| UNITED STATES SECURITIES AND EXCHANGE  COMMISSION |
|---------------------------------------------------|
| Washington, D.C. 20549                       |

 

 
|     | **FORM 10-Q**                                                        |
|----------|----------------------------------------------------------------------|
|     |                                                                 |
| (X)      | QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  |
|     | EXCHANGE  ACT OF 1934                                                |
|     | For  the quarterly period ended **MARCH 31, 2003**                   |
|     |                                                                 |
| ( ) | TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES |
|     | EXCHANGE  ACT OF 1934                                                |
|     | For  the transition period from __________ to __________             |
|     | Commission file numbers 1-743; 1-3744;  1-4793; 1-546-2              |

** **

** **

 

 

 

 
| **NORFOLK SOUTHERN RAILWAY  COMPANY**                       |
|-------------------------------------------------------------|
| (Exact name of registrant as specified  in its charter)**** |

** **

 
| **Virginia**                                              | **53-6002016**                     |
|-----------------------------------------------------------|------------------------------------|
| (State  or other jurisdiction of                          | (IRS  Employer Identification No.) |
| incorporation  or organization)                           |                               |
|                                                      |                               |
|                                                      |                               |
| **Three  Commercial Place**                               |                               |
| **Norfolk,  Virginia**                                    | **23510-2191**                     |
| (Address  of principal executive offices)                 | Zip  Code                          |
|                                                      |                               |
| Registrant's  telephone number, including area code       | **(757)  629-2680**                |
|                                                      |  ****                         |
| **No Change**                                             |
| (Former  name, former address and former fiscal year,**** |
| if  changed since last report.)****                       |

 

 
| 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.                                                                       | (X) Yes    | (  ) No |
|                                                                                                                |   |   |
| Indicate by check mark  whether registrant is an accelerated filer (as defined in Rule 12b-2 of The  Exchange Act). |
|                                                                                                                | (  ) Yes    | (X) No |
|                                                                                                                |   |   |
| The number of shares  outstanding of each of the registrant's classes of Common Stock, as of the  last              |
| practicable date:                                                                                                   |
|                                                                                                                |   |
| **Class**                                                                                                           | **Outstanding as of March 31, 2003** |
| Common  Stock (par value $1.00)                                                                                     | 16,668,997 |
|                                                                                                                |   |
|                                                                                                                     |  |  |  |

**TABLE OF CONTENTS**

 
|                          |                   |                                           | **Page** |
|-------------------------------|------------------------|------------------------------------------------|----------|
|                          |                   |                                           |     |
| Part I.                       | Financial information: |
|                          |                   |                                           |     |
|                          | Item 1.                | Financial statements:                          |     |
|                          |                   |                                           |     |
|                          |                   | Consolidated Statements of Income              | 3        |
|                          |                   | Three Months Ended March 31, 2003 and  2002    |
|                          |                   |                                           |     |
|                          |                   | Consolidated Balance Sheets                    | 4        |
|                          |                   | March 31, 2003 and Dec. 31, 2002               |     |
|                          |                   |                                           |     |
|                          |                   | Consolidated Statements of Cash Flows          | 5        |
|                          |                   | Three Months Ended March 31, 2003 and  2002    |
|                          |                   |                                           |     |
|                          |                   | Notes to Consolidated Financial  Statements    | 6        |
|                          |                   |                                           |     |
|                          |                   | Independent Accountants' Review Report         | 12       |
|                          |                   |                                           |     |
|                          | Item 2.                | Management's Discussion and Analysis of        | 13       |
|                          |                   | Financial Condition and Results of  Operations |
|                          |                   |                                           |     |
|                          | Item 3.                | Quantitative and Qualitative Disclosures       | 19       |
|                          |                   | About Market Risks                             |     |
|                          |                   |                                           |     |
|                          | Item 4.                | Controls and Procedures                        | 19       |
|                          |                   |                                           |     |
| Part II.                      | Other Information:     |                                           |
|                          |                   |                                           |     |
|                          | Item 6.                | Exhibits and Reports on Form 8-K               | 20       |
|                          |                   |                                           |     |
| Signatures                    |                   |                                           | 21       |
|                          |                   |                                           |     |
| Certifications of CEO and CFO | 22                     |
|                          |                   |                                           |     |
| Exhibit Index                 |                   | 24                                             |
|                               |                        |                                                |          |  |  |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2

**PART I. FINANCIALINFORMATION**

 

 

**Item 1. FinancialStatements.**

 

** **

**NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AMajority-Owned Subsidiary of Norfolk Southern Corporation [NS])**

**Consolidated Statements of Income**

**($ inmillions)**

**(Unaudited)**

 

 

|                                                                                                    | **Three Months Ended** |
|---------------------------------------------------------------------------------------------------------|------------------------|
|                                                                                                    | **March 31,**          |
|                                                                                                    | **2003**               | **2002** |
|                                                                                                    |                   |   |   |   |
| ***Railway  operating revenues***                                                                       |                   |   |   |   |
|   Coal                                                                                        | $                      | 354  | $ | 359  |
|   General merchandise                                                                         |                   | 918  |   | 869  |
|   Intermodal                                                                                  |                   | 247  |   | 229  |
|                                                                                                    |                   |   |   |   |
| **     Total Railway Operating Revenues**                                      |                   | 1,519  |   | 1,457  |
|                                                                                                    |                   |   |   |   |
| ***Railway  operating expenses***                                                                       |                   |   |   |   |
|   Compensation and benefits                                                                   |                   | 400  |   | 383  |
|   Materials, services and  rents                                                              |                   | 459  |   | 453  |
|   Conrail rents and services  (Note 2)                                                        |                   | 119  |   | 121  |
|   Depreciation                                                                                |                   | 123  |   | 123  |
|   Diesel fuel                                                                                 |                   | 104  |   | 81  |
|   Casualties and other claims                                                                 |                   | 51  |   | 35  |
|   Other                                                                                       |                   | 74  |   | 61  |
|                                                                                                    |                   |   |   |   |
|      Total  Railway Operating Expenses                                         |                   | 1,330  |   | 1,257  |
|                                                                                                    |                   |   |   |   |
|         Income  from railway operations                         |                   | 189  |   | 200  |
|                                                                                                    |                   |   |   |   |
| Other income (expense) - net                                                                            |                   | (51) |   | (52) |
| Interest expense on debt                                                                                |                   | (7) |   | (9) |
|                                                                                                    |                   |   |   |   |
|         Income before  income taxes and accounting changes |                   | 131  |   | 139  |
|                                                                                                    |                   |   |   |   |
| Provision for income taxes                                                                              |                   | 51  |   | 54  |
|                                                                                                    |                   |   |   |   |
|          Income  before accounting changes                 |                   | 80  |   | 85  |
|                                                                                                    |                   |   |   |   |
| Cumulative effect of changes in  accounting principles, net of taxes (Note 1)                           |                   | 104  |   | --  |
|                                                                                                    |                   |   |   |   |
|          Net income                                        | $                      | 184  | $ | 85  |
|                                                                                                    |                   |   |   |   |
| *See accompanying  notes to consolidated financial statements.*                                         |                   |   |   |   |

 

 

 

 

 

 

 

3

**NORFOLK SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AMajority-Owned Subsidiary of Norfolk Southern Corporation [NS])**

**Consolidated Balance Sheets**

**($ inmillions)**

**(Unaudited)**

** **

 

|                                                                            | **March 31,** | **Dec. 31,** |
|---------------------------------------------------------------------------------|---------------|--------------|
|                                                                            | **2003**      | **2002**     |
| ***Assets***                                                                    |          |         |   |   |
| Current assets:                                                                 |          |         |   |   |
|    Cash  and cash equivalents                                    | $             | 63           | $ | 130 |
|    Accounts  receivable, net (Note 2)                            |          | 119          |   | 117 |
|    Due  from Conrail (Note 2)                                    |          | 3            |   | 6 |
|    Materials  and supplies                                       |          | 98           |   | 95 |
|    Deferred  income taxes                                        |          | 179          |   | 174 |
|    Other  current assets                                         |          | 108          |   | 131 |
|       Total  current assets                       |          | 570          |   | 653 |
|                                                                            |          |         |   |   |
| Investments (Note 4)                                                            |          | 693          |   | 703 |
| Properties less  accumulated depreciation                                       |          | 11,157       |   | 10,837 |
| Other assets                                                                    |          | 663          |   | 660 |
|       Total  assets                               | $             | 13,083       | $ | 12,853 |
|                                                                            |          |         |   |   |
| ***Liabilities and Stockholders' Equity***                                      |          |         |   |   |
| Current liabilities:                                                            |          |         |   |   |
|    Accounts  payable                                             | $             | 852          | $ | 860 |
|    Income  and other taxes                                       |          | 184          |   | 187 |
|    Due  to NS - net (Note 2)                                     |          | 193          |   | 384 |
|    Due  to Conrail (Note 2)                                      |          | 78           |   | 86 |
|    Other  current liabilities                                    |          | 126          |   | 122 |
|    Current  maturities of long-term debt                         |          | 102          |   | 94 |
|       Total  current liabilities                  |          | 1,535        |   | 1,733 |
|                                                                            |          |         |   |   |
| Long-term debt                                                                  |          | 879          |   | 763 |
| Other liabilities                                                               |          | 949          |   | 971 |
| Due to Conrail (Note  2)                                                        |          | 594          |   | 513 |
| Minority interests                                                              |          | 9            |   | 3 |
| Deferred income  taxes                                                          |          | 4,141        |   | 4,057 |
|       Total  liabilities                          |          | 8,107        |   | 8,040 |
|                                                                            |          |         |   |   |
| Stockholders'  equity:                                                          |          |         |   |   |
|    Serial  preferred stock                                       |          | 55           |   | 55 |
|    Common  stock                                                 |          | 167          |   | 167 |
|    Additional  paid-in capital                                   |          | 709          |   | 709 |
|    Accumulated  other comprehensive income (Note 4)              |          | 246          |   | 266 |
|    Retained  income                                              |          | 3,799        |   | 3,616 |
|       Total  stockholders' equity                 |          | 4,976        |   | 4,813 |
|                                                                            |          |         |   |   |
|       Total  liabilities and stockholders' equity | $             | 13,083       | $ | 12,853 |
|                                                                            |          |         |   |   |
| *See accompanying notes to consolidated financial statements.*                  |

 

 

 

4**NORFOLKSOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AMajority-Owned Subsidiary of Norfolk Southern Corporation [NS])**

**Consolidated Statements of Cash Flows**

**($ inmillions)**

**(Unaudited)**

** **

 

|                                                                                                                                 | **Three Months Ended** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------------------|
|                                                                                                                                 | **March 31,**          |
|                                                                                                                                 | **2003**               | **2002** |
| ***Cash  flows from operating activities***                                                                                          |                   |   |   |   |
|    Net income                                                                                                         | $                      | 184  | $ | 85  |
|    Reconciliation of net  income to net cash provided by operating activities:                                        |                   |   |   |   |
|         Net cumulative effect of changes in accounting  principles                           |                   | (104) |   | --  |
|          Depreciation                                                                   |                   | 124  |   | 124  |
|          Deferred  income taxes                                                         |                   | 24  |   | 29  |
|          Gains  and losses on properties and investments                                |                   | (2) |   | (10) |
|          Changes  in assets and liabilities affecting operations:                       |                   |   |   |   |
|             Accounts  receivable                                         |                   | (2) |   | 26  |
|             Materials  and supplies                                      |                   | (3) |   | (4) |
|             Other  current assets and due from Conrail                   |                   | 22  |   | 27  |
|             Income  tax liabilities                                      |                   | 12  |   | (1) |
|             Other  short-term liabilities                                |                   | (25) |   | (43) |
|             Other  - net                                                 |                   | (26) |   | (52) |
|                Net  cash provided by operating activities |                   | 204  |   | 181  |
|                                                                                                                                 |                   |   |   |   |
| ***Cash  flows from investing activities***                                                                                          |                   |   |   |   |
|    Property additions                                                                                                 |                   | (104) |   | (179) |
|    Property sales and  other transactions                                                                             |                   | (3) |   | (9) |
|    Investments,  including short-term                                                                                 |                   | (20) |   | (22) |
|                Net  cash used for investing activities    |                   | (127) |   | (210) |
|                                                                                                                                 |                   |   |   |   |
| ***Cash  flows from financing activities***                                                                                          |                   |   |   |   |
|    Dividends                                                                                                          |                   | (1) |   | (1) |
|    Advances to NS                                                                                                     |                   | (192) |   | (112) |
|    Advances and  repayments from NS                                                                                   |                   | 1  |   | 2  |
|    Proceeds from  borrowings                                                                                          |                   | 87  |   | 133  |
|    Debt repayments                                                                                                    |                   | (39) |   | (40) |
|                Net  cash used for financing activities    |                   | (144) |   | (18) |
|                                                                                                                                 |                   |   |   |   |
|                Net  decrease in cash and cash equivalents |                   | (67) |   | (47) |
|                                                                                                                                 |                   |   |   |   |
| ***Cash  and cash equivalents***                                                                                                     |                   |   |   |   |
|    At beginning of year                                                                                               |                   | 130  |   | 167  |
|                                                                                                                                 |                   |   |   |   |
|    At end of period                                                                                                   | $                      | 63  | $ | 120  |
|                                                                                                                                 |                   |   |   |   |
| ***Supplemental  disclosures of cash flow information***                                                                             |                   |   |
|    Cash paid during the  period for:                                                                                  |                   |   |   |   |
|       Interest  (net of amounts capitalized)                                                           | $                      | 9  | $ | 13  |
|       Income  taxes                                                                                    | $                      | 14  | $ | 27  |
|                                                                                                                                 |                   |   |   |   |
| *See accompanying  notes to consolidated financial statements.*                                                                      |

 

 

5**NORFOLKSOUTHERN RAILWAY COMPANY AND SUBSIDIARIES (NS RAIL)**

**(AMajority-Owned Subsidiary of Norfolk Southern Corporation [NS])**

**Notesto Consolidated Financial Statements**

**(Unaudited)**

 

 

In the opinion of management, the accompanyingunaudited interim financial statements contain all adjustments (consisting ofnormal recurring accruals) necessary to present fairly the Company's financialposition as of March 31, 2003, its results of operations for the three monthsended March 31, 2003 and 2002, and its cash flows for the three months endedMarch 31, 2003 and 2002.

 

Although management believes that thedisclosures presented are adequate to make the information not misleading,these Consolidated Financial Statements should be read in conjunctionwith: (a) the financial statementsand notes included in the Company's latest Annual Report on Form 10-K and(b) any Current Reports on Form 8-K.

 

**1. Changes in Accounting Principles**

 

NS Rail adoptedFinancial Accounting Standards Board (FASB) Statement No. 143, "Accounting forAsset Retirement Obligations," (SFAS No. 143) effective Jan. 1, 2003, andrecorded a $100 million net adjustment ($165 million before taxes)for the cumulative effect of this change in accounting on years prior to2003. Pursuant to SFAS No. 143,the cost to remove crossties must be recorded as an expense when incurred;previously these removal costs were accrued as a component ofdepreciation. This change in accountingin the first quarter of 2003 lowered depreciation expense by almost $7 million (because the depreciation rate for crosstiesno longer reflects cost to remove) and increased compensation and benefits andother expenses by almost $5 million (for the costs to remove retired assets).

 

NS Rail alsoadopted FASB Interpretation No. 46, "Consolidation of Variable InterestEntities," (FIN No. 46) effective Jan. 1, 2003, and recorded a $4 millionnet adjustment ($6 million before taxes) for the cumulative effect of thischange in accounting on years prior to 2003. Pursuant to FIN No. 46, NS Rail has consolidated a special-purposeentity that leases certain locomotives to NS. This entity's assets and liabilities at Jan. 1, 2003, included $169million of locomotives and $157 million of debt related to their purchase aswell as a $6 million minority interest liability. This change in accounting in the first quarter of 2003 increaseddepreciation and interest expense (to reflect the locomotives as owned assets)and lowered lease expense. The neteffect to total railway operating expenses and net income was not material.

 

**2. Related Parties**

 

## **General**

 

NS is the parent holding company of NSR. Rail operations are coordinated at theholding company level by the NS Vice Chairman and Chief Operating Officer. NS charges NS Rail a fee for managementservices it performs for NS Rail (which totaled $134 million and included an $8million mark-up in the first quarter of 2003 and totaled $146 million andincluded a $9 million mark-up in the first quarter of 2002). In addition, NS charges NS Rail arevenue-based licensing fee for use of certain intangible assets owned byNS. This fee amounted to $21 million ineach of the first quarters of 2003 and 2002.

 

NS Rail owns 21,169,125 shares of NScommon stock.

 

## **Operations Over Conrail's Lines**

 

**Overview** -- Through a limited liability company,NS and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primarysubsidiary is Consolidated Rail Corporation (CRC), the major freight railroadin the Northeast. NS has a 58% economicand 50% voting interest in the jointly owned entity, and CSX has the remainderof the economic and voting interests.

 

6

**Operations of Conrail's Lines** -- NSR operates as a part of its railsystem the routes and assets of Pennsylvania Lines LLC (PRR), a wholly ownedsubsidiary of CRC, pursuant to operating and lease agreements. CSX Transportation,Inc. (CSXT) operates the routes and assets of another CRC subsidiary undercomparable terms.

 

TheOperating Agreement between NSR and PRR governs substantially all nonequipmentassets to be operated by NSR and has an initial 25-year term, renewable at theoption of NSR for two five-year terms. Payments under the Opera-ting Agreementare subject to adjustment every six years to reflect changes in values. NSRalso has leased or subleased for varying terms from PRR a number of equipmentassets. Costs necessary to operate and maintain the PRR assets, includingleasehold improvements, are borne by NSR. NSR receives all freight revenues onthe PRR lines.

 

NSRand CSXT also have entered into agreements with CRC governing other propertiesthat continue to be owned and operated by CRC (the Shared Assets Areas). NSRand CSXT pay CRC a fee for joint and exclusive access to the Shared AssetsAreas. In addition, NSR and CSXT pay, based on usage, the costs incurred by CRCto operate the Shared Assets Areas.

 

NS Rail's Consolidated Balance Sheet at March31, 2003, includes $50 million of liabilities related to the Conrailtransaction, principally for contractual obligations to Conrail employeesimposed by the Surface Transportation Board when it approved the transaction. Through March 31, 2003, NS Rail has paid$133 million of these costs.

 

NS Rail provides certain general andadministrative support functions to Conrail, the fees for which are billed inaccordance with several service-provider arrangements and amount toapproximately $7 million annually.

 

"Conrail rents and services" includesexpenses for amounts due to PRR and CRC for use by NSR of operating propertiesand equipment and operation of the Shared Assets Areas.

 

A significant portion of payments made to PRR isborrowed back from a subsidiary of PRR under a note due in 2032. Amounts outstanding under the note comprisethe long-term balance of "Due to Conrail." The interest rate for these loans is variable and was 1.56% atMarch 31, 2003. The current balance"Due to Conrail" is composed of amounts related to expenses includedin "Conrail rents and services," as discussed above.

 

### **Sales of Accounts Receivable**

 

NS Rail sells, without recourse, to abankruptcy-remote special-purpose NS subsidiary, a pool of accountsreceivable. NS Rail services andcollects all of the sold receivables on behalf of the buyers; however, noservicing asset or liability has been recognized because the benefits ofservicing are estimated to be just adequate to compensate NS Rail for itsresponsibilities. Payments collectedfrom sold receivables are remitted to the special-purpose NS subsidiary, which,in turn, reinvests the amounts by purchasing new receivables from NS Rail. NS Rail has no retained interest in the soldreceivables.

 

Under the terms of the new sale agreement, thereceivables are treated as sold and, accordingly, $585 million at March31, 2003, and $513 million at Dec. 31, 2002, of sold receivables are notincluded on the NS Rail Consolidated Balance Sheets. Fees associated with the sale, which arebased on historical dilution and prevailing interest rates, are included in"Other income (expense) - net."

** **

** **

** **

** **

** **

** **

** **

** **

7

**Intercompany Accounts**

 

|                                     | **March 31, 2003** | **Dec. 31, 2002** |
|------------------------------------------|--------------------|-------------------|
|                                     |  ****         |  ****        | **Average** |  **** |  **** | **Average** |
|                                     |  ****         |  ****        | **Interest** |  **** |  **** | **Interest** |
|                                     | **Balance**        | **Rate**          | **Balance** | **Rate** |
|                                     | *($ in millions)*  |
|                                     |               |              |   |   |   |   |
|   Advances due from NS         | $                  | 85           | 2% | $ | 68  | 2% |
|                                     |               |              |   |   |   |   |
|   Advances and notes due to NS |               | (278)             | 3% |   | (452) | 2% |
|                                     |               |              |   |   |   |   |
|   Due to NS - net              | $                  | (193)             |   | $ | (384) |   |

 

Interest is applied to certain advances at theaverage NS yield on short-term investments and to the notes at specifiedrates. NS Rail's results for the threemonths ended March 31 include interest income of $2 million in 2003 and $3million in 2002 and interest expense of $2 million in 2003 and $3 million in2002 related to these intercompany accounts. These amounts are included in "Other income (expense) - net."

 

### **Intercompany Federal Income Tax Accounts**

 

In accordance with the NS Tax AllocationAgreement, intercompany federal income tax accounts are recorded betweencompanies in the NS consolidated group. NS Rail had long-term intercompany federal income tax payables(which are included in "Deferred income taxes" in the ConsolidatedBalance Sheets) of $941 million at March 31, 2003, and $938 millionat Dec. 31, 2002.

 

**3. Derivative Financial Instruments**

 

NS Rail uses derivative financial instruments toreduce the risk of volatility in its diesel fuel costs and to manage itsoverall exposure to fluctuations in interest rates. NS Rail does not engage in the trading of derivatives. NS Rail's management has determined that itsderivative financial instruments qualify as either fair-value or cash-flowhedges, having values which highly correlate with the underlying hedgedexposures, and has designated such instruments as hedging transactions. Credit risk related to the derivativefinancial instruments is considered to be minimal and is managed by requiringhigh credit standards for counterparties and periodic settlements.

 

**Diesel Fuel Hedging**

 

Inthe second quarter of 2001, NS Rail began a program to hedge a portion of itsdiesel fuel consumption. The intent of the program is to assist in themanagement of NS Rail's aggregate risk exposure to fuel price fluctuations,which can significantly affect NS Rail's operating margins and profitability.In order to minimize this risk, NS Rail instituted a continuous hedgingstrategy for a portion of its estimated future fuel needs by entering into aseries of swaps in order to lock in the purchase prices of some of its dieselfuel. Management has designated these derivative instruments as cash-flowhedges of the exposure to variability in expected future cash flowsattributable to fluctuations in diesel fuel prices.

 

Followingis a summary of NS Rail's diesel fuel swaps:

 

|                                                                                                       |             | **First Quarter** |
|------------------------------------------------------------------------------------------------------------|------------------|-------------------|
|                                                                                                       |             | **2003**          | **2002** |
| Number  of swaps entered into during the first quarter                                                     |             | 72                | 72 |
| Approximate  number of gallons hedged (millions)                                                           |             | 94                | 101 |
| Approximate  average price per gallon of Nymex                                                             |             |   $0.74      |  $0.61 |
|    No.  2 heating oil                                                                       |             |              |   |
|                                                                                                       | **Remainder of** |              |   |
|                                                                                                       | **2003**         | **2004**          | **2005** |
| Percent  of estimated future diesel fuel consumption

   covered  as of March 31, 2003 | 68%              | 33%               | 2% |
|                                                                                                            |                  |                   |  |  |  |

 

 

8

Hedgesare placed each month by competitive bid among selected counterparties. Thegoal of this hedging strategy is to average fuel costs over an extended periodof time while minimizing the incremental cost of hedging. The program providesthat NS Rail will not enter into any fuel hedges with a duration of more than36 months, and that no more than 80% of NS Rail's average monthly fuelconsumption will be hedged for any month within the 36-month period. Dieselfuel costs represented 8% and 6% of NS Rail's operating expenses for the firstquarters of 2003 and 2002, respectively.

 

NS Rail's fuelhedging activity resulted in a net decrease in diesel fuel expense of $26million for first quarter 2003 and a net increase in diesel fuel expense of $4million for first quarter 2002. Theeffect of the hedges was to yield average costs of 75 cents per gallon for thefirst quarter of 2003 and 70 cents per gallon for the same period of 2002,including federal taxes and transportation. Ineffectiveness, or the extent to which changes in the fair values ofthe heating oil contracts do not offset changes in the fair values of theexpected diesel fuel oil transactions, was approximately $1 million for eachquarter.

 

**Interest Rate Hedging**

 

NS Rail manages its overall exposure tofluctuations in interest rates by issuing both fixed and floating-rate debtinstruments, and by entering into interest rate hedging transactions. NS Rail had $211 million, or 34.9%, and$220 million, or 35.4%, of its fixed rate debt portfolio hedged at March31, 2003, and Dec. 31, 2002, respectively, using interest rate swaps thatqualify for and are designated as fair-value hedge transactions. These swaps have been effective in hedgingthe changes in fair value of the related debt arising from changes in interestrates, and accordingly, there has been no impact on earnings resulting fromineffectiveness associated with these derivative transactions.

 

**Fair Values**

 

The fair values of NS Rail's diesel fuelderivative instruments at March 31, 2003 and Dec. 31, 2002, were determinedbased upon current fair market values as quoted by third party dealers. Fair values of interest rate swaps weredetermined based upon the present value of expected future cash flowsdiscounted at the appropriate implied spot rate from the spot rate yieldcurve. Fair value adjustments arenon-cash transactions, and accordingly, are excluded from the ConsolidatedStatement of Cash Flows. "Accumulated other comprehensive loss," a component of"Stockholders' equity," included unrealized gains of $23 million and$29 million (pretax) at March 31, 2003, and Dec. 31, 2002, respectively,related to the fair value of derivative fuel hedging transactions that willterminate within twelve months of the respective dates.

 

The asset and liability positions of NS Rail'soutstanding derivative financial instruments were as follows:

 

|                                                | **March 31,**     | **Dec. 31,** |
|-----------------------------------------------------|-------------------|--------------|
|                                                | **2003**          | **2002**     |
|                                                | *($ in millions)* |
| Interest  rate hedges:                              |              |         |   |   |
|   Gross  fair market asset position       | $                 | 22      | $ | 24  |
|   Gross  fair market (liability) position |              | --      |   | --  |
|                                                |              |         |   |   |
| Fuel  hedges:                                       |              |         |   |   |
|   Gross  fair market asset position       |              | 27      |   | 29  |
|   Gross  fair market (liability) position |              | (2)          |   | --  |
|                                                |              |         |   |   |
| Total  net asset position                           | $                 | 47      | $ | 53  |

 

** **

** **

** **

** **

** **

** **

9

**4. Comprehensive Income**

 

 

NS Rail's total comprehensive income was asfollows:

 

|                              | **Three Months Ended** |
|-----------------------------------|------------------------|
|                              | **March 31,**          |
|                              | **2003**               | **2002** |
|                              | *($ in millions)*      |
|                              |                   |   |   |   |
| Net income                        | $                      | 184  | $ | 85  |
| Other comprehensive income (loss) |                   | (20) |   | 95  |
|                              |                   |   |   |   |
| Total comprehensive income        | $                      | 164  | $ | 180  |

 

For NS Rail, "Other comprehensiveincome (loss)" is the unrealized gains and losses on certain investmentsin debt and equity securities, principally NS common stock, and net fair valueadjustments to certain derivative financial instruments.

 

**5. Commitments and Contingencies**

 

**Lawsuits**

 

NSR and certainsubsidiaries are defendants in numerous lawsuits and other claims relatingprincipally to railroad operations. When management concludes that it isprobable that a liability has been incurred and the amount of the liability canbe reasonably estimated, it is accrued through a charge to expenses. While the ultimate amount of liability incurredin any of these lawsuits and claims is dependent on future developments, inmanagement's opinion the recorded liability is adequate to cover the futurepayment of such liability and claims. However, the final outcome of any of these lawsuits and claims cannot bepredicted with certainty, and unfavorable or unexpected outcomes could resultin additional accruals that could be significant to results of operations in aparticular year or quarter. Anyadjustments to recorded liability will be reflected in expenses in the periodsin which such adjustments are known.

 

Presently, there arematters involving labor arbitration and other claims for "New YorkDock" and other income protection benefits where the aggregated range ofloss could be from zero to $40 million. Management believes that NS Rail willprevail in these matters; however, an unfavorable outcome could result inaccruals that could be significant to results of operations in a particularyear or quarter.

 

**Casualty Claims**

 

NS Rail is generally self-insured forcasualty claims. NS Rail has insurance for catastrophic events, but thatcoverage has upper limits. The casualty claims liability is determinedactuarially, based upon claims filed and an estimate of claims incurred but notyet reported. While the ultimate amount of claims incurred is dependent onfuture developments, in management's opinion, the recorded liability isadequate to cover the future payments of claims. However, it is possible thatthe recorded liability may not be adequate to cover the future payments ofclaims. Adjustments to the recorded liability are reflected in operatingexpenses in the periods in which such adjustments are known.

 

**Environmental Matters**

 

NS Rail is subject tovarious jurisdictions' environmental laws and regulations. It is NS Rail'spolicy to record a liability where such liability or loss is probable and itsamount can be estimated reasonably. Claims, if any, against third parties forrecovery of cleanup costs incurred by NS Rail are reflected as receivables(when collection is probable) in the balance sheet and are not netted againstthe associated NS Rail liability. Environmental engineers regularly participatein ongoing evaluations of all identified sites and in determining any necessaryadjustments to liability estimates. NS Rail also has established anEnvironmental Policy Council, composed of senior managers, to oversee andinterpret its environmental policy.

 

 

10

NS Rail's balancesheets included liabilities for environmental exposures in the amount of $28million at March 31, 2003, and $29 million at Dec. 31, 2002 (of which $8million was accounted for as a current liability for each period). At March 31,2003, the liability represented NS Rail's estimate of the probable cleanup andremediation costs based on available information at 113 identified locations.On that date, 10 sites accounted for $15 million of the liability, and noindividual site was considered to be material. NS Rail anticipates that much ofthis liability will be paid out over five years; however, some costs will be paidout over a longer period.

 

At some of the 113 locations, certain NS Railsubsidiaries, usually in conjunction with a number of other parties, have beenidentified as potentially responsible parties by the Environmental ProtectionAgency (EPA) or similar state authorities under the Comprehensive EnvironmentalResponse, Compensation and Liability Act of 1980, or comparable state statutes,which often impose joint and several liability for cleanup costs.

 

With respect to knownenvironmental sites (whether identified by NS Rail or by the EPA or comparablestate authorities), estimates of NS Rail's ultimate potential financialexposure for a given site or in the aggregate for all such sites arenecessarily imprecise because of the widely varying costs of currentlyavailable cleanup techniques, the likely development of new cleanuptechnologies, the difficulty of determining in advance the nature and fullextent of contamination and each potential participant's share of any estimatedloss (and that participant's ability to bear it) and evolving statutory andregulatory standards governing liability.

 

The risk of incurringenvironmental liability -- for acts and omissions, past, present and future -- isinherent in the railroad business. Some of the commodities in NS Rail's trafficmix, particularly those classified as hazardous materials, can pose specialrisks that NS Rail and its subsidiaries work diligently to minimize. Inaddition, several NS Rail subsidiaries own, or have owned, land used asoperating property, or which is leased or may have been leased and operated byothers, or held for sale. Because environmental problems may exist on theseproperties that are latent or undisclosed, there can be no assurance that NSRail will not incur environmentally related liabilities or costs with respectto one or more of them, the amount and materiality of which cannot be estimatedreliably at this time. Moreover, lawsuits and claims involving these andpotentially other now-unidentified environmental sites and matters are likelyto arise from time to time. The resulting liabilities could have a significanteffect on financial condition, results of operations or liquidity in aparticular year or quarter.

 

However, based on itsassessments of the facts and circumstances now known, management believes thatit has recorded the probable costs for dealing with those environmental mattersof which the Corporation is aware. Further, management believes that it isunlikely that any identified matters, either individually or in the aggregate,will have a material adverse effect on NS Rail's financial position, results ofoperations or liquidity.

 

**Purchase Commitments**

 

At March 31, 2003,NS Rail had outstanding purchase commitments of approximately $63 million inconnection with its 2003 capital program.

 

 

 

 

 

 

 

 

11

**IndependentAccountants' Review Report**

 

 

TheStockholders and Board of Directors

NorfolkSouthern Railway Company:

 

Wehave reviewed the accompanying consolidated balance sheet of Norfolk SouthernRailway Company and subsidiaries as of March 31, 2003, and the relatedconsolidated statements of income and cash flows for the three-month periodsended March 31, 2003 and 2002. Theseconsolidated financial statements are the responsibility of the Company'smanagement.

 

Weconducted our reviews in accordance with standards established by the AmericanInstitute of Certified Public Accountants. A review of interim financial information consists principally ofapplying analytical procedures and making inquiries of persons responsible forfinancial and accounting matters. It issubstantially less in scope than an audit conducted in accordance with auditingstandards generally accepted in the United States of America, the objective ofwhich is the expression of an opinion regarding the financial statements takenas a whole. Accordingly, we do notexpress such an opinion.

 

Basedon our reviews, we are not aware of any material modifications that should bemade to the consolidated financial statements referred to above for them to bein conformity with accounting principles generally accepted in the UnitedStates of America. 

 

Asdiscussed in Note 1 to the consolidated financial statements, the Companyadopted Financial Accounting Standards Board Statement No. 143, "Accounting forAsset Retirement Obligations," and Financial Accounting Standards BoardInterpretation No. 46, "Consolidation of Variable Interest Entities," as ofJanuary 1, 2003.

 

Wehave previously audited, in accordance with auditing standards generallyaccepted in the United States of America, the consolidated balance sheet ofNorfolk Southern Railway Company and subsidiaries as of December 31, 2002, andthe related consolidated statements of income, changes in stockholders' equityand cash flows for the year then ended (not presented herein); and in ourreport dated January 28, 2003, we expressed an unqualified opinion on thoseconsolidated financial statements. Inour opinion, the information set forth in the accompanying consolidated balancesheet as of December 31, 2002, is fairly stated, in all material respects, inrelation to the consolidated balance sheet from which it has been derived.

                                                                                                                                         

 

 

/s/KPMG LLP

Norfolk,Virginia

April22, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12

**Item 2. Management'sDiscussion and Analysis of Financial Condition and Results of Operations.**

** **

** **

**NORFOLKSOUTHERN railway company AND SUBSIDIARIES (NS RAIL)**

**(****A Majority-OwnedSubsidiary of Norfolk Southern Corporation [NS])**

**Management'sDiscussion and Analysis of Financial Condition and Results of Operations**

** **

** **

**RESULTS OF OPERATIONS**

 

### **Net Income**

 

First-quarternet income was $184 million in 2003, and included $104 million for thecumulative effect on years prior to 2003 of changes in accounting principles asrequired by the adoption of two accounting pronouncements (see Note 1). First-quarter income before accountingchanges was $80 million, down $5 million, or 6%, compared with results for thefirst quarter of 2002, reflecting lower income from railway operations.

 

### **Railway Operating Revenues**

 

First-quarter railway operating revenues were$1.52 billion in 2003, up $62 million, or 4%, compared with the first quarterof 2002. As shown in the following table, the increase was the result of highertraffic volume and increased average revenues.

 

|  
 

**First quarter**

 
 
 

**2003 vs. 2002**

 
 
 

**Increase (Decrease)**

 

*($ in millions)*

 
 
 

 

 

 
 
Traffic volume (carloads)

$

38 

 
 
Revenue per unit/mix

 

24 

 
 
     Total

$

62 

 
 

Revenues and carloads for the commodity groupswere as follows:

 

 

**First Quarter**

 

**Revenues**

**Carloads**

 

**2003**

**2002**

**2003**

**2002**

 

*($ in millions)*

*(carloads in  thousands)*

 

 

 

 

 

 

 

 

 

Coal

$

354

$

359

 

395

 

398

General merchandise:

 

 

 

 

 

 

 

 

   Automotive

 

242

 

228

 

167

 

163

   Chemicals

 

194

 

186

 

107

 

104

   Metals/construction

 

166

 

160

 

161

 

162

   Agr./consumer prod./govt.

 

166

 

154

 

133

 

125

   Paper/clay/forest

 

150

 

141

 

107

 

105

 

 

 

 

 

 

 

 

 

General merchandise

 

918

 

869

 

675

 

659

Intermodal

 

247

 

229

 

578

 

549

 

 

 

 

 

 

 

 

 

      Total

$

1,519

$

1,457

 

1,648

 

1,606

 

 

 

 

 

13

**Coal**

 

First-quarter coal revenues decreased $5million, or 1%, compared with last year. Total traffic volume (tonnage) handledwas down slightly for the quarter, as lower traffic volume for export, domesticmetallurgical and industrial coal more than offset higher traffic volume forutility coal. Export coal volume washampered by production shortfalls from a key supplier. Domestic metallurgical coal shipments werelower as the harsh winter weather delayed shipments in the Great Lakes region. Utility coal traffic volume benefited fromhigher demand caused by the cold weather; however, the weather also resulted indelayed shipments as frozen coal slowed loading and unloading operations. Average revenue per carload declined 1% inthe first quarter as the effects of more shorter-haul (lower revenue per unit)business more than offset the favorable effects of a fuel surcharge.

 

Coal volumesare expected to strengthen in the second quarter, as utilities' coal stockpileswere depleted during the winter. Forthe last half of the year, coal revenues are expected to be comparable to thoseof 2002.

 
**General Merchandise**
 

First-quartergeneral merchandise revenues increased $49 million, or 6%, compared with lastyear. Traffic volume (carloads)increased 2%, as all commodity groups except the metals and construction groupposted increases. Agriculture, consumerproducts and government volume increased 6% reflecting more shipments of corninto markets affected by the 2002 drought. This is expected to continue until late September when the 2003 cropcomes to market. In addition, trafficvolume benefited from increased volume for sweeteners and more shipments forthe military. Chemicals traffic volumeincreased 3% on stronger demand for industrial intermediate products andincreased plastics shipments, which was supported by higher vehicle productionand consumer products demand. Automotive traffic volume increased 2%, primarily due to the resumptionof production at a plant that had been curtailed during the first quarter of2002. Automotive production for theyear is expected to be lower than that of 2002. General merchandise average revenue per carload increased 3%reflecting increased rates, more longer haul (higher average revenue) business,a fuel surcharge and favorable changes in the mix of traffic.

 

General merchandiserevenues are expected to weaken in the second quarter, when compared with thesecond quarter of 2002, reflecting lower vehicle production. However, for the last half of the year,general merchandise revenues are expected to be comparable to those of 2002 andlargely reflect the performance of the economy.

 
**Intermodal**
 

First-quarterintermodal revenues increased $18 million, or 8%, compared with last year. Container traffic volume benefited fromincreased international and domestic business as well as the conversion oftruck traffic to rail. Intermodalrevenue per unit increased 3% for the quarter, as the favorable effects of fuelsurcharges and ancillary revenues were slightly offset by an unfavorable changein the mix of traffic.

 

Intermodalrevenues are expected to continue to benefit from new business supported bycontinued improvements in service and conversion of truck traffic to rail;however, any weakening in consumer demand could dampen this outlook.** **

 
**Railway Operating Expenses**
 

First-quarterrailway operating expenses were $1.33 billion in 2003, up $73 million, or 6%,compared with last year, as most expense line items were higher.

 

As discussed inNote 1, effective Jan. 1, 2003, NS Rail's method of accounting for crosstieremoval was changed as a result of implementation of SFAS No. 143. This change in accounting in the firstquarter lowered depreciation expense by almost $7 million and increasedcompensation and benefits and other expenses by almost $5 million. For the year, it is expected that thedepreciation reduction will total approximately $29 million, while the expenseincreases will total about $20 million.

 

 

 

14

Compensationand benefits expenses increased $17 million, or 4%, reflecting lower pensionincome, higher wage rates, increased medical costs (despite additional employeecontributions) and the effects of the change in accounting (see Note 1). These increases more than offset reducedpayroll taxes.

 

Materials,services and rents increased $6 million, or 1%, principally because of highermaterial expenses, primarily for locomotive repairs, and volume-relatedintermodal expenses and equipment rents. These increases were partially offset by a lower management fee from NS(see Note 2).

 

Conrail rentsand services expenses decreased $2 million, or 2%, reflecting lower costs inthe Shared Assets Areas.

 

Depreciationexpense was even in the first quarter, as the effects of property additionswere offset by the change in accounting related to crosstie removal costs (seeNote 1). 

 

Diesel fuelexpenses increased $23 million, or 28%, reflecting higher average prices andmarginally higher consumption. Expensesin 2003 included a $26 million benefit from favorable hedge settlements,while the first quarter of 2002 included $4 million of cost related to thehedging program.

 

Casualties andother claims expense increased $16 million, or 46%, primarily because ofdamage to equipment and lading incurred because of several derailments,continuing unfavorable personal injury claims development and higher insurancecosts.

 

Other expenseincreased $13 million, or 21%, reflecting the absence of two items thatbenefited 2002 -- a favorable property tax settlement and a favorable bad debtsettlement.

 

** **

**FINANCIAL CONDITION AND LIQUIDITY**

 

Cash providedby operating activities, NS Rail's principal source of liquidity, was $204million in the first three months of 2003, compared with $181 million in thefirst three months of 2002. The increase was primarily the result of favorablechanges in working capital.

 

A significantportion of payments made to PRR (which are included in "Conrail rents andservices" and, therefore, are a use of cash in "Cash provided byoperating activities") are borrowed back from a PRR subsidiary and,therefore, are a source of cash in "Proceeds from borrowings." NSRail's net cash flow from these borrowings amounted to $80 million in the firstthree months of 2003 and $66 million for the same period of 2002.

 

NS Rail'sworking capital deficit was $965 million at March 31, 2003, compared with $1.1billion at Dec. 31, 2002. The improvement was principally the result of areduction in the net amount due to NS.

 

NS Rail looksto NS to provide needed funding. NScurrently has the capability to increase the amount of accounts receivablebeing sold under the revolving sale program. Over the last twelve months, theamount of receivables NS could sell under this program ranged from $358 millionto $421 million, and the amount of receivables NS sold ranged from zero to $400million. Moreover, NS has a $1 billion credit facility, which expires in 2006,that it can borrow under or use to support commercial paper debt; however,reductions in its credit rating could limit NS' ability to access thecommercial paper markets.

 

As the major NSsubsidiary, NS Rail provides funding to service NS' debt. NS' debt at March 31, 2003, totaled $6.4billion. Of this debt, $1.8 billion isdue between 2003 and 2007.

 

NS Rail expectsto generate sufficient cash flow from operations to meet its ongoing obligations,as well as to advance amounts to NS to service its debt.

 

Cash used forinvesting activities decreased in the first three months of 2003, compared withthe first three months of 2002, principally because of a decline in capitalexpenditures. The decrease reflectedthe absence of locomotive purchases in 2003; however, NS Rail expects toacquire locomotives later in the year.

 

15

Cash used forfinancing activities was $144 million in the first three months of 2003,compared with $18 million in the same period of 2002, reflecting an increase inadvances to NS and the absence in 2003 of proceeds from equipment financing.Advances to NS typically account for most of the cash used for financingactivities and reflect NS' requirements.

** **

** **

**OTHER MATTERS**

** **

**Labor Arbitration**

 

Several hundred claims have been filed with NSRon behalf of employees furloughed after June 1, 1999, for various periodsof time, alleging that the furloughs were a result of the Conrail transactionand seeking "New York Dock" income protection benefits. Several labor organizations have initiatedarbitration on behalf of individual employees. One such dispute has been heard and NSR is awaiting a decision. Another dispute in scheduled to be heard inMay. Other disputes are pending wherein similar benefits are sought under laboragreement provisions that, in management's judgment, do not apply to theinvolved circumstances. Based on knownfacts, including the availability of legal defenses, management believes thatNS Rail will prevail in these disputes and that any potential liability for theinvolved claims should not have a material adverse effect on NS Rail'sfinancial position, results of operations or liquidity. Depending on the outcome of thesearbitrations and claims, other claims may be filed or progressed toarbitration. Should all such claimantsprevail, there could be a significant effect on results of operations in aparticular quarter (see Note 5).

 

**Labor Agreements**

 

Approximately 24,000 of NS Rail's employees arecovered by collective bargaining agreements with 15 different laborunions. These agreements remain ineffect until changed pursuant to the Railway Labor Act. Moratorium provisions in these agreementspermitted NS Rail and the unions to propose such changes in late 1999;negotiations at the national level commenced shortly thereafter. Agreements have been reached with theBrotherhood of Maintenance of Way Employes (BMWE), which represents about 4,200NS Rail employees; the Brotherhood of Locomotive Engineers (BLE), whichrepresents about 4,500 NS Rail employees; the United Transportation Union(UTU), which represents about 6,700 NS Rail employees; the InternationalBrotherhood of Boilermakers and Blacksmiths (IBB), which represents about 100NS Rail employees; the Transportation Communications International Union (TCU),which represents about 4,400 NS Rail employees; and the American TrainDispatchers Department (ATDD), which represents about 400 NS Railemployees. The agreement previouslyreached with the BLE was through 2004; NS Rail recently reached a furthercontract extension with the BLE through 2009 (subject to ratification). Health and welfare issues have been resolvedwith the BMWE and TCU. The UTUagreement provides that, subsequent to a further period of negotiation, healthand welfare issues may be submitted to arbitration. Health and welfare issues with the other organizations have notyet been resolved.

 

**Market Risks and HedgingActivities**

 

NSRail uses derivative financial instruments to reduce the risk of volatility inits diesel fuel costs and to manage its overall exposure to fluctuations ininterest rates.

 

In2001, NS Rail began a program to hedge a portion of its diesel fuelconsumption. The intent of the program is to assist in the management of NSRail's aggregate risk exposure to fuel price fluctuations, which cansignificantly affect NS Rail's operating margins and profitability, through theuse of one or more types of derivative instruments.

 

Dieselfuel costs represented 8% of NS Rail's operating expenses for the first quarterof 2003. The program provides that NS Rail will not enter into any fuel hedgeswith a duration of more than 36 months, and that no more than 80% of NS Rail'saverage monthly fuel consumption will be hedged for any month within any36-month period.

 

Asof March 31, 2003, through swap transactions, NS Rail has hedged approximately68% of expected 2003 diesel fuel requirements. The effect of the hedges is toyield an average cost of 75 cents per hedged gallon, including

 

16

federaltaxes and transportation. A 10% decrease in diesel fuel prices would reduce NSRail's asset related to the swaps by approximately $30 million as of March 31,2003.

 

NS Rail manages its overall exposure tofluctuations in interest rates by issuing both fixed- and floating-rate debtinstruments and by entering into interest-rate hedging transactions to achievean appropriate mix within its debt portfolio.

 

AtMarch 31, 2003, NS Rail's debt subject to interest rate exposure totaled $567million. A 1 percentage point increasein interest rates would increase NS Rail's total annual interest expenserelated to all its variable debt by approximately $6 million. Management considers it unlikely thatinterest rate fluctuations applicable to these instruments will result in amaterial adverse effect on NS Rail's financial position, results of operationsor liquidity.

 

Someof NS Rail's capital leases, which carry an average fixed rate of 7%, wereeffectively converted to variable rate obligations using interest rate swapagreements. On March 31, 2003, theaverage pay rate under these agreements was 2%, and the average receive ratewas 7%. During the first quarters of2003 and 2002, the effect of the swaps was to reduce interest expense by $2million and $3 million, respectively. A portion of the lease obligations ispayable in Japanese yen. NS Raileliminated the associated exchange rate risk at the inception of each leasewith a yen deposit sufficient to fund the yen-denominated obligation. Most of these deposits are held by foreignbanks, primarily Japanese. As a result,NS Rail is exposed to financial market risk relative to Japan. Counterparties to the interest rate swapsand Japanese banks holding yen deposits are major financial institutions believedby management to be creditworthy.

** **

**Environmental Matters**

 

NS Rail is subject to various jurisdictions'environmental laws and regulations. Itis NS Rail's policy to record a liability where such liability or loss isprobable and its amount can be estimated reasonably. Claims, if any, against third parties for recovery of cleanupcosts incurred by NS Rail are reflected as receivables (when collection isprobable) in the balance sheet and are not netted against the associated NSRail liability. Environmental engineersregularly participate in ongoing evaluations of all known sites and indetermining any necessary adjustments to liability estimates. NS Rail also has established anEnvironmental Policy Council, composed of senior managers, to oversee andinterpret its environmental policy.

 

Operating expenses for environmental matterstotaled approximately $2 million in the first quarters of 2003 and 2002. Capital expenditures totaled approximately$1 million for the first quarter of 2003 and $2 million for the first quarterof 2002.

 

NS Rail's balance sheets included liabilitiesfor environmental exposures in the amount of $28 million at March 31, 2003, and$29 million at Dec. 31, 2002 (of which $8 million was accounted for as acurrent liability in each period). AtMarch 31, 2003, the liability represented NS Rail's estimate of the probablecleanup and remediation costs based on available information at 113 knownlocations. On that date, 10 sitesaccounted for $15 million of the liability, and no individual site wasconsidered to be material. NS Railanticipates that much of this liability will be paid out over five years;however, some costs will be paid out over a longer period.

 

At some of the 113 locations, certain NS Railsubsidiaries, usually in conjunction with a number of other parties, have beenidentified as potentially responsible parties by the Environmental ProtectionAgency (EPA) or similar state authorities under the Comprehensive EnvironmentalResponse, Compensation and Liability Act of 1980, or comparable state statutes,which often impose joint and several liability for cleanup costs.

 

With respect to known environmental sites(whether identified by NS or by the EPA or comparable state authorities),estimates of NS Rail's ultimate potential financial exposure for a given siteor in the aggregate for all such sites are unavoidably imprecise because of thewidely varying costs of currently available cleanup techniques, the likelydevelopment of new cleanup technologies, the difficulty of determining inadvance the nature and full extent of contamination and each potentialparticipant's share of any estimated loss (and that participant's ability tobear it), and evolving statutory and regulatory standards governing liability.

 

17

The risk of incurring environmentalliability -- for acts and omissions, past, present and future -- is inherent inthe railroad business. Some of thecommodities in NS Rail's traffic mix, particularly those classified as hazardousmaterials, can pose special risks that NS Rail and its subsidiaries workdiligently to minimize. In addition,several NS Rail subsidiaries own, or have owned, land used as operatingproperty, or which is leased or may have been leased and operated by others, orheld for sale. Because environmentalproblems that are latent or undisclosed may exist on these properties, therecan be no assurance that NS will not incur environmental liabilities or costswith respect to one or more of them, the amount and materiality of which cannotbe estimated reliably at this time. Moreover, lawsuits and claims involving these and potentially otherunidentified environmental sites and matters are likely to arise from time totime. The resulting liabilities couldhave a significant effect on financial condition, results of operations orliquidity in a particular year or quarter.

 

However, based on an assessment of known factsand circumstances, management believes that it is unlikely that any knownmatters, either individually or in the aggregate, will have a material adverseeffect on NS Rail's financial position, results of operations or liquidity.

** **

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Management's Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements that may be identified by the use of words like "believe,""expect," "anticipate" and "project." Forward-looking statements reflectmanagement's good-faith evaluation of information currently available. However, such statements are dependent onand, therefore, can be influenced by, a number of external variables over whichmanagement has little or no control, including: domestic and internationaleconomic conditions; the business environment in industries that produce andconsume rail freight; competition and consolidation within the transportationindustry; fluctuation in prices of key materials, in particular diesel fuel;labor difficulties, including strikes and work stoppages; legislative andregulatory developments; changes in securities and capital markets; and naturalevents such as severe weather, floods and earthquakes. Forward-looking statements are not, andshould not be relied upon as, a guaranty of future performance or results. Nor will they necessarily prove to beaccurate indications of the times at or by which any such performance orresults will be achieved. As a result, actual outcomes and results may differmaterially from those expressed in forward-looking statements. The Companyundertakes no obligation to update or revise forward-looking statements.

** **

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18****
****
**Item 3. Quantitative and Qualitative DisclosuresAbout Market Risks.**

 

           Theinformation required by this item is included in Part I, Item 2,"Management's Discussion and Analysis of Financial Conditions and Resultsof Operations" on page 16 under the heading "Market Risks and HedgingActivities."

 

 

**Item4. Controls and Procedures.******

 

(a) Evaluationof Disclosure Controls and Procedures.

 

NS Rail's ChiefExecutive Officer and Chief Financial Officer have evaluated the effectivenessof NS Rail's disclosure controls and procedures (as such term is defined inRules 13a-14(c) and 15d-14(c) under the Securities

Exchange Act of1934, as amended (the "Exchange Act")) as of a date within 90 daysprior to the filing date of this quarterly report (the "EvaluationDate"). Based on such evaluation,such officers have concluded that, as of the Evaluation Date, NS Rail'sdisclosure controls and procedures are effective in alerting them on a timelybasis to material information relating to NS Rail (including itsconsolidated subsidiaries) required to be included in NS Rail's periodicfilings under the Exchange Act.

 

(b) Changesin Internal Controls.

 

Since theEvaluation Date, there have not been any significant changes in NS Rail'sinternal controls or in other factors that could significantly affect suchcontrols.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

19**PART II. OTHER INFORMATION**

 

 

**Item6. Exhibits and Reports on Form 8-K**

 

 

(a) Exhibit

 

99     Certificationsof the CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted

         pursuantto Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b) Reports on Form 8-K:

 

        None.

 

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20

**SIGNATURES**

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 

 

 
**NORFOLK  SOUTHERN RAILWAY COMPANY**
 

 

Registrant

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

April 30, 2003

/s/ Reginald J. Chaney

 
 

 

Reginald J. Chaney

 
 

 

Corporate Secretary (Signature)

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

April 30, 2003

/s/ John P. Rathbone

 
 

 

John P. Rathbone

 

 

Vice President and Controller

 

 

(Principal Accounting Officer)  (Signature)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21

I,  David R. Goode, certify that:

 

 

 

1.

I  have reviewed this quarterly report on Form 10-Q of Norfolk Southern Railway  Company;

2.

Based  on my knowledge, this quarterly report does not contain any untrue statement  of a material fact

 

or  omit to state a material fact necessary to make the statements made, in light  of the circumstances

 

under  which such statements were made, not misleading with respect to the period  covered by this quarterly report;

3.

Based  on my knowledge, the financial statements, and other financial information  included in this quarterly report, fairly present in all material respects  the financial condition, results of operations and cash flows of the  registrant as of, and for, the periods presented in this quarterly report;

4.

The  registrant's other certifying officers and I are responsible for establishing  and maintaining disclosure controls and procedures (as defined in Exchange  Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a.

designed  such disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this quarterly report is being prepared;

 

b.

evaluated  the effectiveness of the registrant's disclosure controls and procedures as  of a date within 90 days prior to the filing date of this quarterly report  (the "Evaluation Date"); and

 

c.

presented  in this quarterly report our conclusions about the effectiveness of the  disclosure controls and procedures based on our evaluation as of the  Evaluation Date;

5.

The  registrant's other certifying officers and I have disclosed, based on our  most recent evaluation, to the registrant's auditors and the audit committee  of registrant's board of directors (or persons performing the equivalent function):

 

a.

all  significant deficiencies in the design or operation of internal controls  which could adversely affect the registrant's ability to record, process,  summarize and report financial data and have identified for the registrant's  auditors any material weaknesses in internal controls; and

 

b.

any  fraud, whether or not material, that involves management or other employees  who have a significant role in the registrant's internal controls; and

6.

The  registrant's other certifying officers and I have indicated in this quarterly  report whether or not there were significant changes in internal controls or  in other factors that could significantly affect internal controls subsequent  to the date of our most recent evaluation, including any corrective actions  with regard to significant deficiencies and material weaknesses.

 

 

 

Date: April 30, 2003

 

 

 

 

 

 

 

 

 

/s/  David R. Goode

 

David  R. Goode

President  and Chief Executive Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22

I,  Henry C. Wolf, certify that:

 

 

 

1.

I  have reviewed this quarterly report on Form 10-Q of Norfolk Southern Railway  Company;

2.

Based  on my knowledge, this quarterly report does not contain any untrue statement  of a material fact

 

or  omit to state a material fact necessary to make the statements made, in light  of the circumstances

 

under  which such statements were made, not misleading with respect to the period  covered by this quarterly report;

3.

Based  on my knowledge, the financial statements, and other financial information  included in this quarterly report, fairly present in all material respects  the financial condition, results of operations and cash flows of the  registrant as of, and for, the periods presented in this quarterly report;

4.

The  registrant's other certifying officers and I are responsible for establishing  and maintaining disclosure controls and procedures (as defined in Exchange  Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a.

designed  such disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this quarterly report is being prepared;

 

b.

evaluated  the effectiveness of the registrant's disclosure controls and procedures as  of a date within 90 days prior to the filing date of this quarterly report  (the "Evaluation Date"); and

 

c.

presented  in this quarterly report our conclusions about the effectiveness of the  disclosure controls and procedures based on our evaluation as of the  Evaluation Date;

5.

The  registrant's other certifying officers and I have disclosed, based on our  most recent evaluation, to the registrant's auditors and the audit committee  of registrant's board of directors (or persons performing the equivalent function):

 

a.

all  significant deficiencies in the design or operation of internal controls  which could adversely affect the registrant's ability to record, process,  summarize and report financial data and have identified for the registrant's  auditors any material weaknesses in internal controls; and

 

b.

any  fraud, whether or not material, that involves management or other employees  who have a significant role in the registrant's internal controls; and

6.

The  registrant's other certifying officers and I have indicated in this quarterly  report whether or not there were significant changes in internal controls or  in other factors that could significantly affect internal controls subsequent  to the date of our most recent evaluation, including any corrective actions  with regard to significant deficiencies and material weaknesses.

 

 

 

Date: April 30, 2003

 

 

 

 

 

 

 

 

 

/s/  Henry C. Wolf

 

Henry  C. Wolf

Vice  President

Chief  Financial Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

23

 

**ExhibitIndex******

 

 

** **
**Electronic**
 ****

**Submission**

 ****

**Exhibit**

 ****

**Number**

**Description******

 ****

 ****

99

Certifications of the CEO and CFO pursuant to  18 U.S.C. Section 1350, as

 ****

adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.

 ****

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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