ITEM 3. LEGAL PROCEEDINGS
Set forth below is a description of certain legal proceedings involving BNSF and its subsidiaries.
WHEAT AND BARLEY TRANSPORTATION RATES
In September 1980, a class action lawsuit was filed against BNSF Railway in United States District Court for the District of Montana (Montana District Court) challenging the reasonableness of BNSF Railway's export wheat and barley rates. The class consisted of Montana grain producers and elevators. The plaintiffs sought a finding that BNSF Railway single car export wheat and barley rates for shipments moving from Montana to the Pacific Northwest were unreasonably high and requested damages in the amount of $64 million. In March 1981, the Montana District Court referred the rate reasonableness issue to the ICC. Subsequently, the State of Montana filed a complaint at the ICC challenging BNSF Railway's multiple car rates for Montana wheat and barley movements occurring after October 1, 1980.
The ICC issued a series of decisions in this case from 1988 to 1991. Under these decisions, the ICC applied a revenue to variable cost test to the rates and determined that BNSF Railway owed $9,685,918 in reparations plus interest. In its last decision, dated November 26, 1991, the ICC found BNSF Railway's total reparations exposure to be $16,559,012 through July 1, 1991. The ICC also found that BNSF Railway's current rates were below a reasonable maximum and vacated its earlier rate prescription order.
BNSF Railway appealed to the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) those portions of the ICC's decisions concerning the post-October 1, 1980 rate levels. BNSF Railway's primary contention on appeal was that the ICC erred in using the revenue to variable cost rate standard to judge the rates instead of Constrained Market Pricing/Stand Alone Cost principles. The limited portions of decisions that cover pre-October 1, 1980 rates were appealed to the Montana District Court.
On March 24, 1992, the Montana District Court dismissed plaintiffs' case as to all aspects other than those relating to pre-October 1, 1980 rates. On February 9, 1993, the D.C. Circuit served its decision regarding the appeal of the several ICC decisions in this case. The court held that the ICC did not adequately justify its use of the revenue to variable cost standard as BNSF Railway had argued and remanded the case to the ICC for further administrative proceedings.
On July 22, 1993, the ICC served an order in response to the D.C. Circuit's February 9, 1993 decision. In its order, the ICC stated it would use the Constrained Market Pricing/Stand-Alone Cost principles in assessing the reasonableness of BNSF Railway wheat and barley rates moving from Montana to Pacific Coast ports from 1978 forward. The ICC assigned the case to the Office of Hearings to develop a procedural schedule. On October 28, 1994, plaintiffs filed their opening evidence arguing that the revenue received by BNSF Railway exceeded the stand alone costs of transporting that traffic and that BNSF Railway rates were unreasonably high. BNSF Railway filed its evidence March 29, 1995, showing that the stand alone costs of transporting the traffic exceeded the revenue derived by BNSF Railway on that traffic and that consequently, its rates were not unreasonably high. The parties filed briefs simultaneously on August 16, 1995. In a decision served August 14, 1997, in McCarty Farms, Inc. et al. v. Burlington Northern Inc., No. 37808, the STB, successor to the ICC, ruled that the plaintiffs had failed to demonstrate that BNSF Railway rates charged to transport export wheat and barley from Montana to West Coast ports were unreasonable. The STB dismissed the proceeding in its entirety.
The plaintiffs filed petitions to review the STB's decision before the D.C. Circuit and the Montana District Court. In an October 20, 1998 decision, McCarty Farms, Inc. et. al. v. Surface Transportation Board (No. 97-1632), the D.C. Circuit affirmed the STB's decision in all respects for those claims as to which it had jurisdiction (i.e., all claims except those relating to single-car wheat shipments moving before September 12, 1980). The plaintiffs' appeal of the STB decision as to single-car wheat shipments moving before September 12, 1980 was dismissed by the Montana District Court on November 23, 1998. This matter is now considered terminated.
ENVIRONMENTAL PROCEEDINGS
BNSF Railway had been advised that it was a target of a Grand Jury investigation in the United States District Court for the Eastern District of Missouri with respect to former railcar cleaning activities conducted by independent contractors hired by BNSF Railway's predecessors at a rail siding near Cherryville, Missouri. The proceeding related to alleged violations of federal environmental protection statutes with respect to lead contamination at several sites in the Cherryville area. In addition, BNSF Railway had received personal injury claims from certain individuals formerly residing at or near some of these sites. The Missouri Department of Natural Resources (DNR) also was investigating the matter with respect to possible violations of state environmental protection laws and BNSF Railway has been implementing remediation plans developed in conjunction with DNR.
On December 4, 1998, BNSF Railway entered a plea in federal district court to one felony count under CERCLA for failure to immediately report to the federal government a release of a reportable quantity of lead sulfide and one misdemeanor count under the Clean Water Act for a negligent discharge of a pollutant into a waterway. BNSF Railway agreed in the settlement to pay a fine of $7 million and to make restitution payments to the State of Missouri of $3 million, and committed to spend $9 million, which includes amounts previously paid, in remediation costs in connection with its ongoing remediation efforts. In the plea agreement, the parties agreed that BNSF Railway had taken remedial safety and procedural actions in an effort to reduce the likelihood of recurrence of such matters.
In addition, BNSF Railway has negotiated a settlement with the State of Missouri that requires a payment of $900,000 in penalties and $500,000 in natural resource damage. With the public comment period having ended January 26, 1999, BNSF Railway is executing the settlement agreement for entry by the court as a consent decree. Implementation costs of the investigation and remediation activities pursuant to the consent decree are not considered material. The Company considers the federal Grand Jury matter to be terminated, and all pending related matters, including personal injury claims received from certain individuals residing at or near the area, are not considered material.
On December 18, 1995, the State of Illinois filed a Complaint captioned People of the State of Illinois v. Burlington Northern Railroad Company, Beazer East, Inc. and Koppers Industries, Inc. (PCB No. 96-132) before the Illinois Pollution Control Board against BNSF Railway, Beazer East, Inc. and Koppers Industries, Inc. alleging violations of the Illinois Environmental Protection Act with respect to a facility in Galesburg, Illinois. This facility is not operated by BNSF Railway. The proceeding may result in monetary sanctions in excess of $100,000. BNSF Railway and Beazer East, Inc. have made an offer to the State of Illinois to settle this matter.
MERGER-RELATED LITIGATION
Numerous complaints were filed arising out of the Agreement and Plan of Merger dated June 29, 1994, as amended, between BNI and SFP. On June 30, 1994, shortly after announcement of the proposed BNI-SFP merger (Merger), two purported stockholder class action suits were filed in the Court of Chancery of the State of Delaware (Miller v. Santa Fe Pacific Corporation, C.A. No. 13587; Cosentino v. Santa Fe Pacific Corporation, C.A. No. 13588). On July 1, 1994, two additional purported stockholder class action suits were filed in the Court of Chancery of the State of Delaware (Fielding v. Santa Fe Pacific Corporation, C.A. No. 13591; Wadsworth v. Santa Fe Pacific Corporation, C.A. No. 13597).
The actions named as defendants SFP, the individual members of the SFP Board of Directors, and BNI. In general, the actions variously alleged that SFP's directors breached their fiduciary duties to the stockholders by agreeing to the proposed merger for allegedly "grossly inadequate" consideration in light of recent operating results of SFP, recent trading prices of SFP's common stock and other alleged factors, by allegedly failing to take all necessary steps to ensure that stockholders will receive the maximum value realizable for their shares (including allegedly failing to actively pursue the acquisition of SFP by other companies or conducting an adequate "market check"), and by allegedly failing to disclose to stockholders the full extent of the future earnings potential of SFP, as well as the current value of its assets. The Miller and Fielding cases further alleged that the proposed Merger was unfairly timed and structured and, if consummated, would allegedly unfairly deprive the stockholders of standing to pursue certain pending stockholder derivative litigation. Plaintiffs also alleged that BNI was responsible for aiding and abetting the alleged breach of fiduciary duty committed by the SFP Board. The actions sought certification of a class action on behalf of SFP's stockholders. In addition, the actions sought injunctive relief against consummation of the Merger and, in the event that the Merger was consummated, the rescission of the Merger, an award of compensatory or rescissory damages and other damages, including court costs and attorneys' fees, an accounting by defendants of all profits realized by them as a result of the Merger, and various other forms of relief.
On October 6, 1994, shortly after Union Pacific Corporation (UPC) issued a press release in which it announced a proposal for UPC to acquire SFP (the UPC Proposal), plaintiffs in the four lawsuits described above filed in the Court of Chancery of the State of Delaware a Consolidated Amended Complaint (Miller v. Santa Fe Pacific Corporation, C.A. No. 13587). In their Consolidated Amended Complaint, plaintiffs repeated the allegations contained in their earlier lawsuits and further alleged that, in light of the UPC Proposal, SFP's directors had breached their fiduciary duties by failing to fully inform themselves about and to adequately explore available alternatives to the merger with BNI, including the alternative of a merger transaction with UPC, and by failing to fully inform themselves about the value of SFP. The Consolidated Amended Complaint sought the same relief sought in plaintiffs' earlier lawsuits and, in addition, requested that SFP's directors be ordered to explore alternative transactions and to negotiate in good faith with all interested persons, including UPC.
Also, on October 6, 1994, five additional purported stockholder class action suits relating to SFP's proposed participation in the Merger with BNI were filed in the Court of Chancery of the State of Delaware (Weiss v. Santa Fe Pacific Corporation, C.A. No. 13779; Lifshitz v. Krebs, C.A. No. 13780; Stein v. Santa Fe Pacific Corporation, Lewis v. Santa Fe Pacific Corporation, C.A. No. 13783; Abramson v. Lindig, C.A. No. 13784). On October 7, 1994, three more purported stockholder class action suits relating to SFP's proposed participation in the Merger with BNI were filed in the Court of Chancery of the State of Delaware (Graulich v. Santa Fe Pacific Corporation, C.A. No. 13786; Anderson v. Santa Fe Pacific Corporation, C.A. No. 13787; Green v. Santa Fe Pacific Corporation, C.A. No. 13788). All of these lawsuits named as defendants SFP and the individual members of the SFP Board of Directors; the Lifshitz case further named BNI as a defendant. In general, these actions variously alleged that, in light of SFP's recent operating results and the UPC Proposal, SFP's directors breached their fiduciary duties to stockholders by purportedly not taking the necessary steps to ensure that SFP's stockholders would receive "maximum value" for their shares of SFP stock, including purportedly refusing to negotiate with UPC or to "seriously consider" the UPC Proposal and failing to announce any active auction or open bidding procedures. The actions generally sought relief that is materially identical to the relief sought in the Miller case, and in addition sought entry of an order requiring SFP's directors to immediately undertake an evaluation of SFP's worth as a merger/acquisition candidate and to establish a process designed to obtain the highest possible price for SFP, including taking steps to "effectively expose" SFP to the marketplace in an effort to create an "active auction" in SFP. The Weiss case further sought entry of an order enjoining SFP's directors from implementing any poison pill or other device designed to thwart the UPC Proposal or any other person's proposal to acquire SFP.
The Anderson lawsuit was subsequently withdrawn. On October 14, 1994, the Chancery Court entered an order consolidating the remaining 11 purported stockholder class action suits under the heading In Re Santa Fe Pacific Corporation Shareholder Litigation, C.A. No. 13587 (the Shareholder Litigation).
On October 26, 1994, BNI filed a Motion to Dismiss the Consolidated and Amended Complaint.
On March 6, 1995, plaintiffs in the Shareholder Litigation filed a Revised Second Consolidated and Amended Complaint, which superseded their previously filed complaints. The Revised Second Consolidated and Amended Complaint generally repeated many of the same allegations, and requested relief similar to that requested in plaintiffs' earlier complaints. In addition, the Revised Second Consolidated and Amended Complaint alleged that SFP's directors breached their fiduciary duties: by proceeding with and completing the joint SFP-BNI Tender Offer; by approving and implementing the Shareholder Rights Plan, which purportedly resulted in a "premature ending" of the "bidding process" by allegedly deterring and defeating UPC's acquisition overtures, exempting BNI from its provisions, and "coercing" SFP stockholders to vote in favor of the Merger; by approving the termination fee and expense reimbursement provisions of the Merger Agreement by authorizing the stock repurchase provisions of the Merger Agreement, which allegedly were designed to "lock-up" the Merger by providing stockholders with an "illusory promise" that the Merger Agreement exchange ratio would increase, while reserving SFP's right not to repurchase such stock; and by purportedly failing to disclose all material facts necessary for SFP's stockholders to evaluate in an informed manner and vote on the Merger, including purportedly failing to fully disclose the risks that the ICC would not approve the Merger and purportedly failing to fully disclose SFP's intentions with respect to the repurchase of SFP stock, as permitted by the Merger Agreement, as well as whether there will be a fair opportunity for all SFP stockholders to "participate" in any SFP stock repurchases, and on what basis. As additional relief to that requested in the earlier complaints, plaintiffs requested injunctive and other relief: enjoining consummation of the Merger; ordering SFP, SFP's directors, and BNI to make unspecified supplemental disclosures to stockholders; requiring SFP to conduct a new vote on the Merger subsequent to such disclosures; enjoining SFP from improperly or discriminatorily implementing the Shareholder Rights Plan or any other "defensive" tactic; ordering SFP's directors to take all appropriate steps to enhance SFP's value and attractiveness as a merger or acquisition candidate, including "effectively exposing" SFP to the marketplace by means of an active auction on a "level playing field"; and declaring the termination fee and expense reimbursement provisions of the Merger Agreement invalid and unenforceable.
On March 13, 1995, SFP and SFP's directors filed a motion to dismiss the Shareholder Litigation on the grounds that the Plaintiffs failed to state a cause of action upon which relief may be granted. BNI also filed a motion to dismiss the Revised Second Consolidated and Amended Complaint. On May 31, 1995, the Delaware Chancery Court rendered its decision granting the motion to dismiss that was filed by SFP and SFP's directors on March 13, 1995 and the motion to dismiss filed by BNI. The plaintiffs appealed the dismissal to the Delaware Supreme Court.
On November 22, 1995, the Delaware Supreme Court issued an opinion that affirmed in part and reversed in part the May 31, 1995 decision of the Delaware Chancery Court. The Delaware Supreme Court reversed the Chancery Court's dismissal of plaintiffs' claims that, in taking the alleged "defensive" actions identified in the Revised Second Consolidated and Amended Complaint, including approval and implementation of the Shareholder Rights Plan, SFP's directors violated their fiduciary duties to stockholders. The Delaware Supreme Court affirmed the Chancery Court's dismissal of all other claims asserted by plaintiffs in the litigation, including all claims against BNI.
On December 11, 1995, the SFP defendants filed with the Delaware Chancery Court a motion for summary judgment against plaintiffs' remaining claims in the Shareholder Litigation, which motion is pending. On December 29, 1995, the SFP defendants filed their Answer to plaintiffs' Revised Second Consolidated and Amended Complaint.
BNSF Railway believes this lawsuit is meritless and continues to oppose it vigorously.
OTHER CLAIMS
BNSF Railway and its subsidiaries also are parties to a number of other legal actions and claims, various governmental proceedings and private civil suits arising in the ordinary course of business, including those related to environmental matters and personal injury claims. While the final outcome of these and other legal actions referred to under Item 3 of this Report on Form 10-K cannot be predicted with certainty, considering among other things the meritorious legal defenses available, it is the opinion of BNSF Railway management that none of these items, when finally resolved, will have a material adverse effect on the annual results of operations, financial position or liquidity of BNSF Railway, although an adverse resolution of a number of these items could have a material adverse effect on the results of operations in a particular quarter or fiscal year.
Reference is made to Note 4 of the consolidated financial statements for information concerning certain pending administrative appeals with the Internal Revenue Service.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of BNSF Railway's common stock is owned by BNSF and therefore is not traded on any market.
ITEM 7.
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes (beginning on page).
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
BNSF Railway recorded net income for 1998 of $1,206 million, compared with net income of $929 million for 1997. The $277 million increase in net income is primarily due to increased revenues in intermodal, coal and other sectors. More moderate winter weather in the first quarter of 1998 relative to 1997, gains on real estate portfolio sales and a first quarter 1998 $67 million pre-tax gain ($32 million after-tax) on the sale of substantially all of the Company's interest in Santa Fe Pacific Pipeline Partners, L.P. also contributed to the improvement. In addition, 1997 included a $90 million pre-tax special charge ($57 million after-tax) principally related to the consolidation of clerical functions (see Note 9 of the consolidated financial statements).
Excluding the 1998 gain on the pipelines sale and the 1997 special charge, BNSF Railway's adjusted net income for 1998 was $1,174 million compared with 1997 adjusted net income of $986 million.
REVENUE TABLE
The following table presents BNSF Railway's revenue information by commodity for the years ended December 31, 1998 and 1997 and includes certain reclassifications of prior year information to conform to current year presentation.
REVENUES
Total revenues for 1998 were $8,936 million, 7 percent or $570 million higher than revenues of $8,366 million for 1997. The increase primarily reflects increases in the intermodal, coal, chemicals, metals and minerals, forest products, and consumer goods sectors partially offset by lower agricultural commodities and automotive revenues. Average revenue per car/unit decreased slightly in 1998 to $1,132 from $1,139 in 1997. During 1998, BNSF Railway's share of the Western United States (U.S.) rail traffic market, based on reporting to the Association of American Railroads (AAR), increased 2.9 points to 44.3 percent. This gain was primarily the result of the trackage rights gained from UP and operating problems experienced by the UP associated with consolidating operations.
Intermodal revenues of $2,469 million improved $187 million or 8 percent compared with 1997 reflecting increases in the direct marketing, international and truckload sectors. Direct marketing revenues benefited from increased units shipped for UPS, less than truckload (LTL) customers and the United States Postal Service. International revenues were up due to higher volume associated with market share gains and new business established with Sealand, NYK, Maersk and K-Line. Truckload revenues increased primarily due to volume growth from J.B. Hunt and Schneider.
Coal revenues of $2,239 million for 1998 increased $267 million or 14 percent primarily due to strong demand, volume gains associated with market share improvements and favorable operating conditions as a result of a more moderate winter in 1998.
Agricultural commodities revenues of $1,077 million for 1998 were $10 million or 1 percent lower than 1997 due to poor Pacific Northwest (PNW) corn and soybeans exports as well as weak barley exports. This was partially offset by increased movements of minor oilseeds exports.
Chemicals revenues of $841 million for 1998 were $29 million or 4 percent higher than 1997. Increases in industrial chemicals, petroleum products and plastics were partially offset by weak fertilizer markets.
Metals and minerals revenues of $757 million for 1998 were $26 million or 4 percent higher than 1997 and were led primarily by strength in aluminum and non- ferrous materials as well as volume increases in steel products, cement and rock and specialty minerals.
Forest products revenues of $598 million for 1998 were $34 million or 6 percent higher than 1997 primarily due to printing paper volume gains as 1997 was impacted by severe winter weather, increased Canadian newsprint imports and pulpboard volume gains as a result of market share gains. Lumber volumes increased due to higher levels of construction activity.
Consumer goods revenues of $553 million for 1998 were $56 million or 11 percent higher than 1997 primarily due to volume increases in corn syrup traffic to Mexico, Texas and California and increased sugar traffic as 1997 was impacted by severe winter weather. Government and machinery revenues increased as a result of increased Boeing traffic.
Automotive revenues of $388 million for 1998 were $34 million or 8 percent lower than 1997 reflecting decreases in volumes due to the loss of Ford's Southwestern U.S. business and the impact of the 1998 General Motors strike, partially offset by strong Honda loadings.
EXPENSES
Total operating expenses for 1998 were $6,781 million, an increase of $181 million or 3 percent higher than 1997. As discussed above, 1997 included a $90 million ($57 million after-tax) special charge principally related to the consolidation of clerical functions. Excluding the special charge, 1998 operating expenses were $271 million or 4 percent higher than 1997. The operating ratio improved to 75.9 percent for 1998 compared with a 77.8 percent adjusted operating ratio for 1997.
Compensation and benefits expenses of $2,811 million were $138 million or 5 percent higher than 1997. Wages were higher due to volume related increases primarily in train crew costs, wage increases for salaried and union employees, and increased incentive compensation expense. These increases were partially offset by lower labor costs associated with repairs to track and equipment as 1997 was unusually high because of severe winter weather.
Purchased services expenses of $894 million for 1998 were $71 million or 9 percent higher than 1997 due principally to higher joint facility costs from increased operations over trackage rights obtained from UP, increased equipment maintenance costs, and higher ramping costs related to increased intermodal volumes.
Equipment rents expenses of $804 million were $16 million or 2 percent lower than 1997. Improved equipment utilization and lower performance penalties for grain cars were partially offset by volume driven increases for leased coal cars and locomotives.
Fuel expenses of $724 million for 1998 were $23 million or 3 percent lower than 1997, as a result of a 6 cent or 8 percent decrease in the average all-in cost per gallon of diesel fuel, partially offset by a 6 percent volume driven increase in consumption from 1,092 million gallons to 1,155 million gallons. The decrease in the average all-in cost per gallon of diesel fuel includes a 13 cent decrease in the average purchase price, partially offset by current year losses related to BNSF's fuel hedging program. Gross ton-miles per gallon of fuel increased 4 percent reflecting a continuing favorable operating trend resulting from new, fuel efficient locomotives and more fuel efficient operating practices.
Materials and other expenses of $717 million for 1998 were $42 million or 6 percent higher than 1997 principally due to lower credits from joint facility billings due to lower UP traffic levels on BNSF Railway facilities. Other expenses in 1997 also included more income from the sale of easements and higher tax incentives from the State of Nebraska related to investment and employment levels in the state.
Interest expense with external and related parties increased by $12 million to $293 million reflecting higher debt levels, including intercompany notes payable, which increased to $5,056 million at December 31, 1998 from $4,921 million at December 31, 1997, partially offset by lower interest rates.
Other income (expense), net was $72 million higher than 1997 primarily due to the $67 million pre-tax gain on the pipeline partnership sale in the first quarter of 1998 as discussed in Note 2 of the consolidated financial statements. In addition, lower equity in earnings of pipelines due to the first quarter sale of this investment was offset by gains on real estate portfolio sales.
YEAR 2000 BACKGROUND
The Company has established a committee of managers and employees, chaired by the Company's Chief Information Officer, to evaluate and manage the costs and risks associated with becoming Year 2000 compliant and to minimize the impact of the Year 2000 problem on the Company. Because many existing computer programs and microprocessors recognize only the last two digits of years (and not the century designation), they may be unable to accurately recognize and process dates beyond December 31, 1999, and consequently may fail or produce erroneous data. The Year 2000 problem may adversely affect the Company's operations and financial performance if its remediation efforts are not successfully implemented or if the railroads with which the Company connects, critical customers or suppliers fail to become Year 2000 compliant.
STATE OF READINESS
Year 2000 issues were reviewed in September 1995 following the approval of the merger of the two railroads that now constitute BNSF Railway . The core mainframe systems for the merged railroad were selected in part because they were substantially Year 2000 compliant. These systems integrate all transportation-related activities and computer systems that support BNSF Railway's transportation network, including operations, customer information, and revenue data. This merger-related information systems integration and upgrade activity was substantially completed by July 1997.
Following this systems integration, BNSF Railway adopted a three-phase approach to Year 2000: Inventory and Assessment; Remediation; and Certification Testing. Separate teams address technologies administered or maintained by the Information Systems Services department (ISS technologies) and other enterprise- wide products and technologies used by the Company, including embedded microprocessor technology (Enterprise technologies). BNSF Railway has completed the Inventory and Assessment phase for both ISS and Enterprise technologies. During this phase, BNSF Railway inventoried all ISS-administered source code, hardware, software and communications equipment that could be affected by the Year 2000 problem, and identified items potentially needing remediation. In addition, the Enterprise team completed a company-wide audit of Enterprise technologies and associated suppliers and service providers for potential Year 2000 problems.
The Remediation phase is more than three-fourths complete. Remediation includes converting source code and replacing or upgrading purchased software and hardware. Remediation is substantially complete for ISS technologies and is expected to be completed by July 1999 for Enterprise technologies.
The Certification Testing phase includes validating the performance of ISS and Enterprise technologies in a Year 2000 test environment. The Certification Testing phase also includes validating Year 2000 compliance for critical third party suppliers and service providers. This phase, which is ongoing, overlaps with the Remediation phase. Certification testing for ISS technologies began in November 1998, with critical applications receiving priority; testing for all applications is scheduled for completion by the end of September 1999. Certification testing of all critical Enterprise technologies began in May 1998 and is scheduled for completion in February 1999; testing for non-critical Enterprise technologies is scheduled for completion by July 1999.
COSTS
As a result of its merger-related systems integration that was completed in 1997, BNSF Railway achieved substantial Year 2000 compliance on its core mainframe systems. In addition, spending on Year 2000 activities approximates $8 million to date. Currently, the total cost of achieving Year 2000 compliance for the Company's ISS and Enterprise technologies is estimated to be approximately $20 million.
YEAR 2000 RISKS AND CONTINGENCY PLANS
Certain BNSF Railway business processes rely on third parties for the efficient functioning of its transportation network. The Association of American Railroads (AAR) administers systems that benefit all North American railroads and their customers, including interline settlement, shipment tracing and waybill processing. BNSF Railway and other AAR-member railroads are participating in a process to test and certify these systems for Year 2000 compliance. The AAR expects that these systems will be compliant and pilot tested by specific carriers by April 1999, with open carrier testing conducted promptly thereafter. BNSF Railway plans to develop contingency plans for the business processes supported by AAR systems.
Certain BNSF Railway routes and resulting revenues are dependent on the use of trackage rights over other railroads, including UP, Montana Rail Link and the Arizona and California Railroad. Other BNSF Railway traffic may originate or terminate on other carriers' lines or may otherwise involve use of a foreign connection en route. Approximately 60 percent of units handled by BNSF Railway run over BNSF Railway facilities only. BNSF Railway's traffic levels and revenues could be significantly reduced and/or its operational network significantly impaired through congestion and other factors if other railroads are not able to accommodate BNSF Railway trains or interchange traffic for any extended period of time due to Year 2000 problems. However, as a result of its work with other railroads to address Year 2000 problems on an industry-wide basis, management believes that the possibility of extended failures on other railroads is not significant. At present, the Company generally has not determined which of its customers may have Year 2000 problems that could result in reduced traffic for the Company.
It is the opinion of management that Year 2000 problems in BNSF Railway's internal information systems and technology infrastructure will not have a materially adverse effect on the results of operations, liquidity or financial position of the Company. However, there can be no assurance that the systems or equipment of other parties which interact with BNSF Railway's systems will be compliant on a timely basis. BNSF Railway believes that the failure of systems or equipment of one or more of its key third parties or customers is the most reasonably likely worst case Year 2000 scenario, and that an extended failure could have a material adverse effect on the results of operations, liquidity or financial position of the Company. Where appropriate, BNSF Railway is developing contingency plans in the event that BNSF Railway's key third parties do not become Year 2000 compliant on a timely basis, which effort includes the formalization of existing disaster recovery plans. Contingency plans are expected to be in place by the end of the first quarter 1999.
FORWARD LOOKING INFORMATION
The Year 2000 discussion above contains forward-looking statements, including those concerning the Company's plans and estimated completion dates, cost estimates, assessments of Year 2000 readiness of BNSF Railway and third parties, and possible consequences of any failure on the part of the Company or third parties to be Year 2000 compliant on a timely basis. Forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such factors include, but are not limited to, the following: continued availability of qualified personnel to assess, remediate, and test ISS and Enterprise technologies at current estimated costs; emergence of unforeseen software or hardware problems, including where applications interact with each other in ways not anticipated, which could delay or hinder commercial transactions or other operations; the ability to locate and remediate Year 2000 problems with software source code and embedded computer chips in equipment; the failure, in whole or in part, of other railroads or AAR-supported systems to be Year 2000 compliant; the Year 2000 compliance of its business partners and customers and reduced traffic levels due to their failure, in whole or part, to be Year 2000 compliant; business interruption due to delays in obtaining supplies, parts, or equipment from key vendors or suppliers that are affected by Year 2000 problems; the ripple effect of Year 2000-related failures in industries supporting the nation's basic infrastructure, including fuel vendors and pipelines, gas, electric, and water utilities, communications companies, banks and financial institutions, and highway, water, and air transportation systems; and any significant downturn in the general economy, and adverse industry-specific economic conditions at the international, national, and regional levels, wholly or partially caused by Year 2000 problems.
To the extent that all other written statements include predictions concerning future operations and results of operations, such statements are forward-looking statements that involve risks and uncertainties, and actual results may differ materially. Factors that could cause actual results to differ materially include, but are not limited to, general economic downturns, which may limit demand and pricing; labor matters, which may affect the costs and feasibility of certain operations; and competition and commodity concentrations, which may affect traffic and pricing levels.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, BNSF Railway utilizes various financial instruments which inherently have some degree of market risk. The quantitative information presented below and the additional qualitative information presented in Notes 8, 10 and 11 of the consolidated financial statements describe significant aspects of BNSF Railway's financial instrument programs which have a material market risk.
INTEREST RATE SENSITIVITY
The tables below provide information about the Company's financial instruments that are sensitive to changes in interest rates, including debt obligations as of December 31, 1998 and 1997. For debt obligations, the tables present principal cash flows and related weighted average interest rates by contractual maturity dates.
LONG-TERM DEBT
Excluded from the 1998 and 1997 tables is $2,288 million and $2,063 million, respectively, of intercompany notes payable to BNSF. As of December 31, 1998 and 1997, $1,579 million of the intercompany notes payable had a fixed interest rate of 6.9 percent and the remainder had a variable rate. These notes are due on demand; however, it is not anticipated that BNSF Railway will be required to pay these obligations in 1999.
COMMODITY PRICE SENSITIVITY
During 1998 and 1997, fuel expenses approximated 11 percent of total operating expenses. Due to the significance of diesel fuel expenses to the operations of the railroad and the historical volatility of fuel prices, BNSF Railway has established a program to hedge against fluctuations in the price of its diesel fuel purchases. The intent of the program is to protect BNSF Railway's operating margins and overall profitability from adverse fuel price changes. However, to the extent BNSF Railway hedges portions of its fuel purchases, it will not realize the impact of decreases in fuel prices. The fuel-hedging program in 1998 and 1997 includes the use of commodity swap transactions that are accounted for as hedges. Additionally, the 1997 fuel-hedging program also includes forward purchases for delivery at fueling facilities. Any gains or losses associated with changes in the market value of these hedging instruments are deferred and recognized as a component of fuel expense in the period in which the fuel is purchased and used.
Swap transactions are typically based on the price of pipeline delivery Gulf Coast #2 heating oil and require BNSF Railway to purchase a defined quantity at a defined price. Swap transactions are generally settled in cash with the counterparty. Based on historical information, BNSF Railway believes there is a significant correlation between the market prices of diesel fuel and Gulf Coast #2 heating oil.
The tables below provide information about BNSF Railway's diesel fuel hedging instruments that are sensitive to changes in commodity prices. The tables present notional amounts in gallons and the weighted average contract price by contractual maturity date. The prices included in the tables do not include taxes, transportation costs, certain other fuel handling costs and, except for forward contracts, any differences which may occur from time to time between the prices of commodities hedged and the purchase price of BNSF Railway's diesel fuel.
(1) Represents unrecognized gains (losses) (in millions) based on the price of Gulf Coast #2 heating oil.
Additionally, at December 31, 1998 and 1997, BNSF Railway maintained fuel inventories for use in normal operations which were not material to the Company's overall financial position and therefore represented no significant market exposure.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of BNSF Railway and the report thereon of PricewaterhouseCoopers LLP are set forth on pages to.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
Schedules other than that listed above are omitted because they are not required or applicable, or the required information is included in the consolidated financial statements or related notes.
3. Exhibits:
See Index of Exhibits on page E-1 for a description of the exhibits filed as a part of this Report.
(b) Reports on Form 8-K
BNSF Railway filed the following Current Reports on Form 8-K during the quarter ended December 31, 1998, or subsequently:
Current Report on Form 8-K (Date of earliest event reported: December 4, 1998), which disclosed under Item 5, Other Events, the resolution of claims by federal and State of Missouri authorities as to environmental contamination near Cherryville, Missouri stemming from former railcar cleaning activities conducted by independent contractors of BNSF Railway's predecessors.
Current Report on Form 8-K (Date of earliest event reported: November 10, 1998), which referenced under Item 5, Other Events, and filed as an exhibit under Item 7, Financial Statements, Pro Forma Financial Information and Exhibits the following: a statement regarding computation of ratio of earnings to fixed charges (as of September 30, 1998) and the Company's consolidated financial statements and notes thereto for the three and nine month periods ended September 30, 1998.
SIGNATURES
The Burlington Northern and Santa Fe Railway Company, pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE BURLINGTON NORTHERN AND SANTA FE RAILWAY COMPANY
/s/ Robert D. Krebs ------------------------ Robert D. Krebs Chairman, President and Chief Executive Officer (Principal Executive Officer) and Director
Dated: March 31, 1999
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 Burlington Northern and Santa Fe Railway Company and in the capacities and on the date indicated.
/s/ Robert D. Krebs Chairman, President and - ------------------------------- Chief Executive Officer Robert D. Krebs (Principal Executive Officer) and Director
/s/ Denis E. Springer Senior Vice President and - ------------------------------- Chief Financial Officer Denis E. Springer (Principal Financial Officer) and Director
/s/ Thomas N. Hund Vice President and Controller - ------------------------------- (Principal Accounting Officer) Thomas N. Hund
/s/ Douglas J. Babb Director - ------------------------------- Douglas J. Babb
/s/ Jeffrey R. Moreland Director - ------------------------------- Jeffrey R. Moreland
Dated: March 31, 1999
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholder and Board of Directors of The Burlington Northern and Santa Fe Railway Company and Subsidiaries
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)1. and 2. of this Form 10-K present fairly, in all material respects, the financial position of The Burlington Northern and Santa Fe Railway Company and subsidiary companies at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP - ------------------------------ PricewaterhouseCoopers LLP Fort Worth, Texas February 8, 1999
CONSOLIDATED STATEMENT OF INCOME The Burlington Northern and Santa Fe Railway Company and Subsidiaries (Dollars in millions)
See accompanying notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEET
The Burlington Northern and Santa Fe Railway Company and Subsidiaries
(Dollars in millions)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS The Burlington Northern and Santa Fe Railway Company and Subsidiaries (Dollars in millions)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
The Burlington Northern and Santa Fe Railway Company and Subsidiaries
(Dollars in millions)
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE BURLINGTON NORTHERN AND SANTA FE RAILWAY COMPANY
AND SUBSIDIARIES
1. ACCOUNTING POLICIES
THE COMPANY AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Burlington Northern and Santa Fe Railway Company and its majority owned subsidiaries (BNSF Railway or Company). BNSF is a wholly owned subsidiary of Burlington Northern Santa Fe Corporation (BNSF). BNSF Railway was formerly known as the Burlington Northern Railroad Company (BNRR). On December 31, 1996, The Atchison, Topeka and Santa Fe Railway Company (ATSF) merged with and into Burlington Northern Railroad Company (BNRR) and the name of the surviving entity, BNRR, was changed to the Burlington Northern and Santa Fe Railway Company. Additionally, on January 2, 1998, BNSF Railway's parent, Santa Fe Pacific Corporation (SFP), merged with and into BNSF Railway.
BNSF Railway operates one of the largest railroad networks in the United States, with approximately 34,000 route miles covering 28 states and two Canadian provinces. Through one operating transportation services segment, BNSF Railway transports a wide range of products and commodities including the transportation of containers and trailers (intermodal), coal and agricultural commodities which constituted 28 percent, 25 percent and 12 percent, respectively, of total revenues for the year ended December 31, 1998. Revenues derived from sources other than transportation services are not significant.
All significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.
RECLASSIFICATIONS
Certain comparative prior year amounts in the consolidated financial statements and notes have been reclassified to conform with the current year presentation.
CASH AND CASH EQUIVALENTS
All short-term investments with original maturities of less than 90 days are considered cash equivalents. Cash equivalents are stated at cost, which approximates market value.
MATERIALS AND SUPPLIES
Materials and supplies, which consist mainly of rail, ties and other items for construction and maintenance of property and equipment, as well as diesel fuel, are valued at the lower of average cost or market.
PROPERTY AND EQUIPMENT
Property and equipment are depreciated and amortized on a straight-line basis over their estimated useful lives. Upon normal sale or retirement of depreciable railroad property, cost less net salvage is charged to accumulated depreciation and no gain or loss is recognized. Significant premature retirements are recorded as gains or losses at the time of their occurrence. Expenditures which significantly increase asset values or extend useful lives are capitalized. Repair and maintenance expenditures are charged to operating expense when the work is performed. Property and equipment are stated at cost.
The Company incurs certain direct labor, contract service and other costs associated with the development and installation of computer software. Costs for newly developed software or significant enhancements to existing software are typically capitalized. Research, operations and maintenance costs are charged to operating expense when the work is performed.
REVENUE RECOGNITION
Transportation revenues are recognized based upon the proportion of service provided.
2. SALE OF INVESTMENT IN PIPELINE PARTNERSHIP
Santa Fe Pacific Pipelines, Inc. (SFP Pipelines), an indirect, wholly-owned subsidiary of BNSF Railway, served as the general partner of Santa Fe Pacific Pipeline Partners, L.P. (Pipeline Partnership) and of its operating partnership subsidiary, SFPP, L.P. SFP Pipelines owned a two percent interest as the Pipeline Partnership's and SFPP, L.P.'s general partner and an approximate 42 percent interest as limited partner of the Pipeline Partnership. As general partner, SFP Pipelines received two percent of all amounts available for distribution by the Partnership and an additional incentive depending upon the level of cash distributions paid to holders of limited partner interests in the Pipeline Partnership (Partnership Units). SFP Pipeline Holdings, Inc., a direct, wholly-owned subsidiary of BNSF Railway (SFP Holdings), had outstanding $219 million principal amount of Variable Rate Exchangeable Debentures due 2010 (VREDs) at December 31, 1997.
In October 1997, SFP Pipelines and SFP Holdings entered into an agreement with Kinder Morgan Energy Partners, L.P. (Kinder Morgan) pursuant to which Kinder Morgan acquired substantially all of SFP Pipelines' interests in the Pipeline Partnership and SFPP, L.P. for approximately $84 million in cash on March 6, 1998. The Pipeline Partnership was liquidated as part of the transaction and each Partnership Unit was converted into the right to receive 1.39 Kinder Morgan common units. SFP Pipelines' 8,148,148 Partnership Units were converted into the right to receive 11,325,925 Kinder Morgan common units. In addition, the agreement called for the interest of SFP Pipelines in SFPP, L.P. to be partially redeemed for a cash distribution of $5.8 million, with SFP Pipelines retaining only a 0.5 percent special limited partnership interest in SFPP, L.P. The Company recognized a $67 million one-time pre-tax gain ($32 million after-tax) at the time of the sale.
Consummation of the transaction caused an "Exchange Event" under the VRED agreement and in June 1998 all VRED holders received either partnership units of Kinder Morgan or cash equal to the par value of the VREDs. As a result of this transaction, substantially all of the Company's investment in the Pipeline Partnership and SFPP, L.P. and the VREDs were removed from the consolidated balance sheet.
3. OTHER INCOME (EXPENSE), NET
Other income (expense), net includes the following (in millions):
4. INCOME TAXES
Income tax expense was as follows (in millions):
Reconciliation of the federal statutory income tax rate to the effective tax rate was as follows:
The components of deferred tax assets and liabilities were as follows (in millions):
In accordance with the income tax allocation agreement between BNSF and BNSF Railway, the Company makes payments to or receives refunds from BNSF based on its separate consolidated tax liabilities. BNSF filed its first federal income tax return for 1995. The federal income tax returns of BNSF's predecessor companies, BNI and SFP have been examined through 1994 and 1992, respectively. All years prior to 1989 for BNI and 1991 for SFP are closed. Issues relating to the years 1991-1992 for SFP and for the years 1989-1994 for BNI are being contested through various stages of administrative appeal. In addition, BNSF Railway and its subsidiaries have various state income tax returns in the process of examination, administrative appeal or litigation. Management believes that adequate provision has been made for any adjustment that might be assessed for open years through 1998.
5. ACCOUNTS RECEIVABLE, NET
Effective June 1997, an accounts receivable sale agreement which allowed the sale of up to $300 million in receivables effective through 1999, was replaced by an amended and restated agreement which allows BNSF Railway, through a special purpose subsidiary, to sell up to $600 million of variable rate certificates which mature in 2002 evidencing undivided interests in an accounts receivable master trust. The master trust's assets include an ownership interest in a revolving portfolio of BNSF Railway's accounts receivable which are used to support the certificates. At December 31, 1998, $600 million of certificates were outstanding and were supported by receivables of approximately $1.1 billion in the master trust. Certificates outstanding were $581 million at December 31, 1997. BNSF Railway has retained the collection responsibility with respect to the accounts receivable held in trust. BNSF Railway is exposed to credit loss related to collection of accounts receivable to the extent that the amount of receivables in the master trust exceeds the amount of certificates sold. Costs related to such agreements vary on a monthly basis and are generally related to certain interest rates. These costs are included in Other income (expense), net.
BNSF Railway maintains an allowance for corrections to and collectibility of freight and other billings. At December 31, 1998 and 1997, $84 million and $70 million of such allowances had been recorded, respectively. BNSF Railway believes the allowance is adequate to cover disputed and uncollectible receivables at December 31, 1998.
6. PROPERTY AND EQUIPMENT, NET
Property and equipment, net (in millions), and the weighted average annual depreciation rate (%) were as follows:
The consolidated balance sheet at December 31, 1998 and 1997 included $1,082 million and $875 million, respectively, for property and equipment under capital leases.
7. ACCOUNTS PAYABLE AND OTHER CURRENT LIABILITIES
Accounts payable and other current liabilities consisted of the following (in millions):
8. DEBT
Debt outstanding was as follows (in millions):
Aggregate long-term debt scheduled maturities are $268 million, $146 million, $222 million, $248 million and $130 million for 1999 through 2003, respectively.
Certain BNSF Railway properties and other assets are pledged as collateral to, or are otherwise restricted under, the various BNSF Railway long-term debt agreements. Equipment obligations and capital leases are secured by the underlying equipment. During 1998, BNSF Railway entered into $258 million of equipment secured debt of which $173 million was recorded as capital lease obligations.
An indirect wholly-owned subsidiary of BNSF Railway, in connection with its remaining 0.5 percent special limited partner interest in a pipeline partnership, is contingently liable for $190 million of certain debt of the pipeline partnership assumed by Kinder Morgan pursuant to the sale discussed in Note 2: Sale of Investment in Pipeline Partnership. In addition, BNSF Railway and another major railroad jointly and severally guarantee $75 million of debt of KCT Intermodal Transportation Corporation, the proceeds of which are being used to finance the construction of a double track grade separation bridge in Kansas City, Missouri, to be operated and used by Kansas City Terminal Railway Company.
9. EMPLOYEE MERGER AND SEPARATION COSTS LIABILITY BALANCE AND ACTIVITY
Current and long-term employee merger and separation liabilities totaling $474 million and $551 million are included in the consolidated balance sheet at December 31, 1998 and 1997, respectively, and principally represent: (i) employee-related severance costs for the consolidation of clerical functions; (ii) deferred benefits payable upon separation or retirement to certain active conductors, trainmen and locomotive engineers; and (iii) certain non-union employee severance costs.
Liabilities related to the consolidation of clerical functions (the Consolidation Plan) were $211 million and $259 million at December 31, 1998 and 1997, respectively. These liabilities provide for severance costs associated with the Consolidation Plan adopted in 1995 upon consummation of the merger of Burlington Northern Inc. (BNI) and SFP (the Merger). The Consolidation Plan will result in the elimination of approximately 1,600 permanent positions, of which approximately 1,500 positions have been eliminated through 1998, including approximately 250 positions that were eliminated in 1998. Upon adoption in 1995, the Consolidation Plan was expected to be completed by early 1999. However, the Consolidation Plan was partially delayed as a result of the timing related to completion of merger integration and other issues and is now expected to be completed by 2001. Remaining clerical positions to be eliminated by the Company will result in involuntary separations. Benefits paid to affected employees are in the form of lump-sum payments or payments made over five to ten years or in some cases through retirement.
Liabilities related to deferred benefits payable upon separation or retirement to certain active conductors, trainmen and locomotive engineers were $207 million and $224 million at December 31, 1998 and 1997, respectively. These costs were incurred in connection with labor agreements reached prior to the Merger which, among other things, reduced train crew sizes and allowed for more flexible work rules.
Liabilities principally related to certain remaining non-union employee severances resulting from the Merger were $56 million and $68 million at December 31, 1998 and 1997, respectively. These costs will be paid over the next several years based on deferral elections made by affected employees. Approximately 1,500 non-union employees received or are receiving severance payments and special termination benefits under the Company's retirement and health and welfare plans resulting from the Merger.
During 1998, 1997 and 1996, BNSF Railway made employee merger and separation payments of $77 million, $116 million and $183 million, respectively. At December 31, 1998, $65 million of the remaining liabilities are included within current liabilities for anticipated costs to be paid in 1999.
1997 SPECIAL CHARGE
In the fourth quarter of 1997, the Company recorded a $90 million pre-tax special charge. Approximately $65 million of the charge related to the Consolidation Plan and the remainder of the charge related to severance and other costs for non-union employees. BNSF Railway recorded an initial charge in 1995 for the Consolidation Plan, however, the 1995 charge excluded costs associated with voluntary severance for employees who were given the opportunity to relocate and follow their work, but elected severance.
10. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of BNSF Railway's financial instruments at December 31, 1998 and 1997 and the methods and assumptions used to estimate the fair value of each class of financial instruments held by BNSF Railway, were as follows (see also Note 11: Hedging Activities, Leases and Other Commitments regarding the fair values of BNSF Railway's outstanding hedging instruments):
CASH AND CASH EQUIVALENTS
The carrying amount approximated fair value because of the short maturity of these instruments.
LONG-TERM DEBT
The fair value of BNSF Railway's long-term debt was primarily based on quoted market prices for the same or similar issues, or on the current rates that would be offered to BNSF Railway for debt of the same remaining maturities. The carrying amounts of BNSF Railway's long-term debt at December 31, 1998 and 1997 were $2,768 million and $2,858 million, respectively, while the estimated fair values at December 31, 1998 and 1997 were $2,918 million and $3,000 million, respectively.
11. HEDGING ACTIVITIES, LEASES AND OTHER COMMITMENTS HEDGING ACTIVITIES
FUEL During 1998, 1997 and 1996 fuel expenses approximated 11 percent of total operating expenses. Due to the significance of diesel fuel expenses to the operations of the railroad and the historical volatility of fuel prices, the Company has established a program to hedge against fluctuations in the price of its diesel fuel purchases. The intent of the program is to protect the Company's operating margins and overall profitability from adverse fuel price changes. However, to the extent the Company hedges portions of its fuel purchases, it will not realize the impact of decreases in fuel prices. The fuel-hedging program includes the use of commodity swap transactions that are accounted for as hedges. Any gains or losses associated with changes in the market value of the fuel swaps are deferred and recognized as a component of fuel expense in the period in which the fuel is purchased and used. Based on 1998 fuel consumption and excluding the impact of the hedging program, each one-cent increase in the price of fuel would result in approximately $12 million of additional fuel expense on an annual basis.
As of February 8, 1999, BNSF Railway had entered into fuel swaps for approximately 1,776 million gallons at an average price of approximately 49 cents per gallon. The above price does not include taxes, transportation costs, certain other fuel handling costs, and any differences which may occur from time to time between the prices of commodities hedged and the purchase price of BNSF Railway's diesel fuel.
Currently, BNSF Railway's fuel hedging program covers approximately 75 percent, 40 percent, 22 percent and 7 percent of estimated annual and quarterly fuel purchases for 1999, 2000, 2001, and 2002, respectively. Hedge positions are closely monitored to ensure that they will not exceed actual fuel requirements in any period. Unrecognized losses from BNSF Railway's fuel swap transactions were approximately $174 million as of December 31, 1998, of which $120 million relates to swap transactions that will expire in 1999. BNSF Railway also monitors its hedging positions and credit ratings of its counterparties and does not anticipate losses due to counterparty nonperformance.
LEASES
BNSF Railway has substantial lease commitments for locomotives, freight cars, trailers, office buildings and other property. Most of these leases provide the option to purchase the equipment at fair market value at the end of the lease. However, some provide fixed price purchase options. Future minimum lease payments (which reflect leases having non-cancelable lease terms in excess of one year) as of December 31, 1998 are summarized as follows (in millions):
Lease rental expense for all operating leases was $503 million, $456 million and $446 million for the years ended December 31, 1998, 1997 and 1996, respectively. Contingent rentals and sublease rentals were not significant.
OTHER COMMITMENTS
BNSF Railway has entered into commitments to acquire 476 locomotives in 1999. The locomotives will be financed from one or a combination of sources including, but not limited to, cash from operations, capital or operating leases, and debt issuances. The decision on the method used will depend upon the current market conditions and other factors at the time of financing. Additionally, BNSF Railway has committed to acquire 196 and 50 locomotives in 2000 and 2001, respectively.
In connection with the closing of the sale of rail lines in Southern California in 1992 and 1993, BNSF Railway has a $50 million liability recorded for an obligation retained by BNSF Railway which under certain conditions requires the Company to repurchase a portion of the properties sold.
12. ENVIRONMENTAL AND OTHER CONTINGENCIES
ENVIRONMENTAL
BNSF Railway's operations, as well as those of its competitors, are subject to extensive federal, state and local environmental regulation. BNSF Railway's operating procedures include practices to protect the environment from the environmental risks inherent in railroad operations, which frequently involve transporting chemicals and other hazardous materials. Additionally, many of BNSF Railway's land holdings are and have been used for industrial or transportation- related purposes or leased to commercial or industrial companies whose activities may have resulted in discharges onto the property. As a result, BNSF Railway is subject to environmental clean-up and enforcement actions. In particular, the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), also known as the "Superfund" law, as well as similar state laws generally impose joint and several liability for clean-up and enforcement costs without regard to fault or the legality of the original conduct on current and former owners and operators of a site. BNSF Railway has been notified that it is a potentially responsible party (PRP) for study and clean-up costs at approximately 32 Superfund sites for which investigation and remediation payments are or will be made or are yet to be determined (the Superfund sites) and, in many instances, is one of several PRPs. In addition, BNSF Railway may be
considered a PRP under certain other laws. Accordingly, under CERCLA and other federal and state statutes, BNSF Railway may be held jointly and severally liable for all environmental costs associated with a particular site. If there are other PRPs, BNSF Railway generally participates in the clean-up of these sites through cost-sharing agreements with terms that vary from site to site. Costs are typically allocated based on relative volumetric contribution of material, the amount of time the site was owned or operated, and/or the portion of the total site owned or operated by each PRP.
Environmental costs include initial site surveys and environmental studies of potentially contaminated sites as well as costs for remediation and restoration of sites determined to be contaminated. Liabilities for environmental clean-up costs are initially recorded when BNSF Railway's liability for environmental clean-up is both probable and a reasonable estimate of associated costs can be made. Adjustments to initial estimates are recorded as necessary based upon additional information developed in subsequent periods. BNSF Railway conducts an ongoing environmental contingency analysis, which considers a combination of factors including independent consulting reports, site visits, legal reviews, analysis of the likelihood of participation in and the ability of other PRPs to pay for clean-up, and historical trend analyses.
BNSF Railway is involved in a number of administrative and judicial proceedings and other clean-up efforts at approximately 400 sites, including the Superfund sites, at which it is participating in the study or clean-up, or both, of alleged environmental contamination. BNSF Railway paid approximately $64 million, $55 million and $47 million during 1998, 1997 and 1996 respectively, for mandatory and unasserted clean-up efforts, including amounts expended under federal and state voluntary clean-up programs. BNSF Railway has accruals of approximately $185 million for remediation and restoration of all known sites. BNSF Railway anticipates that the majority of the accrued costs at December 31, 1998, will be paid over the next five years. No individual site is considered to be material.
During 1998, BNSF Railway settled an environmental matter in the State of Missouri related to the release of a reportable quantity of lead sulfide into a waterway. BNSF Railway agreed in the settlement to pay a fine of $7 million, make restitution payments to the State of Missouri of $3 million and committed to spend $9 million, which includes amounts previously paid, in connection with its ongoing remediation efforts. BNSF Railway has made payments of approximately $16 million related to this settlement, including approximately $12 million that was paid during 1998, which is included in total 1998 payments discussed above.
Liabilities recorded for environmental costs represent BNSF Railway's best estimates for remediation and restoration of these sites and include both asserted and unasserted claims. Unasserted claims are not considered to be a material component of the liability. Although recorded liabilities include BNSF Railway's best estimates of all costs, without reduction for anticipated recoveries from third parties, BNSF Railway's total clean-up costs at these sites cannot be predicted with certainty due to various factors such as the extent of corrective actions that may be required, evolving environmental laws and regulations, advances in environmental technology, the extent of other parties' participation in clean-up efforts, developments in ongoing environmental analyses related to sites determined to be contaminated, and developments in environmental surveys and studies of potentially contaminated sites. As a result, future charges to income for environmental liabilities could have a significant effect on results of operations in a particular quarter or fiscal year as individual site studies and remediation and restoration efforts proceed or as new sites arise. However, management believes that it is unlikely that any identified matters, either individually or in the aggregate, will have a material adverse effect on BNSF's consolidated financial position or liquidity.
The railroad industry, including BNSF Railway, is subject to future requirements regulating air emissions from diesel locomotives. Final regulations applicable to new and rebuilt locomotive engines were promulgated by the United States Environmental Protection Agency (EPA) and became effective June 15, 1998. The new standards will be phased in between 2000 and 2005. BNSF Railway has evaluated compliance requirements and associated costs and believes the costs will not be material in any given year. BNSF Railway has also entered into agreements with the California State Air Resources Board and the EPA regarding a program to reduce emissions in Southern California through accelerated deployment of locomotives which comply with the federal standards.
OTHER CLAIMS AND LITIGATION
BNSF Railway is party to a number of legal actions and claims, various governmental proceedings and private civil suits arising in the ordinary course of business, including those related to environmental matters and personal injury claims. While the final outcome of these items cannot be predicted with certainty, considering among other things the meritorious legal defenses available, it is the opinion of management that none of these items, when finally resolved, will have a material adverse effect on the annual results of operations, financial position or liquidity of BNSF Railway, although an adverse resolution of a number of these items could have a material adverse effect on the results of operations in a particular quarter or fiscal year.
13. RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFIT PLANS
BNSF Railway is included with certain other BNSF affiliates in the qualified BNSF Retirement Plan and the nonqualified BNSF Supplemental Retirement Plan.
BNSF sponsors two significant defined benefit pension plans: the noncontributory qualified BNSF Retirement Plan, which covers substantially all non-union employees, and the nonqualified BNSF Supplemental Retirement Plan, which covers certain officers and other employees. The benefits under BNSF's plans are based on years of credited service and the highest five-year average compensation levels. BNSF Railway's funding policy is to contribute annually not less than the regulatory minimum and not more than the maximum amount deductible for income tax purposes.
Certain salaried employees of BNSF Railway that have met certain age and years of service requirements are eligible for medical benefits and life insurance coverage during retirement. The retiree medical plan is contributory and provides benefits to retirees, their covered dependents and beneficiaries. Retiree contributions are adjusted annually. The plan also contains fixed deductibles, coinsurance and out-of-pocket limitations. The life insurance plan is noncontributory and covers retirees only. BNSF Railway's policy is to fund benefits payable under the medical and life insurance plans as they come due. Employees beginning salaried employment with BNSF Railway subsequent to September 22, 1995 are not eligible for benefits under these plans.
Components of the net benefit costs for these plans were as follows (in millions):
The following tables show the change in benefit obligation and plan assets of these plans (in millions):
The following tables show the reconciliation of the funded status of these plans with amounts recorded in BNSF Railway's consolidated balance sheet (in millions):
BNSF Railway uses a September 30 measurement date. The assumptions used in accounting for these plans were as follows:
For purposes of the medical and life benefits calculations for 1998, the assumed health care cost trend rate for both managed care and non-managed care medical costs is 9 percent and is assumed to decrease gradually to 5 percent by 2005 and remain constant thereafter. Increasing the assumed health care cost trend rates by one percentage point would increase the accumulated postretirement benefit obligation by $18 million and the combined service and interest components of net postretirement benefit cost recognized in 1998 by $1 million. Decreasing the assumed health care cost trend rates by one percentage point would decrease the accumulated postretirement benefit obligation by $17 million and the combined service and interest components of net postretirement benefit cost recognized in 1998 by $1 million.
OTHER PLANS
Under collective bargaining agreements, BNSF Railway participates in multiemployer benefit plans which provide certain postretirement health care and life insurance benefits for eligible union employees. Insurance premiums paid attributable to retirees, which are generally expensed as incurred, were $18 million, $15 million and $14 million, in 1998, 1997 and 1996, respectively.
DEFINED CONTRIBUTION PLANS
BNSF Railway sponsors 401(k) thrift and profit sharing plans which cover substantially all non-union employees and certain union employees. BNSF Railway matches 50 percent of the first 6 percent of non-union employees' contributions, which are subject to certain percentage limits of the employees' earnings, at each pay period. Depending on BNSF Railway's performance, an additional matching contribution of up to 30 percent of the first 6 percent can be made at the end of the year. Employer contributions for all non-union employees are subject to a five year length of service vesting schedule. BNSF Railway's 401(k) matching expense was $16 million, $14 million and $13 million in 1998, 1997 and 1996, respectively.
14. RELATED PARTY TRANSACTIONS
BNSF Railway is involved with BNSF and certain of its subsidiaries in related party transactions in the ordinary course of business, which include payments made on each other's behalf and performance of services. Under the terms of a tax allocation agreement with BNSF, BNSF Railway made federal and state income tax payments of $113 million during 1998 and $232 million during 1997, which are reflected in changes in working capital in the consolidated statement of cash flows.
BNSF Railway had a net intercompany receivable balance of $86 million at December 31, 1998, which is reflected in accounts receivable, net in the consolidated balance sheet. BNSF Railway had a net intercompany payable balance of $135 million at December 31, 1997, which is reflected in accounts payable and other current liabilities in the consolidated balance sheet. Net intercompany receivable or payable balances are settled in the ordinary course of business.
BNSF Railway had intercompany notes payable to BNSF of $2,288 million and $2,063 million at December 31, 1998 and 1997, respectively, included in the consolidated balance sheet. At December 31, 1998, $1,579 million of the intercompany notes payable had a fixed interest rate of 6.9 percent and $709 million had a variable interest rate of 1.0 percent above the monthly average of the daily effective Federal Funds rate. During 1998, BNSF Railway had borrowings from BNSF of $225 million which was primarily used to fund capital expenditures and other investing activities. Interest is paid semi-annually on all intercompany notes payable. Interest expense on intercompany notes payable is reflected in interest expense, related parties in the consolidated income statement. The intercompany notes are due on demand; however, it is not anticipated that BNSF Railway will be required to pay these obligations in 1999.
SFP Pipelines Holdings, Inc. had a $130 million intercompany note receivable from SFP. During 1997, BNSF assumed the note payable from SFP and SFP recognized the assumption as a capital contribution from BNSF.
Under various plans, BNSF has granted options to employees to purchase its common stock at a price not less than the fair market value at the date of grant. Certain employees of BNSF Railway participate in these plans. In addition, BNSF has other long-term incentive plans administered separately on behalf of employees which are participated in by certain BNSF Railway employees. These plans include, among other things, incentive compensation, issuance of restricted stock and a discounted stock purchase program. Compensation expense is recorded for stock incentive plans in accordance with Accounting Principles Board Opinion 25 and was not material in 1998, 1997 or 1996.
15. QUARTERLY FINANCIAL DATA - UNAUDITED
(1) Amounts do not agree to previously reported amounts due to certain reclassifications between revenues and expenses which were not significant. (2) First quarter 1998 results include a $67 million pre-tax gain ($32 million after-tax) on the sale of substantially all of the Company's interest in Santa Fe Pacific Pipeline Partners, L.P. as discussed in Note 2-Sale of Investment in Pipeline Partnership. (3) Fourth quarter 1997 results include a $90 million pre-tax charge ($57 million after-tax) as discussed in Note 9-Employee Merger and Separation Costs.
SCHEDULE II
THE BURLINGTON NORTHERN AND SANTA FE RAILWAY COMPANY VALUATION AND QUALIFYING ACCOUNTS For the years ended December 31, 1998, 1997, and 1996 (In Millions)
NOTES:
(1) Principally represents cash payments. (2) Classified in the consolidated balance sheets as follows:
THE BURLINGTON NORTHERN AND SANTA FE RAILWAY COMPANY
INDEX OF EXHIBITS
E-1