CSX TRANSPORTATION INC, 10-K405, 1999-03-05

CSX TRANSPORTATION INC
10-K405, 1999-03-05
RAILROADS, LINE-HAUL OPERATING

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FORM 10-K

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended December 25, 1998

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ________________

Commission file number 1-3359

CSX TRANSPORTATION, INC.
(Exact name of registrant as specified in its charter)

Virginia 54-6000720
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

500 Water Street, Jacksonville, FL. 32202
----------------------------------- -----
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (904) 359-3100
--------------

Securities registered pursuant to Section 12(b) of the Act:

Name of each exchange on which each
Title of each class class is registered
------------------------------ -------------------------
Hocking Valley Railroad Company
First Consolidated Mortgage 4-1/2%
Bonds, due July 1, 1999 New York Stock Exchange

Louisville and Nashville Railroad
Company First and Refunding Mortgage
3-3/8% Bonds, Series F, due April 1, 2003 New York Stock Exchange

Louisville and Nashville Railroad
Company First and Refunding Mortgage
2-7/8% Bonds, Series G, due April 1, 2003 New York Stock Exchange

Monon Railroad 6% Income Debentures,
due January 1, 2007 New York Stock Exchange

-1-
<PAGE>

REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I (1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED
DISCLOSURE FORMAT.

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-K or any amendment to this
Form 10-K. (X)

State the aggregate market value of the voting stock held by nonaffiliates of
the registrant. The aggregate market value of the voting stock at February 19,
1999, was $-0-, excluding the voting stock held by the parent of the registrant.

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. The registrant has 9,061,038
shares of common stock, par value $20.00, outstanding at February 19, 1999.

-2-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
1998 FORM 10-K ANNUAL REPORT
Table of Contents

Item No. Page
- ------- ----

PART I

1 Business 4-5
2. Properties 4-5
3. Legal Proceedings 5-6
4. Submission of Matters to a Vote of Security Holders 5

PART II

5. Market for Registrant's Common Stock and Related Stockholder
Matters 6
6. Selected Financial Data 6
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 6
7A.Quantitative and Qualitative Disclosures About Market Risk 7
8. Financial Statements and Supplementary Data 7
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 7

PART III

10. Directors, Executive Officers, Promoters and Control Persons of the
Registrant 7
11. Executive Compensation 7
12. Security Ownership of Certain Beneficial Owners and Management 7
13. Certain Relationships and Related Transactions 7

PART IV

14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 7-8

Signatures 8

Index to Consolidated Financial Statements 9

-3-
<PAGE>

PART I

Items 1. & 2. Business and Properties.

General
-------

CSX Transportation, Inc. (CSXT) is engaged principally in the
business of railroad transportation and operates a system comprising 18,181
miles of first main line track in 20 states principally east of the Mississippi
River (exclusive of New England), southern Ontario and the District of Columbia,
employing an average of 28,358 employees during its most recent fiscal year. It
conducts railroad operations in its own name and through railroad subsidiaries.

In 1999, CSXT's rail system will expand significantly with the
integration of Conrail lines in the Northeast, brought about by the joint
CSX/Norfolk Southern acquisition of Conrail that was approved by federal
regulators in 1998. After integration, CSXT will operate in every major market
east of the Mississippi River with a network comprised of over 23,000 route
miles in 23 states and Canada, plus additional rail service in certain
geographic areas that Conrail will operate for the joint benefit of CSX and
Norfolk Southern.

CSXT is a wholly-owned subsidiary of CSX Corporation (CSX). CSX is a
publicly-owned Virginia corporation with headquarters at One James Center, 901
East Cary Street, Richmond, Virginia, 23219-4031. CSX also controls other
transportation businesses which include Sea-Land Service, Inc., an ocean
container-shipping company; CSX Intermodal, Inc., an intermodal and trucking
company; and Customized Transportation, Inc., a contract logistics service
supplier. CSX also has interests in real estate, resorts and resort management.

For information concerning business conducted by CSXT during 1998,
see "Management's Narrative Analysis and Results of Operations" on pages 28 -
32.

Roadway
-------

On December 25, 1998, CSXT's consolidated system consisted of 30,734
miles of track as follows:

Track
Miles
-----
First Main 18,181
Second Main 2,788
Passing, Crossovers and Turnouts 2,331
Way and Yard Switching 7,434
--------

Total 30,734
========

Included above are 847 miles of leased track, 2,401 miles of track
under trackage rights agreements with other railroads and 208 miles of track
under operating contracts.

-4-
<PAGE>

Equipment
---------

On December 25, 1998, CSXT and subsidiaries owned or leased the
following:

Owned Leased Total
-------- -------- ---------
Locomotives
Freight 2,029 392 2,421
Switching 222 15 237
Auxiliary Units 181 - 181
-------- -------- ---------

Total 2,432 407 2,839
======== ======== =========

Freight Cars
Open Top Hoppers 14,001 9,641 23,642
Gondolas 14,121 12,461 26,582
Covered Hoppers 10,902 7,258 18,160
Box Cars 9,042 6,627 15,669
Flat Cars 670 13,132 13,802
Other 1,326 1,027 2,353
-------- -------- ---------

Total 50,062 50,146 100,208
======== ======== =========

Item 3. Legal Proceedings.

New Orleans Tank Car Fire
- -------------------------

In September 1997, a state court jury in New Orleans, Louisiana returned
a $2.5 billion punitive damages award against CSXT. The award was made in a
class action lawsuit against a group of nine companies based on personal
injuries alleged to have arisen from a 1987 fire. The fire was caused by a
leaking chemical tank car parked on CSXT tracks and resulted in the 36-hour
evacuation of a New Orleans neighborhood. In the same case, the court awarded a
group of 20 plaintiffs compensatory damages of approximately $2 million against
the defendants, including CSXT, to which the jury assigned 15 percent of the
responsibility for the incident. CSXT's liability under that compensatory
damages award is not material and adequate provision was made for the award in a
prior year.

In October 1997, the Louisiana Supreme Court set aside the punitive
damages judgment, ruling the judgment should not have been entered until all
liability issues were resolved. In February 1999, the Louisiana Supreme Court
issued a further decision, authorizing and instructing the trial court to enter
individual punitive damages judgments in favor of the 20 plaintiffs who had
received awards of compensatory damages, in amounts representing an appropriate
share of the jury's awards. While the trial court has not yet taken action under
this decision, the amounts of such punitive damages judgments, if any, are not
expected to be material. CSXT believes that this February 1999 decision will
expedite the process of full appellate review of the 1997 trial. The claims of
20 additional plaintiffs for compensatory damages are scheduled to be tried
beginning in March 1999.

CSXT is pursuing an aggressive legal strategy. Management believes that
any adverse outcome will not be material to its overall results of operations or
financial position, although it could be material to results of operations in a
particular quarterly accounting period.

-5-
<PAGE>

Environmental
- -------------

CSXT has been identified, together with other parties, as a
potentially responsible party in a number of governmental investigations and
actions relating to environmentally impaired sites. Such sites frequently
involve other waste generators and disposal companies that may pay some or all
of such costs associated with site investigation and clean-up or from whom such
costs may be recovered.

The wide range of costs of the possible remediation alternatives,
changing clean-up technology, the length of time over which these matters
develop and evolving governmental standards make it impossible to estimate
precisely the company's potential liability for the costs associated with the
assessment and remediation of contaminated sites.

CSXT has identified and maintains reserves for 248 environmental
sites at which the company is or may be liable for remediation costs. CSXT
reviews its environmental reserves at least quarterly to determine whether
additional provisions are necessary. Based on current information, CSXT believes
its reserves are adequate to meet remedial actions and to comply with present
laws and regulations. The recorded liabilities for estimated future
environmental costs at Dec. 25, 1998 and Dec. 26, 1997 were $75 million and $99
million, respectively. The majority of the Dec. 25, 1998, environmental
liability is expected to be paid out over the next five to seven years, funded
by cash generated from operations. Although CSXT's financial results could be
significantly affected in any quarterly accounting period in which CSXT incurred
substantial remedial expenses at a number of these and other sites, CSXT
believes the ultimate liability for these matters will not materially affect its
overall results of operations and financial condition.

Other Legal Proceedings
- -----------------------

A number of other legal actions, other than the matters described above,
are pending against CSXT in which claims are made in substantial amounts. While
the ultimate results of such actions cannot be predicted with certainty,
management does not currently expect that resolution of these matters will have
a material adverse effect on the consolidated results of operations, financial
position or cash flows of the company.

Item 4. Submission of Matters to a Vote of Security Holders.

Information omitted in accordance with General Instruction I(2)(c).

PART II

Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.

There is no market for CSXT's common stock as CSXT is a wholly-owned
subsidiary of CSX. During the years 1998, 1997 and 1996, CSXT paid
dividends on its common stock aggregating $138 million, $138 million
and $886 million, respectively.

Item 6. Selected Financial Data.

Information omitted in accordance with General Instruction I(2)(a)

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.

Information omitted in accordance with General Instruction I(2)(a).

-6-
<PAGE>

However, in compliance with said Instruction, see "Management's
Narrative Analysis and Results of Operations" on pages 28 - 32.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

The company does not have any market risks requiring disclosure under
this item.

Item 8. Financial Statements and Supplementary Data.

The consolidated financial statements of CSXT and notes thereto
required in response to this item are included herein (refer to Index
to Consolidated Financial Statements on page 9).

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.

None.

PART III

Item 10. Directors, Executive Officers, Promoters and Control Persons of the
Registrant.

Information omitted in accordance with General Instruction I(2)(c).

Item 11. Executive Compensation.

Information omitted in accordance with General Instruction I(2)(c).

Item 12. Security Ownership of Certain Beneficial Owners and Management.

Information omitted in accordance with General Instruction I(2)(c).

Item 13. Certain Relationships and Related Transactions.

Information omitted in accordance with General Instruction I(2)(c).

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a) 1. Financial Statements.

See Index to Consolidated Financial Statements on page 9.

2. Financial Statement Schedules.

The information required by Schedule II is included
in Note 8 to the consolidated financial statements. All
other financial statement schedules are not applicable.

3. Exhibits.

(3.1) Articles of Incorporation, as amended (incorporated
by reference to

-7-
<PAGE>

Exhibit 3.1 to Form 10-K dated March 8, 1996).

(3.2) By-laws of the Registrant, as amended to
October 21, 1998.

(27) Financial Data Schedule

(b) Reports on Form 8-K.

None.
Signatures
----------

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 5th day of
March, 1999.

CSX TRANSPORTATION, INC.

/s/ JAMES L. ROSS
-----------------
James L. Ross
(Principal Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Signatures Title
---------- -----

/s/ John W. Snow Chairman of the Board and Director
- ----------------
John W. Snow*

/s/ Alvin R. Carpenter President and Chief Executive Officer
- ----------------------
Alvin R. Carpenter* (Principal Executive Officer) and
Director

/s/ Mark G. Aron Director
- ----------------
Mark G. Aron*

/s/ Ronald J. Conway Executive Vice President-Operations and
- --------------------
Ronald J. Conway Director

/s/ Paul R. Goodwin Director
- -------------------
Paul R. Goodwin*

/s/ Michael J. Ward Executive Vice President-Coal and
- -------------------
Michael J. Ward* Merger Planning and Director

/s/ Patricia J. Aftoora
- -----------------------
*Patricia J. Aftoora
(Attorney-in-Fact)

March 5, 1999

-8-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements

Page
----

Report of Independent Auditors 10

CSX Transportation, Inc. and Subsidiaries:

Consolidated Financial Statements and Notes to Consolidated
Financial Statements Submitted Herewith:

Consolidated Statement of Earnings -
Fiscal Years Ended December 25, 1998
December 26, 1997 and December 27, 1996 11

Consolidated Statement of Cash Flows -
Fiscal Years Ended December 25, 1998,
December 26, 1997 and December 27, 1996 12

Consolidated Statement of Financial Position -
December 25, 1998 and December 26, 1997 13

Consolidated Statement of Retained Earnings
Fiscal Years Ended December 25, 1998,
December 26, 1997 and December 27, 1996 14

Notes to Consolidated Financial Statements 15

-9-
<PAGE>

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
-------------------------------------------------

To the Shareholder and Board of Directors
of CSX Transportation, Inc.

We have audited the accompanying consolidated statements of financial
position of CSX Transportation, Inc. and subsidiaries as of December 25, 1998
and December 26, 1997, and the related consolidated statements of earnings, cash
flows, and retained earnings for each of the three fiscal years in the period
ended December 25, 1998. These financial statements are the responsibility of
the company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits 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 (appearing on pages 11-27) present fairly, in all material respects, the
consolidated financial position of CSX Transportation, Inc. and subsidiaries at
December 25, 1998 and December 26, 1997, and the consolidated results of their
operations and their cash flows for each of the three fiscal years in the period
ended December 25, 1998, in conformity with generally accepted accounting
principles.

/s/ ERNST & YOUNG LLP

Jacksonville, Florida
February 26, 1999

-10-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
(Millions of Dollars)

Fiscal Years Ended
---------------------------------------------------
Dec. 25, Dec. 26, Dec. 27,
1998 1997 1996
---------------- ---------------- ----------------
<S> <C> <C> <C>
OPERATING REVENUE
Merchandise $ 3,291 $ 3,299 $ 3,181
Coal 1,498 1,560 1,584
Other 167 130 144
----------- ----------- -----------

Total 4,956 4,989 4,909
----------- ----------- -----------

OPERATING EXPENSE
Labor and Fringe Benefits 1,949 1,921 1,890
Materials, Supplies and Other 818 668 728
Related Party Service Fees 330 287 278
Equipment Rent 381 347 366
Depreciation 448 427 413
Fuel 251 299 308
Restructuring Credit (30) -- --
----------- ----------- -----------

Total 4,147 3,949 3,983
----------- ----------- -----------

OPERATING INCOME 809 1,040 926

Other Income (Expense) (134) 11 46

Interest Expense 77 74 70
----------- ----------- -----------

EARNINGS BEFORE INCOME TAXES 598 977 902

Income Tax Expense 220 352 325
----------- ----------- -----------

NET EARNINGS $ 378 $ 625 $ 577
=========== =========== ===========

</TABLE>

See accompanying Notes to Consolidated Financial Statements.

-11-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Millions of Dollars)
<TABLE>
<CAPTION>

Fiscal Years Ended
------------------------------------------
Dec. 25, Dec. 26, Dec. 27,
1998 1997 1996
------------- ----------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Earnings $ 378 $ 625 $ 577
Adjustments to Reconcile Net Earnings
to Net Cash Provided
Depreciation 448 427 413
Deferred Income Taxes 185 155 198
Restructuring Credit (30) - -
Productivity/Restructuring Charge Payments (25) (49) (77)
Other Operating Activities 7 (7) (12)
Changes in Operating Assets and Liabilities
Accounts and Notes Receivable (9) (76) (37)
Sale of Accounts Receivable - Net (23) 20 41
Other Current Assets (103) (8) (22)
Accounts Payable 106 22 (40)
Other Current Liabilities 37 9 1
---------- ---------- ---------

Net Cash Provided by Operating Activities 971 1,118 1,042
---------- ---------- ---------

INVESTING ACTIVITIES
Property Additions (1,212) (712) (764)
Proceeds from Property Dispositions 5 28 56
Affiliated Company Activity - 1 40
Other Investing Activities (15) (35) 10
---------- ---------- ---------

Net Cash Used by Investing Activities (1,222) (718) (658)
---------- ---------- ---------

FINANCING ACTIVITIES
Long-Term Debt Issued 166 82 118
Long-Term Debt Repaid (72) (75) (80)
Cash Dividends Paid (138) (138) (886)
Parent Company Advances Repaid - - (19)
Affiliated Company Activity - - 56
Other Financing Activities (2) (2) 1
---------- ---------- ---------

Net Cash Used by Financing Activities (46) (133) (810)
---------- ---------- ---------

Net Increase (Decrease) in Cash and Cash Equivalents (297) 267 (426)

CASH AND CASH EQUIVALENTS
Cash and Cash Equivalents at Beginning of Period 474 207 633
---------- ---------- ---------

Cash and Cash Equivalents at End of Period $ 177 $ 474 $ 207
========== ========== =========

SUPPLEMENTAL CASH FLOW INFORMATION
Interest Paid - Net of Amounts Capitalized $ 77 $ 70 $ 63
========== ========== =========
Income Taxes Paid $ 67 $ 232 $ 135
========== ========== =========
</TABLE>

See accompanying Notes to Consolidated Financial Statements.

-12-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Millions of Dollars)
<TABLE>
<CAPTION>

Dec. 25, Dec. 26,
1998 1997
-------------- --------------
<S> <C> <C>

ASSETS
Current Assets
Cash (principally investment in CSX Cash
Management Plan - see Note 5) $ 177 $ 474
Accounts and Notes Receivable 170 138
Materials and Supplies 171 131
Deferred Income Taxes 111 116
Other Current Assets 102 39
----------- -----------

Total Current Assets 731 898
----------- -----------

Properties 15,215 14,261
Accumulated Depreciation (4,559) (4,245)
----------- -----------

Properties-Net 10,656 10,016
----------- -----------

Affiliates and Other Companies 223 207
Other Long-Term Assets 287 282
----------- -----------

Total Assets $ 11,897 $ 11,403
=========== ===========

LIABILITIES
Current Liabilities
Accounts Payable $ 751 $ 595
Labor and Fringe Benefits Payable 278 334
Casualty, Environmental and Other Reserves 174 182
Current Maturities of Long-Term Debt 100 164
Due to Parent Company 25 22
Due to Affiliate 90 90
Other Current Liabilities 50 21
----------- -----------

Total Current Liabilities 1,468 1,408

Casualty, Environmental and Other Reserves 521 582
Long-Term Debt 906 839
Deferred Income Taxes 2,776 2,582
Other Long-Term Liabilities 661 693
----------- -----------

Total Liabilities 6,332 6,104
----------- -----------

SHAREHOLDER'S EQUITY
Common Stock, $20 Par Value:
Authorized 10,000,000 Shares;
Issued and Outstanding 9,061,038 Shares 181 181
Other Capital 1,294 1,263
Retained Earnings 4,090 3,855
----------- -----------

Total Shareholder's Equity 5,565 5,299
----------- -----------

Total Liabilities and Shareholder's Equity $ 11,897 $ 11,403
=========== ===========
</TABLE>

See accompanying Notes to Consolidated Financial Statements.

-13-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
(Millions of Dollars)

Dec. 25, Dec. 26, Dec. 27,
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Beginning Balance $ 3,855 $ 3,368 $ 3,674

Net Earnings 378 625 577

Dividends - Common (138) (138) (886)

Other (5) - 3
------------ ------------ --------------

Ending Balance $ 4,090 $ 3,855 $ 3,368
============ ============ ==============

</TABLE>

See accompanying Notes to Consolidated Financial Statements.

-14-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All Tables in Millions of Dollars)

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES.

Nature of Operations

CSX Transportation, Inc. (CSXT) is a rail freight transportation
company operating a system composed of 18,181 route miles of track in 20 states
in the eastern, midwestern, and southern portions of the United States and in
Ontario, Canada. Coal, bulk products, and manufactured products each contribute
approximately one-third of the company's transportation revenue. Coal shipments
primarily supply domestic utility and export markets. Shipments of bulk products
for domestic and export markets include chemicals, minerals, agricultural
products, and phosphates and fertilizer. Shipments of manufactured products for
domestic and export markets include automobiles, forest products, metals, and
food and consumer products.

CSXT is a wholly-owned subsidiary of CSX Corporation (CSX).

Principles of Consolidation

The Consolidated Financial Statements include CSXT and its
majority-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated. Investments in companies that are not
majority-owned are carried at either cost or equity, depending on the extent of
control.

Fiscal Year

The company's fiscal reporting period ends on the last Friday in
December. The financial statements presented are for the fiscal periods ended
Dec. 25, 1998, Dec. 26, 1997 and Dec. 27, 1996. Each fiscal year consists of
four 13-week quarters.

Cash and Cash Equivalents

Cash and cash equivalents primarily represent amounts due from CSX
for CSXT's participation in the CSX cash management plan.

Materials and Supplies

Materials and supplies consist primarily of fuel and items for
maintenance of property and equipment, and are carried at average cost.

Properties

All properties are stated at cost, less an allowance for accumulated
depreciation. Main-line track is depreciated on a group basis using a
unit-of-production method. All other property and equipment is depreciated on a
straight-line basis over estimated useful lives of three to 50 years.

Regulations enforced by the Surface Transportation Board (STB) of
the U.S. Department of Transportation require periodic formal studies of
ultimate service lives for all railroad assets. Resulting service life estimates
are subject to review and approval by the STB. For retirements or disposals of
depreciable rail assets that occur in the ordinary course of business, the asset
cost (net of
-15-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES, Continued.

Properties, Continued.

salvage value or sales proceeds) is charged to accumulated depreciation and no
gain or loss is recognized. For retirements or disposals of depreciable
non-operating property, and for all dispositions of land, gains or losses are
recognized at the time of disposal. Expenditures that significantly increase
asset values or extend useful lives are capitalized. Repair and maintenance
expenditures are charged to operating expense when the work is performed.

Properties and other long-lived assets are reviewed for impairment
whenever events or business conditions indicate the carrying amount of such
assets may not be fully recoverable. Initial assessments of recoverability are
based on estimates of undiscounted future net cash flows associated with an
asset or group of assets. Where impairment is indicated, the assets are
evaluated for sale or other disposition, and their carrying amount is reduced to
fair value based on discounted net cash flows or other estimates of fair value.

The company acquired $255 million in property in 1996 which did not
require an immediate outlay of cash. These property additions included the
acquisition of $164 million in railcars and locomotives, formerly leased from a
CSX-affiliated company. The property additions also included the early delivery
of 55 alternating current locomotives under an arrangement in which payment of
the $91 million aggregate purchase price was deferred to the subsequent periods
in which the locomotives would have originally been delivered. Under generally
accepted accounting principles, these noncash transactions are not reflected in
the 1996 Consolidated Statement of Cash Flows.

Revenue Recognition

Transportation revenue is recognized proportionately as shipments
move from origin to destination.

Environmental Costs

Environmental costs that relate to current operations are expensed or
capitalized as appropriate. Expenditures that relate to remediating an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded when CSXT's
responsibility for environmental remedial efforts is deemed probable, and the
costs can be reasonably estimated. Generally, the timing of these accruals
coincides with the completion of a feasibility study or CSXT's commitment to a
formal plan of action.

Common Stock and Other Capital

There have been no changes in common stock during the last three
years. During 1998 and 1996, CSX contributed to the company $24 million and $70
million, respectively, in net pension assets.

-16-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES, Continued.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires that management make estimates in
reporting the amounts of certain revenues and expenses for each fiscal year and
certain assets and liabilities at the end of each fiscal year. Actual results
may differ from those estimates.

Prior-Year Data

Certain prior-year data have been reclassified to conform to the 1998
presentation.

Accounting Pronouncements

The FASB has issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" that requires companies to record
derivatives on the statement of financial position, measured at fair value. The
statement also sets forth new accounting rules for gains or losses resulting
from changes in the values of derivatives. While the company does not currently
use derivative financial instruments, and its historical use of such instruments
has not been material, the company plans to adopt this statement in the first
quarter of 2000 to the extent it may apply at that time. The company would not
expect the adoption of Statement No. 133 to have a material impact on its
financial statements.

NOTE 2. SUPPLEMENTAL STATEMENT OF EARNINGS FINANCIAL DATA.

Operating expense includes the following:
<TABLE>
<CAPTION>

1998 1997 1996
---- ---- ----
<S> <C> <C> <C>

Selling, General and Administrative Expense $832 $778 $776
==== ==== ====
</TABLE>

NOTE 3. OTHER INCOME (EXPENSE).

1998 1997 1996
--------- --------- ---------

Interest Income - CSX Cash Management Plan $ 22 $ 26 $ 33
Interest Income - Other 3 4 9
Income from Real Estate Operations(a) 33 57 51
Net Losses from Accounts Receivable Sold (58) (57) (55)
Conrail Transition Expenses (143) (25) -
Miscellaneous 9 6 8
--------- --------- ---------

Total $ (134) $ 11 $ 46
========= ========= =========

(a) Gross revenue from real estate operations was $67 million, $87 million
and $76 million in 1998, 1997 and 1996, respectively.

-17-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 4. INCOME TAXES.

Income tax expense information is as follows:

1998 1997 1996
--------- --------- ---------

Current
Federal $ 41 $ 173 $ 106
State and Foreign (6) 24 21
--------- --------- ---------
Total 35 197 127
--------- --------- ---------

Deferred
Federal 153 134 202
State 32 21 (4)
--------- --------- ---------
Total 185 155 198
--------- --------- ---------

Total Expense $ 220 $ 352 $ 325
========= ========= =========

Income tax expense reconciled to the tax computed at statutory rates
is as follows:

1998 1997 1996
------------- ------------- -------------

Tax at Statutory Rates $ 209 35% $ 342 35% $ 316 35%
State Income Taxes 17 3% 29 3 10 1
Other (6) (1) (19) (2) (1) -
======= ===== ======= ===== ======= ====
Total Expense $ 220 37% $ 352 36% $ 325 36%
======= ===== ======= ===== ======= ====

The significant components of deferred tax assets and liabilities include:

Dec. 25, Dec. 26,
1998 1997
-------- --------

Deferred Tax Assets
Productivity/Restructuring Charges $ 120 $ 143
Employee Benefit Plans 175 165
Other 259 290
-------- --------
Total 554 598
-------- --------

Deferred Tax Liabilities
Accelerated Depreciation 2,933 2,789
Other 286 275
-------- --------
Total 3,219 3,064
-------- --------

Net Deferred Tax Liabilities $ 2,665 $ 2,466
======== ========

-18-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 4. INCOME TAXES, Continued

In addition to the annual provision for deferred income tax expense,
the change in the year-end net deferred income tax liability balances include
$14 million related to the contribution of net pension assets from CSX.

CSXT and its subsidiaries are included in the consolidated federal
income tax return filed by CSX. The consolidated federal income tax expense or
benefit is allocated to CSXT and its subsidiaries as though CSXT had filed a
separate consolidated return. At Dec. 25, 1998 and Dec. 26, 1997, approximately
$140 million and $150 million, respectively, of income taxes due from CSX were
included in Other Current Liabilities.

Examinations of the federal income tax returns of CSX and its
principal subsidiaries have been completed through 1990. Returns for 1991
through 1996 are currently under examination. Management believes adequate
provision has been made for any adjustments that might be assessed.

NOTE 5. RELATED PARTIES.

Cash and cash equivalents at Dec. 25, 1998 and Dec. 26, 1997,
includes $229 million and $496 million, respectively, representing amounts due
from CSX for CSXT's participation in the CSX cash management plan. Under this
plan, excess cash is advanced to CSX for investment and CSX makes cash funds
available to its subsidiaries as needed for use in their operations. CSX is
committed to repay all amounts due on demand should circumstances require. The
companies are charged for borrowings or compensated for investments based on
returns earned by the plan portfolio.

Related Party Service Fees expense consists of amounts related to a
management service fee charged by CSX, data processing related charges from CSX
Technology, Inc. (CSX Technology); the reimbursement, under an operating
agreement, from CSX Intermodal, Inc. (CSXI), for costs incurred by CSXT related
to intermodal operations; charges from Total Distribution Services, Inc. (TDSI),
for services provided at automobile ramps; and charges from Bulk Intermodal
Distribution Services, Inc. (BIDS) for services provided at bulk commodity
facilities. The management service fee charged by CSX represents compensation
for certain corporate services provided to CSXT. These services include, but are
not limited to, development of corporate policy and long-range strategic plans,
allocation of capital, placement of debt, maintenance of employee benefit plans,
internal audit and tax administration. The fee is calculated as a percentage of
CSX's investment in CSXT which is identical to the method used to determine the
management fee charged to all other major subsidiaries of CSX. Management
believes this to be a reasonable method. The data processing related charges are
compensation to CSX Technology for the development, implementation and
maintenance of computer systems, software and associated documentation for the
day-to-day operations of CSXT. CSX Technology, CSXI, TDSI, and BIDS are
wholly-owned subsidiaries of CSX.

CSXT entered into operating lease agreements with CSXI in October
1991 and December 1992 under which it agreed to lease 3,400 rebuilt coal gondola
cars through March 2006 and 65 locomotives through May 2008, respectively.
Effective March 1, 1996, the operating leases were terminated and CSXT purchased
the cars and locomotives from CSXI for $164 million, an amount approximating
CSXI's net book value. In conjunction with this transaction, CSXT assumed $145

-19-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 5. RELATED PARTIES, Continued.

million in long-term debt secured by the equipment and $19 million of advances
payable from CSXI to CSX. CSXT repaid the $19 million advances due to CSX in
December 1996.

In March 1996, CSXT entered into a loan agreement with CSX Insurance
Company (CSX Insurance), a wholly-owned subsidiary of CSX, whereby CSXT may
borrow up to $100 million from CSX Insurance. The loan is payable in full on
demand. At Dec. 25, 1998, $90 million was outstanding under the agreement.
Interest on the loan is payable monthly at .25% over the LIBOR rate, and was
5.87% at Dec. 25, 1998. Interest expense related to the loan was $5 million
for each of the fiscal years ended Dec. 25, 1998 and Dec. 26, 1997.

During 1988, CSXT participated with Sea-Land Service, Inc.
(Sea-Land), a wholly-owned subsidiary of CSX, in four sale-leaseback
arrangements. Under these arrangements, Sea-Land sold equipment to a third party
and CSXT leased the equipment and assigned the lease to Sea-Land. Sea-Land is
obligated for all lease payments and other associated equipment expenses. If
Sea-Land defaults on its obligations under the arrangements, CSXT would assume
the asset lease rights and obligations of $99 million at Dec. 25, 1998.

NOTE 6. ACCOUNTS RECEIVABLE.

CSXT has an ongoing agreement to sell without recourse, on a
revolving basis each month, an undivided percentage ownership interest in all
rail freight accounts receivable to CSX Trade Receivables Corporation, a
wholly-owned subsidiary of CSX. Accounts receivable sold under this agreement
totaled $642 million at Dec. 25, 1998 and $664 million at Dec. 26, 1997. In
addition, CSXT has a revolving agreement with a financial institution to sell
with recourse on a monthly basis an undivided percentage ownership interest in
all miscellaneous accounts receivable. Accounts receivable sold under this
agreement totaled $47 million at Dec. 25, 1998 and Dec. 26, 1997. The sales of
receivables have been reflected as reductions of "Accounts Receivable" in the
Consolidated Statement of Financial Position. The net losses associated with
sales of receivables were $58 million and $57 million for the fiscal years ended
Dec. 25, 1998 and Dec. 26, 1997, respectively.

-20-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 7. PROPERTIES.

Dec. 25, 1998
--------------------------------------

Accumulated
Cost Depreciation Net
---------- -------------- ----------

Road $ 10,202 $ 2,745 $ 7,457
Equipment 4,762 1,806 2,956
Other 251 8 243
----------- ---------- ----------

Total $ 15,215 $ 4,559 $ 10,656
=========== ========== ==========

Dec. 26, 1997
--------------------------------------

Accumulated
Cost Depreciation Net
---------- -------------- ----------

Road $ 9,603 $ 2,658 $ 6,945
Equipment 4,400 1,580 2,820
Other 258 7 251
----------- ---------- ---------

Total $ 14,261 $ 4,245 $10,016
=========== ========== =========

NOTE 8. CASUALTY, ENVIRONMENTAL AND OTHER RESERVES.

Activity relating to casualty, environmental and other reserves is as
follows:

Casualty Environmental Separation
Reserves(a)(b) Reserves (a) Liabilities Total
(a)(c)
------------ ---------------- -------------- ---------
<S> <C> <C> <C> <C>
Balance Dec. 29, 1995 $ 364 $ 137 $ 376 $ 877
Charged to Expense and Other Additions 116 16 - 132
Payments and Other Reductions (151) (36) (26) (213)
--------- -------- --------- ---------
Balance Dec. 27, 1996 329 117 350 796

Charged to Expense and Other Additions 141 12 - 153
Payments and Other Reductions (135) (30) (20) (185)
--------- -------- --------- ---------
Balance Dec. 26, 1997 335 99 330 764

Charged to Expense and Other Additions 161 3 - 164
Restructuring Credit - - (30) (30)
Payments and Other Reductions (161) (27) (15) (203)
========= ======== ========= =========
Balance Dec. 25, 1998 $ 335 $ 75 $ 285 $ 695
========= ======== ========= =========
</TABLE>

-21-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 8. CASUALTY, ENVIRONMENTAL AND OTHER RESERVES, Continued.

(a) Balances include current portion of casualty and environmental reserves and
separation liabilities, respectively, of $139 million, $20 million and $15
million at Dec. 25, 1998, $137 million, $20 million and $25 million at Dec.
26, 1997 and $135 million, $20 million and $44 million at Dec. 27, 1996.

(b) Casualty reserves are estimated based upon the first reporting of an
accident or personal injury to an employee. Liabilities for accidents are
based upon field reports and liabilities for personal injuries are based
upon the type and severity of the injury and the use of current trends and
historical data.

(c) Separation liabilities include $285 million at Dec. 25, 1998, $300 million
at Dec. 26, 1997 and $318 million at Dec. 27, 1996 related to productivity
charges recorded in 1991 and 1992 to provide for the estimated costs of
implementing workforce reductions, improvements in productivity and other
cost reductions. The remaining liabilities are expected to be paid out over
the next 20 to 25 years.

During 1998, CSXT recorded a restructuring credit of $30 million,
reflecting the reversal of certain separation and labor protection reserves
established as part of a 1995 restructuring charge. These reserves were
associated with planned work-force reductions that are no longer anticipated as
a result of a new telecommunications contract entered into in July 1998.

NOTE 9. LONG-TERM DEBT.

Average
Interest Rates Dec. 25, Dec. 26,
Type and Maturity Date at 1998 1997
Dec. 25, 1998
- ---------------------------- ------------------- ------------ ------------

Equipment Obligations
(1999-2014) 7% $ 770 $ 761
Mortgage Bonds
(1999-2003) 3% 72 75
Capital Leases and Other
Obligations 6% 164 167
(1999-2021)
--------- ---------

Total 1,006 1,003

Less Debt Due Within One 100 164
Year
--------- ---------

Total Long-Term Debt $ 906 $ 839
========= =========

CSXT has long-term debt maturities for 1999 through 2003 aggregating
$100 million, $77 million, $71 million, $105 million and $145 million,
respectively.

A portion of the properties and certain other assets of CSXT and its
subsidiaries are pledged as security for various long-term debt issues.

-22-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS.

Fair values of the company's financial instruments are estimated by
reference to quoted prices from market sources and financial institutions, as
well as other valuation techniques. Long-term debt is the only financial
instrument of the company with a fair value significantly different from its
carrying amount. At Dec. 25, 1998, the fair value of long-term debt, including
current maturities, was $1.058 billion, compared with a carrying amount of
$1.006 billion. At Dec. 26, 1997, the fair value of long-term debt, including
current maturities, was $1.042 billion, compared with a carrying amount of
$1.003 billion. The fair value of long-term debt has been estimated using
discounted cash flow analyses based upon the company's current incremental
borrowing rates for similar types of financing arrangements.

NOTE 11. EMPLOYEE BENEFIT PLANS.

Pension Plans

CSX and its subsidiaries, including CSXT, sponsor defined benefit
pension plans principally for salaried employees. The plans provide eligible
employees with retirement benefits based principally on years of service and
compensation rates near retirement. During 1989, CSXT's pension plan for
salaried employees was merged with the CSX Pension Plan, and all assets of
CSXT's plan were transferred to the merged plan. Since the plans were merged,
CSX has allocated to CSXT a portion of the net pension expense for the CSX
Pension Plan based on CSXT's relative level of participation in the merged plan,
which considers the assets and personnel previously in the CSXT plan. The
allocated expense from the CSX Pension Plan amounted to $30 million in 1998, $38
million in 1997 and $32 million in 1996. During 1998 and 1996, CSXT received $38
million ($24 million after tax) and $113 million ($70 million after tax),
respectively, in pension assets from CSX through capital contributions.

Savings Plans

CSXT maintains savings plans for virtually all full-time salaried
employees and certain employees covered by collective bargaining agreements of
CSXT and subsidiary companies. Expense for these plans was $15 million for 1998,
$18 million for 1997 and $15 million for 1996.

Other Postretirement Benefit Plans

In addition to the CSX defined benefit pension plans, CSXT
participates with CSX and other affiliates in two defined benefit postretirement
plans that provide medical and life insurance benefits to most full-time
salaried employees upon their retirement. The postretirement medical plan is
contributory, with retiree contributions adjusted annually. The life insurance
plan is non-contributory. CSX allocates to CSXT a portion of the expense for
these plans based on CSXT's relative level of participation. The allocated
expense amounted to $19 million in 1998, $22 million in 1997, and $22 million in
1996.

Other Plans

Under collective bargaining agreements, the company participates in a
number of union-sponsored, multi-employer benefit plans. Payments to these plans
are made as part of aggregate

-23-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 11. EMPLOYEE BENEFIT PLANS, Continued.

Other Plans, Continued

assessments generally based on number of employees covered, hours worked,
tonnage moved or a combination thereof. Total contributions of $154 million,
$152 million and $142 million, respectively, were made to these plans in 1998,
1997 and 1996.

Certain officers and key employees of CSXT participate in stock
purchase, performance and award plans of CSX. CSXT is allocated its share of any
cost to participate in these plans.

NOTE 12. SUMMARY OF COMMITMENTS AND CONTINGENCIES.

Lease Commitments

CSXT leases equipment under agreements with terms up to 21 years.
Non-cancelable, long-term leases generally include provisions for maintenance,
and options to purchase at fair value and to extend the terms. At Dec. 25, 1998,
minimum equipment rentals under non-cancelable operating leases totaled
approximately $176 million for 1999, $141 million for 2000, $131 million for
2001, $125 million for 2002, $133 million for 2003 and $781 million thereafter.

Rent expense on equipment operating leases, including net daily
rental charges on railroad operating equipment of $222 million, $201 million and
$205 million in 1998, 1997 and 1996, respectively, amounted to $381 million in
1998, $347 million in 1997 and $366 million in 1996.

Purchase Commitments

CSXT entered into various agreements from 1993 to 1998 to purchase
590 locomotives. These large orders cover normal locomotive replacement needs
for 1994 through 1999 and introduced alternating current traction technology to
the locomotive fleet. CSXT has taken delivery of 50 direct current and 392
alternating current locomotives through Dec. 25, 1998. The remaining 148
alternating current units are scheduled to be delivered in 1999.

Long-Term Operating Agreements

CSXT has various long-term railroad operating agreements that allow
for exclusive operating rights over various railroad lines. Under these
agreements, CSXT is obligated to pay usage fees of approximately $9 million
annually. The terms of these agreements range from 30 to 40 years.

Commitments Related to Conrail Transaction

In April 1997, CSXT entered into certain agreements pertaining to the
joint acquisition of Conrail, Inc. (Conrail) by CSX and Norfolk Southern
Corporation (Norfolk Southern). Under these agreements and other agreements to
be completed or executed among the parties, appropriate portions of the Conrail
rail system are expected to be integrated with the CSXT system. Once the
integration of the CSXT and Conrail lines occurs, currently planned for June 1,
1999, CSXT will have material multi-year commitments under various leasing and
operating agreements with certain Conrail entities. The amounts of these
commitments have not yet been finalized.

-24-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 12. SUMMARY OF COMMITMENTS AND CONTINGENCIES, Continued.

Contingent Liabilities

Guarantees
- ----------

CSXT and its subsidiaries are contingently liable individually and
jointly with others as guarantors of long-term debt and obligations principally
relating to leased equipment, joint ventures and joint facilities. These
contingent obligations were immaterial to the company's results of operations
and financial position at Dec. 25, 1998.

Environmental
- -------------

CSXT is a party to various proceedings involving private parties and
regulatory agencies related to environmental issues. CSXT has been identified as
a potentially responsible party (PRP) at 113 environmentally impaired sites that
are or may be subject to remedial action under the Federal Superfund statute
(Superfund) or similar state statutes. A number of these proceedings are based
on allegations that CSXT, or its railroad predecessors, sent hazardous
substances to the facilities in question for disposal. Such proceedings arising
under Superfund or similar state statutes can involve numerous other waste
generators and disposal companies and seek to allocate or recover costs
associated with site investigation and clean-up, which could be substantial.

CSXT is involved in a number of administrative and judicial
proceedings and other clean-up efforts at 248 sites, including the sites
addressed under the Federal Superfund statute or similar state statutes, where
it is participating in the study and/or clean-up of alleged environmental
contamination. The assessment of the required response and remedial costs
associated with most sites is extremely complex. Cost estimates are based on
information available for each site, financial viability of other PRPs, where
available, and existing technology, laws and regulations. CSXT's best estimates
of the allocation method and percentage of liability when other PRPs are
involved are based on assessments by consultants, agreements among PRPs, or
determinations by the U.S. Environmental Protection Agency or other regulatory
agencies.

At least once each quarter, CSXT reviews its role, if any, with
respect to each such location, giving consideration to the nature of CSXT's
alleged connection to the location (i.e., generator, owner or operator), the
extent of CSXT's alleged connection (i.e., volume of waste sent to the location
and other relevant factors), the accuracy and strength of evidence connecting
CSXT to the location, and the number, connection and financial position of other
named and unnamed PRPs at the location. The ultimate liability for remediation
can be difficult to determine with certainty because of the number and
creditworthiness of PRPs involved. Through the assessment process, CSXT monitors
the creditworthiness of such PRPs in determining ultimate liability.

Based upon such reviews and updates of the sites with which it is
involved, CSXT has recorded, and reviews at least quarterly for adequacy,
reserves to cover estimated contingent future environmental costs with respect
to such sites. The recorded liabilities for estimated future environmental costs
at Dec. 25, 1998 and Dec. 26, 1997 were $75 million and $99 million,
respectively. These recorded liabilities, which are undiscounted, include
amounts representing CSXT's estimate of unasserted claims, which CSXT believes
to be immaterial. The liability has been accrued for future costs for all sites
where the company's obligation is probable and where such costs can be
reasonably estimated. The liability includes future costs for remediation and
restoration of sites as well as any significant ongoing monitoring costs, but
excludes any anticipated insurance recoveries. The majority

-25-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 12. SUMMARY OF COMMITMENTS AND CONTINGENCIES, Continued.

Contingent Liabilities and Long-Term Operating Agreements, Continued.

Environmental, Continued
- ------------------------

of the Dec. 25, 1998, environmental liability is expected to be paid out over
the next five to seven years, funded by cash generated from operations.

The company does not currently possess sufficient information to
reasonably estimate the amounts of additional liabilities, if any, on some sites
until completion of future environmental studies. In addition, latent conditions
at any given location could result in exposure, the amount and materiality of
which cannot presently be reliably estimated. Based upon information currently
available, however, the company believes that its environmental reserves are
adequate to accomplish remedial actions to comply with present laws and
regulations, and that the ultimate liability for these matters will not
materially affect its overall results of operations and financial condition.

New Orleans Tank Car Fire
- -------------------------

In September 1997, a state court jury in New Orleans returned a $2.5
billion punitive damages award against CSXT. The award was made in a
class-action lawsuit against a group of nine companies based on personal
injuries alleged to have arisen from a 1987 fire. The fire was caused by a
leaking chemical tank car parked on CSXT tracks and resulted in the 36-hour
evacuation of a New Orleans neighborhood. In the same case, the court awarded a
group of 20 plaintiffs compensatory damages of approximately $2 million against
the defendants, including CSXT, to which the jury assigned 15% of the
responsibility for the incident. CSXT's liability under that compensatory
damages award is not material.

CSXT is pursuing an aggressive legal strategy. Management believes
that any adverse outcome will not be material to CSXT's overall results of
operations or financial position, although it could be material to results of
operations in a particular quarterly accounting period.

Other Legal Proceedings
- ------------------------

A number of other legal actions are pending against CSXT in which
claims are made in substantial amounts. While the ultimate results of lawsuits
and claims involving CSXT cannot be predicted with certainty, management does
not currently expect that these matters will have a material adverse effect on
the consolidated results of operations, financial position and cash flows of the
company.

-26-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(All Tables in Millions of Dollars)

NOTE 13. QUARTERLY DATA (Unaudited).

1998
---------------------------------------------
1st 2nd 3rd 4th
---------- ----------- ----------- ----------

Operating Revenue $ 1,251 $ 1,249 $ 1,201 $ 1,255
Operating Income 213 238 172 186
Net Earnings 107 124 67 80

1997
---------------------------------------------
1st 2nd 3rd 4th
---------- ----------- ----------- ----------

Operating Revenue $ 1,247 $ 1,253 $ 1,215 $ 1,274
Operating Income 235 293 235 277
Net Earnings 131 171 136 187

-27-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS

1998 OPERATING RESULTS

CSXT produced operating income of $809 million in 1998, down 22% from
1997. Operating revenue was down slightly from the prior year, to $4.96 billion.
While merchandise revenue saw modest gains on increased traffic, coal revenue
declined $62 million on 4% fewer carloads. The decline in coal revenue was
attributable to the strong U.S. dollar and competition from foreign coal
producers, which softened the demand for export coal.

Traffic By Commodity
<TABLE>
<CAPTION>

Carloads Revenue
(Thousands) (Millions of
Dollars)
-------------------- ---------------------
1998 1997 1998 1997
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
Automotive 412 387 $ 533 $ 543
Chemicals 444 435 731 747
Minerals 455 445 398 394
Food and Consumer 142 149 156 163
Agricultural Products 277 269 360 347
Metals 318 316 318 314
Forest Products 457 471 493 499
Phosphates and Fertilizer 539 506 302 292
Coal 1,651 1,714 1,498 1,560
--------- --------- --------- ----------

Total 4,695 4,692 4,789 4,859
========= =========

Other Revenue 167 130
--------- ----------

Total Operating Revenue $ 4,956 $ 4,989
========= ==========
</TABLE>

CSXT experienced growth in several merchandise commodity groups during
1998. Agricultural product moves were up 3% due to strong demand for Midwest
grain in the Southeast. Continued strength in the Southeast's construction
industry was primarily responsible for the 2% increase in Minerals carloads over
1997, while strong demand from U.S. steel mills in the early part of the year
drove an increase of 1% in Metals traffic over 1997. Phosphates and fertilizer
shipments were up 7% due to continued strong export demand and strong demand
from U.S. and Canadian agricultural firms. The railroad's automotive revenue was
down 2% from the prior year, due in part to the estimated loss of $13 million in
revenue caused by the work stoppages at two of General Motors' Flint, Mich.,
plants.

Operating expenses were up 5% from 1997 to $4.15 billion, reflecting the
impact of a shift in mix to lower margin cargo, increases in certain casualty
and litigation reserves, and Year 2000 preparations. Labor and fringe benefits
expense increased slightly due to wage increases and additional employee
training and certification, partially offset by lower stock compensation
expense. The higher casualty and litigation accruals and Year 2000 costs drove
materials, supplies and other expense up 17% over the prior year. Fuel expense
was $48 million lower than 1997, reflecting an 11 cent decrease in the average
price per gallon, while fuel consumption remained level with the prior year.

Included in 1998 operating expenses is a $30 million restructuring
credit recorded in the third quarter. This one-time credit reflected the
reversal of separation and labor protection

-28-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS
CONTINUED

1998 OPERATING RESULTS, Continued.

Traffic By Commodity, Continued.

reserves established as part of a 1995 restructuring charge to cover a planned
reduction in the unit's telecommunications work force. Under a new
telecommunications contract signed in July 1998, those work-force reductions are
no longer anticipated, and the related costs will not be incurred.

OTHER MATTERS

Conrail Transaction
- -------------------

In April 1997, CSXT entered into certain agreements pertaining to the
joint acquisition of Conrail by CSX and Norfolk Southern. Under these agreements
and other agreements to be completed or executed among the parties, appropriate
portions of the Conrail rail system are expected to be integrated with the CSXT
system.

CSX and Norfolk Southern filed an application for control of Conrail
with the STB in June 1997. On July 23, 1998, following an extensive review, the
STB issued a written decision approving the application with limited conditions.
The decision permitted CSX and Norfolk Southern to exercise joint control over
Conrail on August 22, 1998.

CSXT is actively planning for the smooth integration of Conrail
operations into its rail system. Plans involve all facets of combining the two
systems, including: safety; customer service; train scheduling, switching and
routing; equipment utilization and track programs; commuter and passenger rail
operations; marketing; technology; labor agreements; and administration. Related
capital improvements to certain routes and facilities on the CSXT rail system
also have been initiated and are substantially complete. The integration of rail
operations is expected to take place once operating and technology systems are
in place and necessary implementing agreements have been reached, which
currently is expected to occur June 1, 1999.

CSXT is incurring significant expenditures in connection with the
integration of Conrail operations. Transition expenses, principally costs
related to information technology integration, totaled $143 million for the
fiscal year ended December 25, 1998. Capital expenditures, principally a major
track construction project to accommodate increased traffic flows in a primary
service corridor after integration, totaled $261 million for the fiscal year
ended December 25, 1998.

Upon integration, CSXT will separately operate designated routes,
facilities, and equipment pursuant to various operating agreements with Conrail
and its subsidiaries. Certain other Conrail assets will be operated for the
benefit of CSXT and Norfolk Southern. Under the operating agreements, CSXT will
pay Conrail for the use of assets and for services Conrail provides.
Substantially all of Conrail's customer freight contracts will be assumed by
CSXT or other subsidiaries of CSX, or by Norfolk Southern. As CSX and Norfolk
Southern move to integrate the Conrail operations, as expected, they will
compete for traffic located in markets formerly served solely by Conrail. The
company expects that as a result of this process of entering new markets, there
may be changes in the historic rate and traffic patterns, including some rate
reductions and traffic volume shifts. The process will be driven by market
conditions, and the company presently cannot assess the impact of these
transition effects on either the timing or

-29-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS
CONTINUED

OTHER MATTERS, Continued.

Conrail Transaction, Continued.
- ------------------------------

realization of the projected benefits of the Conrail transaction. The majority
of Conrail's operations workforce will be employed by CSXT or other subsidiaries
of CSX, or by Norfolk Southern, although certain operations personnel, as well
as certain management and administrative employees, will remain at Conrail to
oversee its ongoing business activities.

Year 2000 Planning
- ------------------

State of Year 2000 Readiness

In 1996, CSX began a comprehensive initiative to address the potential
exposure associated with the functioning of its information technology systems
and non-information technology systems with respect to dates in the Year 2000
and beyond. The initiative fully encompasses all CSXT systems and operations.
The company is following a standard Year 2000 readiness model, consisting of the
following phases:

Awareness - General education about the Year 2000 problem.
Inventory - Cataloging of all systems and business relationships that
may be impacted by a Year 2000 date rollover.
Assessment - Estimating the degree of severity of the Year 2000 problem
for cataloged items.
Remediation - Repair, replacement, or retirement of non-Year 2000
compliant systems. Validation - Testing to confirm the compliance of
Year 2000 readiness systems.

CSX's readiness efforts are focused first and foremost on the continued
safe operation of its rail and other transportation systems, encompassing
employee safety and the safety of the general public and the environments in
which the company operates. Maintaining service continuity both to customers and
with vendors before, during, and after the millennium change also is a priority.
CSX also is focusing efforts on ensuring that, after the safety and service
continuity issues are addressed, a Year 2000 issue does not disrupt CSXT's
revenue.

Overall, the Year 2000 initiative with respect to CSXT is currently
proceeding on schedule and planned completion of all key areas is expected by
mid-1999. The company's Year 2000 readiness efforts are organized in five areas,
which have the following status:
<TABLE>
<CAPTION>

Effort Estimated Completion Current Phase
- ----------------------------------- ------------------------- ----------------------------
<S> <C> <C>
Core Information Systems Third Quarter 1999 Remediation and Validation
Distributed Information
Technology Third Quarter 1999 Assessment and Remediation
Electronic Commerce Second Quarter 1999 Remediation and Validation
Non-Information Technology
(embedded) Systems Third Quarter 1999 Inventory and Assessment
Trading Partners Fourth Quarter 1999 Inventory and Assessment
</TABLE>

As part of the Year 2000 initiative, CSX and CSXT are in communication
with significant suppliers, large customers and financial institutions to assess
their Year 2000 readiness and expect to

-30-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS, CONTINUED

OTHER MATTERS, Continued.

Year 2000 Planning, Continued.
- -----------------------------

State of Year 2000 Readiness, Continued.

conduct interface tests with external trading partners in 1999 upon completion
of internal testing of remediated applications.

CSXT is also participating in interface tests with other Class I
railroads to ensure that electronic data interchanges can be processed in a Year
2000 format. The industry effort has been coordinated by the Association of
American Railroads since 1997 and is scheduled for completion by the second
quarter of 1999.

Year 2000 Costs

CSXT has incurred total costs of $35 million to date related to Year
2000 compliance, which represents approximately 62% of the estimated
expenditures for the entire Year 2000 initiative. CSX estimates that over the
life of the project, Year 2000 costs will comprise approximately 10% of the
total information technology budget for CSXT. The cost of the Year 2000
initiative is being expensed as incurred and funded by cash generated from
operations. Projections of the remaining cost and completion date for the Year
2000 initiative are based on management's current estimates, which are derived
utilizing numerous assumptions of future events including the continued
availability of certain resources, and are inherently uncertain. No major
projects have been delayed as a result of Year 2000 readiness efforts, and CSX
is currently assessing its Year 2000 progress with respect to CSXT systems and
operations with the assistance of outside consultants.

In connection with the integration of Conrail, CSX and Norfolk Southern
are jointly addressing the Year 2000 compliance of Conrail's core information
technology applications and non-information technology embedded systems. Certain
of Conrail's operations systems are being made Year 2000 compliant as a
contingency in the event that there are delays in the integration or Conrail
continues to operate such systems after the integration is completed. Conrail's
estimated cost for its Year 2000 initiative is approximately $16 million.

There are a number of other major information technology projects currently
under development or deployment, some of which replaced legacy systems that may
or may not have been Year 2000 compliant. These projects were required to
increase CSX's operational capacity as a direct result of the integration of
Conrail. These projects are not included in the Year 2000 costs outlined above.

Risks

CSX believes its Year 2000 planning efforts are adequate to address all
major risks with CSXT's systems and operations. However, if some or all of the
company's remediated or replaced internal computer systems fail the testing
phase, or if any software applications or embedded systems critical to the
company's operations are overlooked in the assessment and remediation phases,
particularly if the result is a systemwide failure, there could be a material
adverse effect on the company's results of operations, liquidity and financial
condition.

-31-
<PAGE>

CSX TRANSPORTATION, INC. AND SUBSIDIARIES
MANAGEMENT'S NARRATIVE ANALYSIS AND RESULTS OF OPERATIONS, CONTINUED

OTHER MATTERS, Continued.

Year 2000 Planning, Continued.
- -----------------------------

Contingency Plans

Contingency planning is an established and ongoing effort within CSX and
CSXT to address many types of potential operating disruptions, including Year
2000 issues. For example, detailed emergency operating plans already exist for
unanticipated outages of electricity, telecommunications, and other essential
services. Detailed Year 2000 contingency plans are expected to be complete by
June 1999.

CSX is creating contingency plans to address the consequences to CSXT of
each of the primary failure scenarios outlined below. For each of the three
primary types of most reasonably likely worst-case scenarios, CSX anticipates
that detailed contingency measures will include the following:

Systemwide failures - In the event of complete or nearly complete loss
of key assets or services throughout the entire CSXT system, CSXT will
conduct and maintain a safe and orderly shutdown of all operations that
depend on those systems.
Geographically isolated failures - In the event of complete or nearly
complete loss of key assets or services throughout a region, CSXT will
conduct and maintain a safe and orderly shutdown of all affected
operations within that region.
Movable asset failures - In the event of a Year 2000 failure of a
transportation asset, such as a locomotive, CSXT will remove the asset
from service and scale its operations accordingly. This is essentially
the same process currently used for non-Year 2000 failures.

Forward Looking Statements
- --------------------------

Estimates and forecasts in Management's Discussion and Analysis are
based on many assumptions about complex economic and operating factors with
respect to industry performance, general business and economic conditions and
other matters that cannot be predicted accurately and that are subject to
contingencies over which the company has no control. Such forward-looking
statements are subject to uncertainties and other factors that may cause
actual results to differ materially from the views, beliefs, and
projections expressed in such statements. The words "believe," "expect,"
"anticipate," "project," and similar expressions signify forward-looking
statements. Readers are cautioned not to place undue reliance on any
forward-looking statements made by or on behalf of the company. Any such
statement speaks only as of the date the statement was made. The company
undertakes no obligation to update or revise any forward-looking statement.

Factors that may cause actual results to differ materially from those
contemplated by these forward-looking statements include, among others, the
following possibilities: (i) cost savings expected from the integration of
Conrail may not be fully realized or realized within the time frame anticipated,
(ii) revenues following the integration of Conrail may be lower than expected,
(iii) costs or difficulties related to the integration of Conrail may be greater
than expected, (iv) general economic or business conditions, either nationally
or internationally, including an increase in fuel prices, a tightening of the
labor market or changes in demands of organized labor resulting in higher
wages, or increased benefits or other costs or disruption of operations may
adversely affect the company, (v) legislative or regulatory changes, including
possible enactment of initiatives to reregulate the rail industry, may
adversely affect the company, (vi) changes may occur in the securities markets,
and (vii) disruptions of the operations of the company or any other
governmental or private entity may occur as a result of technology issues
related to the Year 2000.

-32-

<ARTICLE> 5
<MULTIPLIER> 1,000,000

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-25-1998
<PERIOD-START> DEC-27-1997
<PERIOD-END> DEC-25-1998
<CASH> 177
<SECURITIES> 0
<RECEIVABLES> 170
<ALLOWANCES> 0
<INVENTORY> 171
<CURRENT-ASSETS> 731
<PP&E> 15,215
<DEPRECIATION> 4,559
<TOTAL-ASSETS> 11,897
<CURRENT-LIABILITIES> 1,468
<BONDS> 906
0
0
<COMMON> 181
<OTHER-SE> 5,384
<TOTAL-LIABILITY-AND-EQUITY> 11,897
<SALES> 0
<TOTAL-REVENUES> 4,956
<CGS> 0
<TOTAL-COSTS> 4,147
<OTHER-EXPENSES> 134
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 77
<INCOME-PRETAX> 598
<INCOME-TAX> 220
<INCOME-CONTINUING> 378
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 378
<EPS-PRIMARY> 0
<EPS-DILUTED> 0

</TABLE>

BY-LAWS

CSX TRANSPORTATION, INC.
(As Amended to October 21, 1998)

--------------------------------

ARTICLE I.

Stockholders' Meetings.

SECTION 1. Annual meeting. The annual meeting of stockholders of the Company
---------------
shall be held on the second Tuesday in March, either within or without the State
of Virginia.

SECTION 2. Special Meetings. Special meetings of the stockholders of the
Company may be held at such places within or without that State as provided
in the notice of the meeting, and may be called by the Chairman or a majority
of all of the Directors.

SECTION 3. Actions without meeting. Any action which may be taken at a meeting
------------------------
of the shareholders may be taken without a meeting, if a consent or consents in
writing, setting forth the action so taken, shall be signed by all of the
shareholders who would be entitled to vote at a meeting for such purpose and
shall be filed with the Secretary.

ARTICLE II.

Board of Directors.

SECTION 1. Number, term and election. The Board of Directors shall be elected at
-------------------------
the annual meeting of the stockholders or at any special meeting held in lieu
thereof. The number of Directors shall be seven. This number may be increased or
decreased at any time by amendment of these by-laws, but shall always be a
number of not less than three. No person shall be eligible for election as a
Director, nor shall any Director be eligible for re-election, if he shall have
attained the age of 70 years at the time of such election. Directors shall hold
office until removed or until the next annual meeting of the stockholders is
held and their successors are elected.

SECTION 2. Quorum. A majority of the Directors shall constitute a quorum.
------
Less than a quorum may adjourn the meeting to a fixed time and place, no further
notice of any adjourned meeting being required.

SECTION 3. Removal and vacancies. The stockholders at any meeting, by a vote of
---------------------
the holders of a majority of all the shares of Capital Stock at the time
outstanding and having voting power, may remove any Director and fill any
vacancy. Vacancies arising among the Directors, including a vacancy resulting
from an increase by the Board of Directors in the number of directors, so long
as the increase so created is not more than two, may be filled by the remaining
Directors, though less than a quorum of the Board, unless sooner filled by the
stockholders.

SECTION 4. Meetings and notices. Meetings of the Board may be called to meet at
--------------------
any time and place by the Secretary or an Assistant Secretary by direction of
the Chairman of the Board, or a President, or at the request of any three
members of the Board. Notice of any meeting may be given orally or by mailing or
delivering such notice to each Director at his residence or business address or
by telephone or telegraphing it to him. Any such notice shall state the time and
place of the meeting. Meetings may be held without notice if all of the
Directors are present or those not present waive notice before or after the
meeting.

<PAGE>

Any action which may be taken at a meeting of the Board may be
taken without a meeting, if a consent or consents in writing setting forth the
action so taken shall be signed by all of the Directors and shall be filed with
the Secretary.

Any action required to be taken at a meeting of the Board may be
taken by means of a conference telephone or similar communications equipment
whereby all persons participating in the meeting can hear each other, and
participation by such means shall constitute presence in person at such meeting.
When such meeting is conducted, a written record shall be made of the action
taken at such meeting.

ARTICLE III.

Officers.

At the first meeting of the Board of Directors held after the
annual meeting of the stockholders, the Board of Directors shall elect officers
of the Company as follows: A Chairman of the Board, a President, one or more
Vice-Presidents, a Secretary and a Treasurer.

All officers elected by the Board of Directors shall, unless
removed by the Board of Directors as hereinafter set forth, hold office until
the first meeting of the Board of Directors after the next annual meeting of the
stockholders and until their successors are elected.

The Board of Directors may elect a Vice-Chairman of the Board
from among the members thereof.

A President may appoint such additional officers and subordinate
officials as he may deem necessary for the efficient conduct of the affairs of
the Company.

The powers, duties, and responsibilities of officers, employees,
and agents of the Company not prescribed in these by-laws shall be established
from time to time by the Board of Directors or by a President.

Any officer shall be subject to removal at any time if elected by
the Board of Directors, by the affirmative vote of a majority of all of the
members of the Board of Directors, or, if appointed by a President, by that
President.

ARTICLE IV.

Chairman of the Board.

The Chairman of the Board of Directors shall be elected from
among the Directors. He shall preside at all meetings of the Board of Directors.
He shall, from time to time, secure information concerning all affairs of the
Company and shall communicate same to the Board. He shall also, from time to
time, communicate to the officers such action of the Board as may in his
judgment affect the performance of their official duties.

-2-
<PAGE>

ARTICLE V.

President.

The President, or if there be more than one, then each of them,
shall, subject to the direction and control of the Board of Directors and the
Chairman, participate in the supervision of the policies and operations of the
Company and shall be the chief administrative officer or officers of the
Company. In general, each President shall perform all duties incident to the
office of President, and such other duties as from time to time may be
prescribed by the Board of Directors or the Chairman. In the absence of the
Chairman, a President, as designated by the Chairman or the Board of Directors,
shall preside at meetings of stockholders and of the Board of Directors.

ARTICLE VI.

Secretary.

SECTION 1. The Secretary shall attend all meetings of the stockholders and the
Board of Directors and record their proceedings, unless a temporary secretary be
appointed. He shall give due notice as required of all meetings of the
stockholders and Directors. He shall keep or cause to be kept at a place or
places required by law a record of the stockholders of the Company, giving the
names and addresses of all stockholders and the number, class, and series of the
shares held by each. He shall be custodian of the seal of the Company, and of
all records, contracts, leases, and other papers and documents of the Company,
unless otherwise directed by the Board of Directors, and shall perform such
other duties as may be assigned to him by the Board of Directors or the Chairman
of the Board or a President.

SECTION 2. In case of the Secretary's absence or incapacity, the Chairman shall
designate an appropriate officer to perform the duties of the Secretary.

ARTICLE VII.

Treasurer

SECTION 1. The Treasurer shall receive, keep and disburse all moneys belonging
or coming to the Company, shall keep regular, true and full accounts of all
receipts and disbursements and make detailed reports of the same to the Board of
Directors whenever required. He shall also perform such other duties in
connection with the administration of the financial affairs of the Company as
the Board of Directors, or a President, shall assign to him.

SECTION 2. In case of the Treasurer's absence or incapacity, the Chairman shall
designate an appro-priate officer to perform the duties of the Treasurer.

ARTICLE VIII.

Compensation.

The Board of Directors or a committee thereof shall fix salaries
above a level established from time to time by the Board of Directors and shall
determine and fix other compensation for officers and employees of the Company
and shall implement, monitor, and review the employee compensation and

-3-
<PAGE>

employee benefit plans of the Company. No member of the Board of Directors or
such committee shall vote on any matter involving the amount of his own
compensation. The salaries of officers and employees below the level established
by the Board of Directors shall be fixed by the President.

ARTICLE IX.

Depositaries.

The money of the Company shall be kept in such bank or banks as
the Board of Directors shall from time to time direct or approve. All checks and
other instruments for the disbursement of funds shall be executed manually or by
facsimile by such officers or agents of the Company as may be authorized by the
Board of Directors.

ARTICLE X.

Seal.

The seal of the Company, of which there may be any number of
counterparts, shall be circular in the form and shall bear the words, "CSX
Transportation, Inc. 1944".

ARTICLE XI.

Fiscal Year.

The fiscal year of the Company shall begin immediately after
midnight of the last Friday in December and shall end at midnight on the last
Friday of December of each calendar year.

-4-