND LATERAL CLEARANCES AND SUPPORT During the term of this Agreement and any extension or renewals, NCRR will not impair vertical and horizontal clearances and the structural support of the track structures and other railroad facilities and appurtenances thereto needed by NSR to conduct its freight operations, consistent with the then current system-wide practices of NSR. Any proposal by NCRR or those claiming rights through NCRR which will have the effect of reducing any clearances or support present on the date hereof will be submitted to the PPC/Dispute Resolution procedure for resolution. Section 21. OTHER PROPERTY ISSUES (a) NCRR hereby releases all claims to Linwood Yard on the Effective Date hereof. (b) Upon termination of this Agreement, as an equal value exchange, NSR will be granted by NCRR a permanent exclusive easement over a continuous main track, satisfactory to both parties, with connections, between Pomona and Elm and NCRR will be granted by NSR a one-half interest, with connections, in Pomona Yard, the terms of which shall be addressed according to the PPC/Dispute Resolution provisions. (c) All other property issues shall be deferred until the expiration or termination of the Agreement. If a cessation of service by NSR occurs on a segment pursuant to Section 17 hereof, all property issues relating to such segment shall be resolved in connection with such cessation. Each party agrees that in advance of termination of the Agreement, or any proposed cessation of service on a segment pursuant to Section 17 hereof, the parties will negotiate in good faith regarding any interim access agreements necessary for efficient operation of each party's terminal, interchange, or yard facilities until the deferred property issues are finally resolved. Section 22. INDUSTRIAL DEVELOPMENT NSR and NCRR will work cooperatively with the North Carolina Departments of Commerce and Transportation and with regional economic development interests to enhance economic development in the areas served by NSR on the NCRR track segments. NSR will make special efforts on the eastern segment of the line and will cooperate with industrial development efforts to identify and secure long term railroad users to locate adjacent to such NCRR line. PAGE 101 EXHIBIT 10(i), Page 24 of 44 Section 23. LIABILITY NCRR and NSR hereby establish or provide for future consideration of certain criteria for liability, indemnity and insurance provisions and other related financial considerations which will apply to the several types of passenger operations which are currently or may in the future be conducted on or near the tracks over which NSR has trackage rights, and to establish a mechanism for handling future negotiations pertaining to liability issues as contemplated herein, and for resolving any future disagreements between the parties concerning such provisions. The term "financial consideration" as used in this Section 23 relates to financial agreements with Amtrak relating only to liability and indemnity concerns. For example, the term "financial consideration" shall not be deemed to include incentive payments provided to NSR for performance of Amtrak passenger trains. The types of passenger operations contemplated by the parties, and the criteria applicable to each, are set forth below. (a) Current or expanded Amtrak intercity passenger operations at scheduled speeds at or below 90 mph. Amtrak currently operates intercity passenger service on NCRR tracks over which NSR has trackage rights, and in connection therewith, Amtrak provides to NSR certain indemnities and financial considerations related to those indemnities under its Basic Agreement with NSR. (The "Basic Agreement" between Amtrak and NSR shall be defined as the Agreement between Southern Railway Company and The Alabama Great Southern Railroad Company and National Railroad Passenger Corporation, dated January 2, 1979, as revised effective June 1, 1999.) To the extent Amtrak operates intercity passenger service on such tracks at scheduled speeds of 90 mph or less, whether under a contract with NSR or a contract with NCRR, and whether at its current or at some expanded future level, NSR's rights and obligations pertaining to indemnity and related financial considerations shall be those provided by Amtrak to NSR under its Basic Agreement. (b) High speed passenger operations Passenger operations of any type at scheduled speeds in excess of 90 mph ("high speed" operations) will not be undertaken by NCRR or any other operator on or in close proximity to the tracks on which NSR has trackage rights, unless an appropriate type and level of liability, indemnity and insurance protection covering such operations has been agreed upon and implemented. Upon notice by NCRR to NSR that NCRR proposes such high speed passenger operations, NCRR and NSR shall, for a period not longer than six months, attempt to agree on what constitutes "close proximity," and on appropriate liability, indemnity and insurance protections for the proposed high speed passenger operations. Upon failure to agree within that six month period upon what constitutes "close proximity" or upon types and levels of liability, indemnity and insurance protection, the unresolved issues shall then be resolved PAGE 102 EXHIBIT 10(i), Page 25 of 44 pursuant to the PPC/Dispute Resolution provisions of this Agreement. NCRR and NSR agree that high speed passenger operations will require different types and levels of liability and indemnity protection, and that the liability, indemnity and insurance provisions of the 1998 Amended and Restated Operating Access Agreement Between Norfolk Southern Railway Company and Northern Virginia Transportation Commission & Potomac and Rappahannock Transportation Commission (VRE Agreement) is one example of the types and levels of liability, indemnity and insurance protection appropriate for high speed operations. (c) Additional passenger operations No passenger operations other than those described in Sections 23 (a) and (b) above (for example, non-Amtrak intercity passenger operations, commuter or light rail passenger operations) shall be operated, whether by NCRR or any other party, on or in close proximity to the tracks on which NSR has trackage rights, unless an appropriate type and level of liability, indemnity and insurance protection covering such operations has been agreed upon by all parties. Upon notice by NCRR to NSR that such passenger operations are proposed, NCRR and NSR shall, for a period not longer than six months, attempt to agree, if necessary, on what constitutes "close proximity," and on appropriate liability, indemnity and insurance protection for the proposed passenger operations. Upon failure to agree within that six month period upon what constitutes "close proximity" or upon types and levels of liability, indemnity and insurance protection, the unresolved issues shall then be resolved pursuant to the PPC/Dispute Resolution provisions of this Agreement. The principles set forth in subparagraphs (i) through (iv) below shall be applied in determining liability, indemnity and insurance obligations for such passenger operations, and to the extent lawful under the laws of the State of North Carolina, shall be applied without regard to the fault or negligence of any party: (i) In case of an accident involving only the trains or equipment of the operator of such passenger service, the operator shall be solely responsible for all injuries to its employees and passengers, all damages to track, equipment, lading or other property, and for all liability to third parties. (ii) In the case of an accident involving only the trains or equipment of NSR, NSR shall be responsible for all injuries to its employees, all damages to track, equipment, lading or other property, and for all liability to third parties. (iii) In case of an accident involving the trains of both NSR and the operator of such passenger service: 1. NSR and the operator shall be separately responsible for, and each shall separately bear, all liability for injuries PAGE 103 EXHIBIT 10(i), Page 26 of 44 to its own passengers and employees, and for damages to its own property, including property and lading in its possession. 2. NSR and the operator shall be jointly responsible for and shall equally bear all liability for injuries and damages not covered in subparagraph (iii) 1 above. (iv) Except as provided in Sections 23 (a) and (b) above, all passenger operators shall provide and maintain commercial liability insurance or equivalent protection sufficient to cover the risks to which they are subjected by the provisions of this Section 23 (c). (d) Passenger operator qualifications No passenger service of any type shall be operated unless the proposed operator is fully qualified pursuant to federal law to operate such passenger service. Amtrak will not be permitted by NCRR to operate additional intercity passenger service trains on the trackage over which NSR has trackage rights hereunder unless NSR is first consulted regarding any such plans. (e) Notice regarding matters in this section Any notice given by NCRR to NSR with respect to new passenger operations shall be in writing and shall specify that such notice is being given pursuant to Section 23 of this Agreement. (f) Cooperation in securing legislation NCRR and NSR acknowledge and agree that the types and levels of liability, indemnification and insurance protection the parties may deem appropriate as they pertain to certain passenger operations may not be possible without legislation. The parties agree that should legislation be necessary to accomplish their goals, they shall cooperate in seeking such legislation. Section 24. ENVIRONMENTAL PROVISIONS (a) Environmental Definitions (i) "Environmental Occurrence" means (1) any violation of applicable federal, state or local environmental laws, regulations, administrative orders or judicial decrees, as they apply to any part of the Leased Properties; (2) any noise, vibration or the deposit, spill, discharge, or other release of a Contaminating Substance on or from any part of the Leased Properties; or (3) any failure to provide PAGE 104 EXHIBIT 10(i), Page 27 of 44 information, make all appropriate submissions, and fulfill all applicable legal obligations of the owner and/or operator of the Leased Properties. (ii) "Contaminating Substance" means oil, petroleum or any substance declared to be hazardous or toxic or treated as a pollutant or contaminant under any law or regulation now or hereafter enacted or promulgated by any governmental authority. (iii) "Designated Returned Property" means those parcels identified in EXHIBIT B. (iv) "Leased Properties" means the properties leased to NSR and/or A&EC that (1) were included within the leaseholds as of December 31, 1994, under the 1895 Lease or the 1939 Lease (including the Designated Returned Property and the Line of Road); or (2) which then or thereafter became additions to the properties leased under the 1895 Lease or the 1939 Lease before the Effective Date. (v) "Line of Road" means the property over which NSR is the exclusive freight operator under the Trackage Rights Agreement and this Agreement, as well as Designated NSR Facility Property as determined pursuant to Section 18 of this Agreement. (b) Responsibility for Environmental Occurrences on the Leased Properties During the Leasehold Period and Until the Effective Date. (i) NSR agrees to indemnify, defend and hold harmless NCRR and its respective officers, directors, beneficiaries, shareholders, partners, agents, and employees from all fines, suits, procedures, claims, liabilities, damages (including without limitation diminution in property value and other economic loss) and actions of every kind, and all reasonable costs and expenses associated therewith (including attorneys' and consultants' fees) if NCRR is a named or charged party arising from any Environmental Occurrence that occurred on the Leased Properties during the leasehold period and until the Effective Date. (ii) If NSR's responsibility with respect to a specific parcel is triggered by Section 24(b)(i), NSR reserves the right upon written notice to NCRR to undertake site investigation, cleanup and remediation itself in a reasonable and prompt manner. (iii) NCRR will provide NSR with reasonable access to any properties of NCRR on which NSR takes action under Section 24(b)(ii) to investigate, clean up or remediate environmental harm, or on which NSR desires to undertake any other related action the performance of which is rendered more efficient or less costly when performed on such property, or which is needed by NSR to access any such properties. PAGE 105 EXHIBIT 10(i), Page 28 of 44 (c) Responsibility for Environmental Occurrences on the Designated Returned Property On and After the Effective Date or Return Date (i) NCRR agrees to indemnify, defend, and hold harmless NSR and its officers, directors, beneficiaries, shareholders, partners, agents, and employees from all fines, suits, procedures, claims, liabilities, damages and actions of every kind, and all reasonable costs and expenses associated therewith (including attorneys' and consultants' fees) if NSR is a named or charged party arising from any Environmental Occurrence, other than an Environmental Occurrence for which NSR is responsible under Section 24(d)(i) below, that occurs on any Designated Returned Property after the Effective Date or the Return Date, whichever comes later. (ii) If an Environmental Occurrence for which NCRR is responsible under Section 24(c)(i) is related to any Environmental Occurrence for which NSR is responsible under Section 24(b)(i), NCRR will be responsible only to the extent that contamination that was present prior to the Effective Date or Return Date is exacerbated by the later Environmental Occurrence. (iii) If NCRR's responsibility with respect to a specific parcel is triggered by Section 24(c)(i), NCRR reserves the right upon written notice to NSR to undertake site investigation, cleanup and remediation itself in a reasonable and prompt manner. (iv) NSR will provide NCRR, at no charge to NCRR, with reasonable access to any property controlled by NSR on which NCRR takes action under Section 24(c)(i) to investigate, clean up or remediate environmental harm, or on which NCRR desires to undertake any other related action the performance of which is rendered more efficient or less costly when performed on such property, or which is needed by NCRR to access any such properties. (d) Responsibility for Environmental Occurrences Resulting From NSR Operations On and After the Effective Date (i) NSR agrees to indemnify, defend, and hold harmless NCRR and its officers, directors, beneficiaries, shareholders, partners, agents, and employees from all fines, suits, procedures, claims, liabilities, damages (including without limitation diminution in property value and other economic loss) and actions of every kind, and all reasonable costs and expenses associated therewith (including attorneys' and consultants' fees) if NCRR is a named or charged party arising from any Environmental Occurrence that occurs on property owned by NCRR on or after the Effective Date, but only to the extent such Environmental Occurrence results from PAGE 106 EXHIBIT 10(i), Page 29 of 44 the operations of NSR, its agents or any party with a direct contractual relationship with NSR relating to NSR's operations, including Amtrak under an Amtrak/NSR Direct Service Agreement. (ii) NSR will be responsible for (1) overseeing its own environmental operations, (2) responding to notices, claims, lawsuits, or orders pertaining to environmental issues or incidents arising out of its freight operations or Amtrak/NSR Direct Services and occurring on or adjacent to the Line of Road or adjacent properties, and (3) complying with and performing all environmental obligations of the freight operator of the Line of Road during the term of the Trackage Rights Agreement and any renewals. NSR will not allow the release, discharge or disposal of any wastes of any kind, whether hazardous or not, on the properties of NCRR. For purposes of the preceding sentence only, the agreement of NSR not to allow the release, discharge or disposal of any wastes on the properties of NCRR will not apply to the temporary storage of wastes in tanks or containers or to the discharge of waste water or other effluent subject to a valid permit in accordance with all applicable environmental laws and regulations. Should NSR inadequately perform any action required under applicable environmental laws, rules, regulations, ordinances or judgments, NCRR or its represen- tative shall have the right to take whatever reasonable corrective action NCRR deems necessary to perform the work, at the sole expense of NSR. (iii) NCRR will provide NSR with reasonable access to any properties of NCRR on which NSR is required by this Section 24(d) to take action to investigate or remediate environmental harm, or on which NSR is required hereunder to take any other related action the performance of which is rendered more efficient or less costly when performed on such property, or which is needed by NSR to access any such properties. (iv) To the extent permitted by applicable laws and regulations, the following will be provided to NCRR or to NSR within 30 days of the receipt or submission thereof by NSR or by NCRR, as the case may be: (A) Any administrative or judicial investigation, complaint, order or demand filed, served on or delivered to NCRR or NSR by any governmental agency at any time during the term of this Agreement because of or arising from the deposit, spill, discharge or other release of a Contaminating Substance which occurred on any part of the Leased Properties before the Effective Date, or the Line of Road, or any parcel in which the other party has an interest on and after the Effective Date; PAGE 107 EXHIBIT 10(i), Page 30 of 44 (B) Notice of any claims, lawsuits or other actions against NCRR or NSR at any time during the term of this Agreement for injunctive relief or recovery of losses sustained because of or arising from the deposit, spill, discharge or other release of a Contaminating Substance which occurred on any part of the Leased Properties before the Effective Date, or the Line of Road, or any parcel in which the other party has an interest on and after the Effective Date; (C) A copy of any analytical results, correspondence or report pertaining to underground storage tanks, above ground storage tanks, wetlands or any environmental investigation of any part of the Line of Road, which is submitted to NCRR or NSR by any third party (excluding NCRR's or NSR's contractors and consultants, but including governmental agencies) or submitted by NCRR or NSR to any governmental agency at any time during the term of this Agreement; (D) A copy of the results of environmental tests performed by or on behalf of a governmental agency at any time during the term of this Agreement because of or related to any deposit, spill, discharge or other release of a Contaminating Substance occurring on any part of the Line of Road; and (E) A copy of all environmental reports, notices and correspondence submitted by NCRR or NSR to any governmental agency after the effective date of this Agreement pursuant to any applicable federal, state, or local law, ordinance or regulation pertaining to the Line of Road at any time during the term of this Agreement. (v) If there is an Environmental Occurrence which NCRR has a reasonable good faith belief may constitute a risk of liability, expense or criminal exposure to NCRR, NCRR will be given full access to and opportunity to copy any relevant environmental reports, studies or data pertaining to such Environmental Occurrence in the possession of NSR (excepting privileged communications with counsel for NSR), upon 30 days prior written notice to NSR. (d) Remediation Standards No cleanup or remediation will be required pursuant to this Agreement unless Contaminating Substances are present in amounts requiring reporting to state or federal environmental agencies and in amounts requiring cleanup or remediation under applicable environmental laws and regulations. If a cleanup or remediation work is required on any parcel of Leased Properties that is used for non-residential purposes as of July 1, 1999, the indemnifying party under Sections 24(b), (c) or (d) will not be required to meet more stringent standards due to existing or possible future PAGE 108 EXHIBIT 10(i), Page 31 of 44 development of the parcel for residential uses. The obligation to indemnify for cleanup and remediation expenses or the undertaking of such work shall not be increased based upon any development requiring excavation of the surface or subsurface of the given parcel for the construction of underground garages, basements, or subsurface occupation. The parties agree that the cleanup standard applicable to such parcel may be based upon a site specific risk assessment, if such approach complies with applicable environmental laws and regulations or is accepted by the environmental agency having jurisdiction over the parcel. (e) Retention of Rights In addition to the rights conveyed by this Section 24, NCRR and NSR each retains all statutory and common law rights and causes of action against the other, including but not limited to its rights under federal and state environmental laws, arising out of Environmental Occurrences. (f) Termination of Indemnification Obligations (i) The parties' indemnification and defense obligations under Sections 24(b), (c) and (d) of this Agreement arising out of an Environmental Occurrence will terminate seven (7) years after the party seeking indemnification has actual knowledge or receives proper notice from the other party or a third party of the Environmental Occurrence, and in any event such obligations will terminate seven (7) years after the termination of this Agreement and any extensions thereof. If the party seeking indemnification for an Environmental Occurrence submits a valid claim in writing to the other party within this time period, the indemnifying party's obligations under this Agreement will continue indefinitely with respect to that Environmental Occurrence until the matter is resolved. For purposes of this Section 24(f)(i), any notice or claim must meet the following additional requirements: (1) In the case of a notice by either NSR or NCRR to each other, it must refer to this Section 24(f)(i) and must be delivered either by hand; by registered or certified mail, return receipt requested; by next-day delivery, with written evidence of receipt; or by fax, with confirmation by registered or certified mail, return receipt requested. (2) It must specifically describe the suspected Environmental Occurrence, the nature and scope of the contamination, the property affected, any claims that have been made and plans for investigation or remediation, to the extent such information is available. PAGE 109 EXHIBIT 10(i), Page 32 of 44 (ii) Unless the parties' obligations have terminated under Section 24(f)(i), NCRR and NSR each agrees to waive and not to assert as a defense to its indemnification obligations under this Section 24 any statute of limitations, statute of repose, laches or other time related defense with respect to any Environmental Occurrence. (g) Environmental Information for Designated Returned Property With respect to the Designated Returned Properties, on or before October 1, 1999, NSR will identify any contamination of which it has knowledge and will provide to NCRR all information and reports pertaining thereto, and NCRR will have the right to inspect such properties before their return. Such right of inspection will include the right to perform an environmental site assessment. (h) Dispute Resolution Any dispute arising under this Section 24, if not resolved within 90 days of being raised by either party, shall be addressed pursuant to the PPC/Dispute Resolution provision of this Agreement. Section 25. "REIT" COOPERATION (a) NSR will cooperate with NCRR in maintaining NCRR's status as a Real Estate Investment Trust ("REIT") for income tax purposes. (b) NCRR and NSR intend that, to the extent permitted by law, the payments by NSR for trackage rights be treated as rents from real property for purposes of NCRR's continued qualification as a REIT. Section 26. PROPERTY TAXES (a) NSR shall continue to pay property (ad valorem) taxes assessed against NSR as a result of the allocation of a portion of its system value to the taxing jurisdiction in which NCRR owns property over which NSR serves as the exclusive freight operator pursuant to the Agreement. (b) NSR: (i) shall be responsible for property (ad valorem) taxes, if any, determined pursuant to the North Carolina General Statutes and related rules and regulations of the North Carolina Department of Revenue on Non-operating Property that is owned by NCRR and which NSR has the exclusive right to use under the Agreement and (ii) shall be responsible for any property taxes, assessments, or liens with respect to Designated Returned Property not paid by NSR or any of its subtenants/licensees for all periods prior to the Return Date. NCRR shall be responsible for property (ad valorem) taxes on all other Non-operating Property; provided, however, where NSR has the non-exclusive right to use Non-operating Property under PAGE 110 EXHIBIT 10(i), Page 33 of 44 the Agreement, then NSR shall be responsible for its pro rata share of the property taxes on such property based on NSR's usage of such property. For purposes of this Section 26, Non-operating Property shall mean property that is appraised as non-system property by the North Carolina Department of Revenue or separately assessed by the local assessor as non-public service company property. (c) NSR or NCRR will not be required to pay any tax it is obligated to pay under the provisions of this Section during the time it shall reasonably and in good faith and by appropriate legal or administrative proceedings contest the validity or the amount thereof. (d) NSR and NCRR and their respective assignees and designees shall have the right to control and defend at their expense any audit or examination by any taxing authority, or any judicial proceeding, relating to any taxes required to be paid by them respectively under this Section. (e) If during the term of the Agreement, including any renewal period, the manner in which property (ad valorem) taxes are assessed against railroads is changed, or if improvements are made by NCRR or any other party hereunder that are not used by NSR and that affect the amount of property taxes assessed against NSR, the parties will attempt in good faith to agree upon any changes which may be necessary to this Section 26, using the PPC/Dispute Resolution procedures herein if necessary; it being the parties' understanding that the amount of property taxes payable by NSR under this Section 26 shall not be increased by property taxes attributable: (i) to the portion of property owned by NCRR that is not used by NSR or (ii) to expenditures or additions to capacity that are not used by NSR. Section 27. REGULATORY APPROVAL AND EFFECTIVE DATE (a) The grant of trackage rights hereunder and any renewals are subject to prior approval or exemption from prior approval by the Surface Transportation Board ("STB") or any successor agency of the undertakings of NSR herein, as may be required or appropriate under 49 U.S.C. Section 11323, or any successor federal legislation and such approval or exemption action becoming final. (b) After (i) all requisite governmental and corporate approvals for this grant of rights have become effective or have been satisfied; (ii) this Agreement and all associated documents have been fully executed and delivered; and (iii) any court orders enjoining the implementation of this Agreement have expired or are no longer in effect, this Agreement and the Trackage Rights Agreement shall be effective contemporaneously (the "Effective Date"). PAGE 111 EXHIBIT 10(i), Page 34 of 44 Section 28. RESOLUTION OF LITIGATION NCRR and NSR agree that the STB compensation and federal court proceedings will be voluntarily dismissed by the parties without prejudice within twenty days of execution of this Agreement and all necessary approvals have been obtained. (a) NCRR and NSR agree that the STB compensation and federal court proceedings will be voluntarily dismissed by the parties without prejudice within twenty days of execution of this Agreement and all necessary approvals have been obtained. (b) Except with respect to (i) personal property claims released as set forth in Section 6, "Release" and (ii) property claims resolved as set forth in Section 21, "Other Property Issues," none of NCRR's claims for improvements, additions, betterments, improvements to real property, property rights, franchises or privileges under the Old Leases are waived or affected by virtue of the execution and delivery of this Agreement. (c) The terms of the Old Leases create potential claims that NSR and/or A&EC would owe and be obligated to deliver to NCRR additional properties (hereinafter "Claims for Additions"). The parties acknowledge that to the extent Claims for Additions exist, the circumstance that such additional properties and/or rights may have been acquired or now be held in the name of a company affiliated with NSR or A&EC will not, of itself, be determinative of the issue of whether the Claims for Additions are valid. (d) No claim or demand contemplated by the Old Leases for the return of real property and related railroad facilities otherwise to be determined at the expiration or termination thereof may be made until, and therefore each of them is postponed to, the termination of this Agreement or any renewal (or any cessation of service over a segment pursuant to Section 17 hereof with respect to such segment). NCRR and NSR agree that nothing in this Agreement shall abridge, estop, compromise, release or waive any such claims deferred under this Agreement and that no defense of waiver, latches, acquiescence, release, estoppel, or the like arising on or after December 31, 1994 with respect to any such claims existing on that date may be asserted by reason of NCRR's agreement not to assert such claims at this time. Section 29. POLICY PLANNING COMMITTEE/DISPUTE RESOLUTION NCRR and NSR will establish a joint senior-level Policy Planning Committee ("PPC" or "Committee"). The PPC will serve as a planning resource to the various issues which are properly before it, including but not limited to dispatching matters, maintenance levels and the implementation of third-party operations on NCRR lines. PAGE 112 EXHIBIT 10(i), Page 35 of 44 There will be three representatives from each of NSR and NCRR on the committee. Those appointed shall be empowered to act within the parameters of the committee's area of concern, subject to necessary management approvals of expenditures. The PPC will meet not less than twice a year on a scheduled basis. If either party desires an additional meeting or meetings, it shall provide a proposed agenda and a thirty-day notice to the other party. The other party may either agree to the proposed meeting date or request a fifteen-day extension, at which time the meeting will take place. The parties will alternate sites of the scheduled meetings or may agree to meet at a site convenient to both parties. The party requesting the special meeting will travel to the other party's headquarters location. Any special meeting may be held via telephone conference. DISPUTE RESOLUTION - PPC The PPC shall also address and attempt to resolve Disputes. As used in this section, a "Dispute" is any controversy, claim, issue, or other dispute between NCRR and NSR that arises out of, in connection with, or in relation to this Agreement or the Trackage Rights Agreement, whether it arises in contract, in tort, by statute, or otherwise. "Dispute" includes, but is not limited to: (a) any failure to agree on matters as to which this Agreement expressly or implicitly contemplates subsequent agreement by the parties (except for any matters left to the sole discretion of a party); (b) any question about the parties' relationship under this Agreement or the Trackage Rights Agreement; (c) any question about the interpretation, performance, breach, validity, scope, duration, enforceability or termination of the provisions in this Agreement or the Trackage Rights Agreement; and (d) any question of arbitrability that arises under this Agreement or the Trackage Rights Agreement. If a Dispute between the parties cannot be resolved by the parties in the ordinary course of business, that Dispute shall be resolved as follows: (a) The Dispute shall be submitted to the PPC for resolution. Either party shall have the right to submit the Dispute to the PPC by providing the other party with written notice to that effect in the manner set forth later in this Agreement for the giving of notices. The notice (the "Notice") shall describe the Dispute and indicate that the party providing the Notice wishes to resolve the Dispute pursuant to the dispute resolution provisions in this section. The submitted Dispute shall be addressed at the next regularly scheduled meeting of the PPC unless the party providing the Notice declares that the Dispute is urgent and requests that a special meeting be held to address the submitted Dispute, provided that the party exercising that right has complied with the Notice requirements for meetings and agenda items described above. (b) If the PPC fails to resolve a Dispute properly submitted to it pursuant to the provisions set forth above at the meeting scheduled pursuant to the Notice (or if such meeting is not held, on or PAGE 113 EXHIBIT 10(i), Page 36 of 44 before the date such meeting is scheduled to be held), the Dispute shall then be submitted to NSR's Chief Operating Officer and NCRR's President for resolution. (c) If NSR's Chief Operating Officer and NCRR's President fail to resolve a Dispute properly submitted to them pursuant to the provisions set forth above within 90 days following the date the meeting scheduled pursuant to the Notice is held (or, if such meeting is not held, the date such meeting is scheduled to be held), the Dispute shall then be arbitrated as set forth below. DISPUTE RESOLUTION - ARBITRATION Notice of Arbitration. Either NCRR or NSR shall have the right to initiate arbitration of any Dispute not resolved as provided above by providing a notice of arbitration to the other party in the manner set forth later in this Agreement for the giving of notices. This notice shall clearly describe the Dispute to be arbitrated and indicate whether the party initiating arbitration wishes to submit the dispute to one arbitrator or to three arbitrators. Number of Arbitrators. If the party initiating the arbitration indicates a desire to submit the Dispute to only one arbitrator, and the party receiving the notice gives notice of its consent to the use of a single arbitrator within ten business days in the manner set forth later in this Agreement for the giving of notices, then one-arbitrator arbitration shall be used. Otherwise, three-arbitrator arbitration shall be used. Arbitration Site. The arbitration hearing shall be conducted at a neutral location of the arbitrator's or arbitrators' choosing. Arbitration Rules. The arbitration shall be conducted pursuant to the American Arbitration Association's Commercial Arbitration Rules (or their successor) (the "Arbitration Rules"). The use of the Commercial Arbitration Rules shall not require the actual submission of the Dispute to the American Arbitration Association. The Arbitration Rules shall apply except to the extent they are inconsistent with the requirements of this Agreement. Other arbitration rules or any arbitration forum may be used if agreed to by the parties. Three-Arbitrator Arbitration. Under this procedure, the Dispute shall be resolved by a panel of three arbitrators. These arbitrators shall be knowledgeable about the subject matter of the Dispute. For example, with regard to railroad operational matters, arbitrators knowledgeable in Class I railroad operations and rail passenger operations shall be selected. These arbitrators shall comply with the Code of Ethics for Arbitrators in Commercial Disputes issued by the American Bar Association and the American Arbitration Association. These arbitrators shall not be current or previous employees of the parties, nor shall they within the past ten years have received regular remuneration from either party other than for arbitration services. PAGE 114 EXHIBIT 10(i), Page 37 of 44 The party who submits the Dispute to arbitration shall select and identify the first of these arbitrators in the notice of arbitration. The other party shall identify the second in a notice to be given not more than 45 days after it receives the notice of arbitration. Within 30 days of the second arbitrator's selection, the two arbitrators shall select a third, from nominations by the parties or otherwise, and notify the parties of the selection. If the two selected arbitrators cannot agree on a third within 90 days of the notice of arbitration, the parties shall submit the Dispute to the American Arbitration Association and the third arbitrator shall be chosen in accordance with the Arbitration Rules or, if those Rules provide no means to make the selection, pursuant to the Federal Arbitration Act, currently codified as 9 U.S.C. Sec. 1 et seq. The decision of the majority of the arbitrators shall constitute their award. Their award shall be rendered in writing within 90 days of the selection of the third arbitrator unless otherwise agreed between the parties, and it shall contain a brief description of the rationale for the award. The award shall be final and binding on the parties. One-Arbitrator Arbitration. Under this procedure, the Dispute shall be resolved by a single arbitrator. The arbitrator shall be knowledgeable about the subject matter of the Dispute. For example, with regard to railroad operational matters, an arbitrator knowledgeable in Class I railroad operations and rail passenger operations shall be selected. The arbitrator shall comply with the Code of Ethics for Arbitrators in Commercial Disputes issued by the American Bar Association and the American Arbitration Association. The arbitrator shall not be a current or previous employee of the parties, nor shall he or she within the past ten (10) years have received regular remuneration from either party other than for arbitration services. The parties will meet by telephone within ten days of receipt of the notice of arbitration and seek agreement on the identity of the arbitrator. If the parties are unable to reach agreement on the identity of the arbitrator within 30 days of the notice of arbitration, either (i) the parties shall submit the Dispute to the American Arbitration Association and the arbitrator shall be chosen in accordance with the Arbitration Rules or, if those rules provide no means to make the selection, pursuant to the Federal Arbitration Act, currently codified as 9 U.S.C. Sec. 1 et seq., or (ii) either party may initiate three-arbitrator arbitration to resolve the Dispute by resubmitting an appropriate notice of arbitration. The award shall be rendered in writing within 45 days of the selection of the arbitrator unless otherwise agreed between the parties, and it shall contain a brief description of the rationale for the award. The award shall be final and binding on the parties. PAGE 115 EXHIBIT 10(i), Page 38 of 44 General Provisions. The decision of the arbitrator(s) shall be final and binding. Judgment to enforce the decision or award of the arbitrator(s) may be entered in any court having jurisdiction, and the Parties shall not object to the jurisdiction of the North Carolina General Court of Justice for that purpose. All proceedings relating to any such arbitration, and all testimony, written submissions and awards of the Arbitrator(s) therein, shall be private and confidential as among the parties and shall not be disclosed to any other person, except that NCRR or NSR may disclose them to third parties if (1) the information is publicly available; (2) disclosure is recommended or required under applicable laws, rules, or regulations, including, without limitation, securities laws; or (3) disclosure is reasonably necessary to prosecute or defend any judicial action to enforce, vacate, or modify such arbitration award. The arbitrator(s) shall resolve all questions of state law by application of the substantive law of North Carolina. They shall not apply North Carolina's choice of law rules. The arbitrator(s) shall not be authorized to award punitive damages, regardless of the otherwise applicable substantive law they apply to resolve the Dispute. The Arbitrator(s) shall have the power to require the performance of acts found to be required by this Agreement, and to require the cessation or non-performance of acts found to be prohibited by this Agreement. In an appropriate case, either party (or both) may request a temporary restraining order, preliminary injunction, declaratory judgment or other interim measure from a court or administrative body of competent jurisdiction while arbitration proceedings are pending. Such a request shall not be deemed incompatible with an agreement to arbitrate or a waiver of the right to arbitrate. Each party shall pay the compensation, costs, fees and expenses of its own witnesses, experts and counsel. The compensation and any costs and expenses of the arbitrator(s) and all other costs of the arbitration shall be equally divided between the parties. In any judicial proceeding to enforce this Agreement to arbitrate, the only issues to be determined shall be the existence (but not the scope) of an agreement to arbitrate or the failure of NCRR or NSR to comply with that agreement. All other issues shall be decided by the Arbitrator(s), whose decision thereon shall be final and binding. There may be no appeal of an order compelling arbitration except as part of an appeal concerning confirmation of the decision of the Arbitrator(s). PAGE 116 EXHIBIT 10(i), Page 39 of 44 No party to this Agreement shall initiate a lawsuit or any administrative proceeding (a "lawsuit") against another party to this Agreement if that lawsuit involves a Dispute that could otherwise be arbitrated under this section, except to the extent that the lawsuit seeks (i) to compel an arbitration permitted by this section; (ii) to confirm (and have judgment entered on) or to vacate an arbitration award made pursuant to this section; (iii) to stay the running of any statute of limitations; or (iv) to prevent any other occurrence (including, without limitation, the passing of time) that would give rise to a defense such as laches, estoppel, or waiver that initiating a lawsuit may be necessary to avoid. If a lawsuit is brought for the purposes described in (iii) or (iv), no party shall pursue such litigation beyond such action as is necessary to prevent prejudice to its cause of action pending ultimate resolution by arbitration under this section. If a third party initiates a lawsuit against a party to this Agreement (the "Defendant"), and this gives rise to a Dispute, neither party to this Agreement shall pursue a claim in the lawsuit against the other without the other's consent except as provided in the preceding paragraph. The parties acknowledge that this Agreement is a "contract evidencing a transaction involving commerce" as that phrase is used in the Federal Arbitration Act at 9 U.S.C. Sec. 2. The parties agree that the arbitrators shall be guided by the terms of the Agreement and the General Principles set forth herein. Section 30. NOTICES Any notices given hereunder shall be effective if sent by registered or certified mail (United States Mail) and addressed as follows: If to NSR: Senior Vice President-Operations Norfolk Southern Corporation Three Commercial Place Norfolk, Virginia 23510 If to NCRR: President North Carolina Railroad Company 3200 Atlantic Avenue, Suite 110 Raleigh, North Carolina 27604 or to such other official and/or address as any of the parties hereto may specify in a written notice to the other parties hereto, sent as stated above. PAGE 117 EXHIBIT 10(i), Page 40 of 44 Section 31. SUCCESSORS AND ASSIGNS Neither party hereto shall transfer or assign this Agreement, or any of its rights, interests or obligations hereunder, to any person, firm, or corporation which is not affiliated with such party without obtaining the prior written consent of the other party to this Agreement; provided, however, that neither party shall be required to obtain the prior approval of the other party in connection with any assignment effected by a merger, consolidation or corporate reorganization or other transaction where substantially all of the rail assets and liabilities of such party are brought under common control with the assets of another party. Section 32. MISCELLANEOUS (a) Except to the extent controlled by federal laws and regulations, this Agreement shall in all respects be governed by the laws of the State of North Carolina. (b) This Agreement, together with its attachments and exhibits, contains all the agreements of the parties hereto and supersedes any previous negotiations. (c) There have been no representations made by or on behalf of the NCRR or NSR or understandings made between or among the parties hereto other than those set forth in this Agreement. This Agreement may not be modified except by a written instrument signed by the parties hereto. (d) All obligations of the parties hereunder not fully performed as of the expiration or earlier termination of the term of this Agreement and any renewal shall survive such expiration or earlier termination of the term hereof and any renewal. (e) If any clause, phrase, provision or portion of this Agreement or the application thereof to any party or circumstance shall be invalid or unenforceable under applicable law, such event shall not affect, impair or render invalid or unenforceable the remainder of this Agreement or any other clause, phrase, provision or portion hereof, nor shall it affect the application of any other clause, phrase, provision or portion hereof to other parties or circumstances. (f) The section headings herein are for convenience of reference and shall in no way define, increase, limit, or describe the scope or intent of any provision of this Agreement. (g) Neither party shall be liable to the other in damages nor shall this Agreement be terminated nor a default be deemed to have occurred because of any failure to perform hereunder caused by a "Force Majeure." Each party will be excused from performance of any of its obligations hereunder, except obligations involving the payment hereunder of money to the other party or to a third party, PAGE 118 EXHIBIT 10(i), Page 41 of 44 where such non-performance is occasioned by Force Majeure. Force Majeure shall mean fire not caused by NSR operations, earthquake, flood, explosion, a wreck not involving NSR trains, strike, riot, insurrection, civil disturbance, act of public enemy, embargo, war, act of God, inability to obtain labor, materials or supplies, any governmental regulation, restriction or prohibition, or any other similar cause beyond the party's reasonable control. Section 33. INSPECTIONS AND RECORDS; AUDIT (a) Audit and reporting records (including but not limited to payment amounts, cost and payment calculations, real estate records, engineering data, freight and passenger traffic data, etc.) will be exchanged by the parties on a periodic basis. (b) NSR will maintain written records of the delays to passenger and, if any, commuter trains and NSR shall provide those records to NCRR on a monthly basis. These records will include the length and cause of delay, including those which are caused by circumstances which are beyond the NSR control. NSR shall provide any information in its possession on circumstances that cause delay outside of NSR control. (c) NSR will provide NCRR with the following annual reports, records or documents on or before June 1 of the following year: (i) Rail, signal, and bridge program maintenance improvements reports showing improvements made on the NCRR lines during the previous calendar year, including, without limitation, the number of new ties installed, miles surfaced, and length of new or used rail installed, by line segment; (ii) Updated track profiles; (iii) Previous calendar year's car loads originated and terminated by station, and number of car miles by line segment (Raleigh- Morehead City, Raleigh-Greensboro, and Greensboro-Charlotte) as available in NSR's records or systems in use; (iv) Scheduled program maintenance for the then-current calendar year. (v) Copies of the previous calendar year's annual reports filed with the North Carolina Utilities Commission and the Surface Transportation Board ("STB") or its successor (currently designated as Form R1 for the STB); (d) By January 1, 2000, and not less than every three years thereafter, NSR will furnish to NCRR copies of the following records then in use by NSR: (i) changes to valuation or similar maps of NCRR PAGE 119 EXHIBIT 10(i), Page 42 of 44 including intersection points with other lines, and (ii) a bridge inventory (including but not limited to date of construction, type, and condition on the NCRR lines operated and/or maintained by NSR). (e) Up to two NCRR designated inspectors may inspect NCRR trackage operated by NSR not less than every two years, traveling by high rail vehicle with NSR supervisors or other NSR-designated personnel during their regular inspection trips, and over the track sections routinely scheduled by NSR for inspection. It is the intention of the parties that NCRR have the opportunity to inspect its lines in their entirety annually, subject however, to NSR's availability to schedule such inspection trips over a reasonable period of time in order to minimize disruption of NSR operations and use of NSR personnel. (f) If NSR incurs costs or expenses associated with providing the information required in this Section 33 other than for copies of records and reports ordinarily maintained by NSR in the course of its business, the allocation of such costs between the parties shall be addressed by the PPC/Dispute Resolution provision of this Agreement. Section 34. CONFIDENTIALITY (a) Except as may be otherwise agreed between NCRR and NSR, any documents and records (the "information") shared between the parties pursuant to this Agreement shall not be disclosed to third parties without first obtaining the written consent of the party providing the information to the other party hereto. (b) NCRR or NSR may disclose the information to third parties if the information is publicly available or if disclosure is recommended or required under applicable laws, rules, or regulations, including, without limitation, securities laws. PAGE 120 EXHIBIT 10(i), Page 43 of 44 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. WITNESS NORFOLK SOUTHERN RAILWAY COMPANY /s/ Henry D. Light By: /s/ R. A. Brogan ---------------------------------- Title: ---------------------------------- WITNESS NORTH CAROLINA RAILROAD COMPANY /s/ Najla J. Silek By: /s/ Sam Hunt ---------------------------------- Title: ---------------------------------- Subject to necessary corporate and governmental approvals. PAGE 121 EXHIBIT 10(i), Page 44 of 44 EXHIBIT INDEX -------------- Exhibit No. Document ---------- -------- A Timetable and Track Profiles as of July 1, 1999 B Designated Returned Properties C Third Party Property/Agreement Request Chart ATTACHMENT ----------- Trackage Rights Agreement -----END PRIVACY-ENHANCED MESSAGE-----