| -----------------------------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, 2004**                   |
|     |                                                                 |
| ( ) | 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 ofMarch 31, 2004 |
| Common Stock (par  value $1.00)                                                                                                                                            | 16,668,997 |
| The  registrant meets the conditions set forth in General Instruction H(1)(a) and  (b) of Form 10-Q and is therefore filing this form with the reduced  disclosure format. |
|                                                                                                                                                                            |  |  |  |

**TABLEOF CONTENTS**

 
|           |                    |                                           | Page   |
|----------------|-------------------------|------------------------------------------------|--------|
|           |                    |                                           |   |
| Part  I.       | Financial  information: |
|           |                    |                                           |   |
|           | Item  1.                | Financial  statements:                         |   |
|           |                    |                                           |   |
|           |                    | Consolidated  Statements of Income             | 3      |
|           |                    | Three  Months EndedMarch   31, 2004 and 2003   |
|           |                    |                                           |   |
|           |                    | Consolidated  Balance Sheets                   | 4      |
|           |                    | March 31, 2004  andDec. 31, 2003               |   |
|           |                    |                                           |   |
|           |                    | Consolidated  Statements of Cash Flows         | 5      |
|           |                    | Three  Months EndedMarch   31, 2004 and 2003   |
|           |                    |                                           |   |
|           |                    | Notes  to Consolidated Financial Statements    | 6      |
|           |                    |                                           |   |
|           |                    | Independent  Accountants' Review Report        | 13     |
|           |                    |                                           |   |
|           | Item  2.                | Management's  Discussion and Analysis of       | 14     |
|           |                    | Financial  Condition and Results of Operations |
|           |                    |                                           |   |
|           | Item  3.                | Quantitative  and Qualitative Disclosures      | 18     |
|           |                    | About  Market Risks                            |   |
|           |                    |                                           |   |
|           | Item  4.                | Controls  and Procedures                       | 18     |
|           |                    |                                           |   |
| Part  II.      | Other  Information:     |                                           |
|           |                    |                                           |   |
|           | Item  6.                | Exhibits  and Reports on Form 8-K              | 19     |
|           |                    |                                           |   |
| Signatures     |                    |                                           | 19     |
|           |                    |                                           |   |
| Exhibit  Index |                    | 19                                             |
|                |                         |                                                |        |  |  |

 

2**PART I. FINANCIAL INFORMATION**

 

 

**Item 1. Financial Statements.**

 

** **

**NORFOLK****SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AWholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Consolidated Statements of Income**

**(Unaudited)**

 

 

|                                                                                                    | Three Months Ended |
|---------------------------------------------------------------------------------------------------------|--------------------|
|                                                                                                    | **March  31,**     |
|                                                                                                    | **2004**           | **2003** |
|                                                                                                    | *($ in millions)*  |
|                                                                                                    |               |   |   |   |
| ***Railway  operating revenues***                                                                       |               |   |   |   |
|   Coal                                                                                        | $                  | 398  | $ | 354  |
|   General  merchandise                                                                        |               | 967  |   | 918  |
|   Intermodal                                                                                  |               | 280  |   | 247  |
|                                                                                                    |               |   |   |   |
|      Total railway operating revenues                                          |               | 1,645  |   | 1,519  |
|                                                                                                    |               |   |   |   |
| ***Railway  operating expenses***                                                                       |               |   |   |   |
|   Compensation  and benefits                                                                  |               | 420  |   | 400  |
|   Materials,  services and rents                                                              |               | 454  |   | 459  |
|   Conrail  rents and services (Note 1)                                                        |               | 116  |   | 119  |
|   Depreciation                                                                                |               | 126  |   | 123  |
|   Diesel  fuel                                                                                |               | 107  |   | 104  |
|   Casualties  and other claims                                                                |               | 40  |   | 51  |
|   Other                                                                                       |               | 80  |   | 74  |
|                                                                                                    |               |   |   |   |
|      Total  railway operating expenses                                         |               | 1,343  |   | 1,330  |
|                                                                                                    |               |   |   |   |
|         **Income from railway operations**                      |               | 302  |   | 189  |
|                                                                                                    |               |   |   |   |
| Other  income (expense) - net                                                                           |               | (65) |   | (51) |
| Interest  expense on debt                                                                               |               | (5) |   | (7) |
|                                                                                                    |               |   |   |   |
|         Income before  income taxes and accounting changes |               | 232  |   | 131  |
|                                                                                                    |               |   |   |   |
| Provision  for income taxes                                                                             |               | 89  |   | 51  |
|                                                                                                    |               |   |   |   |
|          Income  before accounting changes                 |               | 143  |   | 80  |
|                                                                                                    |               |   |   |   |
| Cumulative  effect of changes in accounting principles, net of taxes (Note 4)                           |               | --  |   | 104  |
|                                                                                                    |               |   |   |   |
| **         Net income**                                    | $                  | 143  | $ | 184  |
|                                                                                                    |               |   |   |   |
| *See  accompanying notes to consolidated financial statements.*                                         |               |   |   |   |

 

3

 

**NORFOLK****SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AWholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Consolidated Balance Sheets**

**(Unaudited)**

** **

** **

 

|                                                                                | **March 31,**      | **Dec. 31,** |
|-------------------------------------------------------------------------------------|--------------------|--------------|
|                                                                                | **2004**           | **2003**     |
| *** ***                                                                        | *($  in millions)* |
| ***Assets***                                                                        |               |         |   |   |
| Current assets:                                                                     |               |         |   |   |
|    Cash and cash equivalents                                         | $                  | 82           | $ | 257 |
|    Accounts receivable, net  (Note 1)                                |               | 121          |   | 121 |
|    Materials and supplies                                            |               | 96           |   | 91 |
|    Deferred income taxes                                             |               | 182          |   | 175 |
|    Other current assets                                              |               | 151          |   | 159 |
|       Total  current assets                           |               | 632          |   | 803 |
|                                                                                |               |         |   |   |
| Investments                                                                         |               | 769          |   | 779 |
| Properties less accumulated depreciation                                            |               | 11,397       |   | 11,346 |
| Other assets                                                                        |               | 706          |   | 684 |
| **      Total  assets**                               | $                  | 13,504       | $ | 13,612 |
|                                                                                |               |         |   |   |
| ***Liabilities and Stockholder's Equity***                                          |               |         |   |   |
| Current liabilities:                                                                |               |         |   |   |
|    Accounts payable                                                  | $                  | 827          | $ | 890 |
|    Income and other taxes                                            |               | 212          |   | 168 |
|    Due to NS - net (Note 1)                                          |               | 765          |   | 781 |
|    Due to Conrail (Note 1)                                           |               | 89           |   | 81 |
|    Other current liabilities                                         |               | 119          |   | 112 |
|    Current maturities of  long-term debt                             |               | 102          |   | 102 |
|       Total  current liabilities                      |               | 2,114        |   | 2,134 |
|                                                                                |               |         |   |   |
| Long-term debt                                                                      |               | 783          |   | 813 |
| Other liabilities                                                                   |               | 1,035        |   | 1,033 |
| Due to Conrail (Note 1)                                                             |               | 785          |   | 716 |
| Deferred income taxes                                                               |               | 4,406        |   | 4,372 |
|      ** Total liabilities**                           |               | 9,123        |   | 9,068 |
|                                                                                |               |         |   |   |
| Stockholder's equity:                                                               |               |         |   |   |
|    Common stock                                                      |               | 167          |   | 167 |
|    Additional paid-in capital                                        |               | 721          |   | 721 |
|    Accumulated other  comprehensive income (Note 5)                  |               | 308          |   | 323 |
|    Retained income                                                   |               | 3,185        |   | 3,333 |
| **      Total  stockholder's equity**                 |               | 4,381        |   | 4,544 |
| ** **                                                                          |               |         |   |   |
| **      Total  liabilities and stockholder's equity** | $                  | 13,504       | $ | 13,612 |
|                                                                                |               |         |   |   |
| *See accompanying notes to consolidated  financial statements.*                     |

 

4**NORFOLK****SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AWholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Consolidated Statements of Cash Flows**

**(Unaudited)**

** **

** **

 

|                                                                                                                                 | Three Months  Ended |
|--------------------------------------------------------------------------------------------------------------------------------------|---------------------|
|                                                                                                                                 | **March  31,**      |
|                                                                                                                                 | **2004**            | **2003** |
| *** ***                                                                                                                         | *($ in millions)*   |
| ***Cash  flows from operating activities***                                                                                          |                |   |   |   |
|    Net  income                                                                                                        | $                   | 143  | $ | 184  |
|    Reconciliation  of net income to net cash provided by operating activities:                                        |                |   |   |   |
|         Net cumulative effect of changes in  accounting principles                           |                | --  |   | (104) |
|          Depreciation                                                                   |                | 126  |   | 124  |
|          Deferred  income taxes                                                         |                | 31  |   | 24  |
|          Gains  and losses on properties and investments                                |                | --  |   | (2) |
|          Changes  in assets and liabilities affecting operations:                       |                |   |   |   |
|             Accounts  receivable (Note 1)                                |                | --  |   | (2) |
|             Materials  and supplies                                      |                | (5) |   | (3) |
|             Other  current assets                                        |                | 19  |   | 22  |
|             Income  tax liabilities                                      |                | 56  |   | 12  |
|             Other  short-term liabilities                                |                | (57) |   | (25) |
|             Other  - net                                                 |                | (18) |   | (26) |
|                Net  cash provided by operating activities |                | 295  |   | 204  |
|                                                                                                                                 |                |   |   |   |
| ***Cash  flows from investing activities***                                                                                          |                |   |   |   |
|    Property  additions                                                                                                |                | (171) |   | (104) |
|    Property  sales and other transactions                                                                             |                | (6) |   | (3) |
|    Investments,  including short-term                                                                                 |                | (21) |   | (20) |
|    Investment  sales and other transactions                                                                           |                | 1  |   | --  |
|                Net  cash used for investing activities    |                | (197) |   | (127) |
|                                                                                                                                 |                |   |   |   |
| ***Cash  flows from financing activities***                                                                                          |                |   |   |   |
|    Dividends                                                                                                          |                | --  |   | (1) |
|    Advances  to NS                                                                                                    |                | (315) |   | (192) |
|    Advances  and repayments from NS                                                                                   |                | 6  |   | 1  |
|    Proceeds  from borrowings                                                                                          |                | 88  |   | 87  |
|    Debt  repayments                                                                                                   |                | (52) |   | (39) |
|                Net  cash used for financing activities    |                | (273) |   | (144) |
|                                                                                                                                 |                |   |   |   |
|                Net  decrease in cash and cash equivalents |                | (175) |   | (67) |
|                                                                                                                                 |                |   |   |   |
| ***Cash  and cash equivalents***                                                                                                     |                |   |   |   |
|    At  beginning of year                                                                                              |                | 257  |   | 130  |
|                                                                                                                                 |                |   |   |   |
|    At  end of period                                                                                                  | $                   | 82  | $ | 63  |
|                                                                                                                                 |                |   |   |   |
| ***Supplemental  disclosures of cash flow information***                                                                             |                |   |
|    Cash  paid during the period for:                                                                                  |                |   |   |   |
|       Interest  (net of amounts capitalized)                                                           | $                   | 8  | $ | 9  |
|       Income  taxes                                                                                    | $                   | --  | $ | 14  |
|                                                                                                                                 |                |   |   |   |
| *See  accompanying notes to consolidated financial statements.*                                                                      |

 

5

 

**NORFOLK****SOUTHERN RAILWAY COMPANY AND SUBSIDIARIES**

**(AWholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

 

In the opinion ofmanagement, the accompanying unaudited interim financial statements contain alladjustments (consisting of normal recurring accruals) necessary to presentfairly Norfolk Southern Railway Company and Subsidiaries' (NS Rail) financialposition as of March 31, 2004, and its results of operations and its cash flowsfor the three months ended March 31, 2004 and 2003 in conformity withaccounting principles generally accepted in the United States of America.

 

Althoughmanagement believes that the disclosures presented are adequate to make theinformation not misleading, these Consolidated Financial Statements should beread in conjunction with: (a) thefinancial statements and notes included in NS Rail's latest Annual Report onForm 10-K and (b) any Current Reports on Form 8-K.

 

**1. Related Parties**

 

## General

 

NorfolkSouthern Corporation (NS) is the parent holding company of Norfolk SouthernRailway Company (NSR, collectively with its subsidiaries, NS Rail). 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 $127 million and included an $8million mark-up in the first quarter of 2004 and totaled $134 million andincluded an $8 million mark-up in the first quarter of 2003). In addition, NS charges NS Rail arevenue-based licensing fee for use of certain intangible assets owned byNS. This fee amounted to $24 million inthe first quarter of 2004 and $21 million in the first quarter of 2003.

 

NS Railowns 21,016,125 shares of NS common stock.

 

## Operations Over Conrail's Lines

 

**Overview**-- Through a limited liability company, NS and CSX Corporation (CSX) jointlyown Conrail Inc. (Conrail), whose primary subsidiary is Consolidated RailCorporation (CRC), a principal freight railroad in the Northeast. NS has a 58% economic and 50% voting interestin the jointly owned entity, and CSX has the remainder of the economic andvoting interests.

 

NSRoperates as a part of its rail system the routes and assets of PennsylvaniaLines LLC (PRR), a wholly owned subsidiary of CRC, pursuant to operating andlease agreements. CSX Transportation, Inc. (CSXT) operates the routes andassets of another CRC subsidiary (NYC) under comparable terms.

 

**Operation of Conrail's Lines** -- The June 1999 OperatingAgreement between NSR and PRR governs substantially all track assets operatedby NSR and has an initial 25-year term, renewable at the option of NSR for twofive-year terms. Payments under the Opera-ting Agreement are subject toadjustment every six years to reflect changes in values. NSR also has leased orsubleased equipment for varying terms from PRR. Costs necessary to operate andmaintain the PRR assets, including leasehold improvements, are borne by NSR.NSR receives all freight revenues on the PRR lines.

 

NSR and CSXT also have entered into agreements withCRC governing other properties that continue to be owned and operated by CRC(the Shared Assets Areas). NSR and CSXT pay CRC a fee for joint and exclusiveaccess to the Shared Assets Areas. In addition, NSR and CSXT pay, based onusage, the costs incurred by CRC to operate the Shared Assets Areas.

 

NSRail's Consolidated Balance Sheet atMarch 31, 2004, includes $27million of liabilities related to the Conrail transaction, principally forcontractual obligations to Conrail employees imposed by the SurfaceTransportation Board when it approved the transaction. ThroughMarch 31, 2004, NS Rail haspaid $156 million of these costs.

 

6

 

NS Railprovides certain general and administrative support functions to Conrail, thefees for which are billed in accordance with several service-providerarrangements and amount to approximately $7 million annually.

 

"Conrailrents and services" includes expenses for amounts due to PRR and CRC foruse by NSR of operating properties and equipment and operation of the SharedAssets Areas.

 

Asignificant portion of payments made to PRR is borrowed back from a subsidiaryof PRR under a note due in 2032. Amountsoutstanding under the note comprise the long-term balance of "Due toConrail." The interest rate forthese loans is variable and was 1.6% atMarch 31, 2004.. The current balance "Due toConrail" is composed of amounts related to expenses included in"Conrail rents and services," as discussed above.

 

**Conrail CorporateReorganization**

 

NS,CSX and Conrail are jointly seeking to reorganize Conrail and establish directownership and control by NSR and CSXT of PRR and NYC, respectively. The proposed reorganization would replace theoperating agreements described above and allow NSR and CSXT to directly own andoperate PRR and NYC, respectively. Thereorganization would not involve the Shared Assets Areas, and would have noeffect on the competitive rail service provided in the Shared Assets Areas. Conrail would continue to own, manage andoperate the Shared Assets Areas as previously approved by the SurfaceTransportation Board (STB).

 

Consummationof the reorganization requires a ruling from the Internal Revenue Service(IRS), the approval of the STB and filings with the Securities ExchangeCommission. In addition, NS, CSX andConrail must obtain the consent of Conrail's debt holders to carry out thetransaction and obtain a valuation of PRR and of NYC.

 

In2003, the IRS issued a ruling that the reorganization as contemplated wouldqualify as a tax-free distribution. Inorder to implement the reorganization approved by the IRS, the companies haveengaged an investment banking firm to provide a valuation. Also in 2003, the STB granted itsauthorization to carry out the reorganization, subject to a condition requiringNS, CSX and Conrail to either: (i)obtain the voluntary consent of the Conrail debt holders; or (ii) proposefurther proceedings to determine whether the terms offered to the Conrail debtholders are fair, just and reasonable. NSR and CSXT have filed registration statements on Form S-4 with the SECto allow a proposed exchange offer relating to Conrail's unsecured debt (seebelow).

 

Asa part of the proposed reorganization, Conrail would undertake a restructuringof its existing unsecured and secured public indebtedness. There are currently two series of unsecuredpublic debentures with an outstanding principal amount of $800 million and 13series of secured debt with an outstanding principal amount of approximately$321 million. Guaranteed debt securitiesof two newly formed corporate subsidiaries of NSR and CSXT will be offered in a58%/42% ratio in exchange for Conrail's unsecured debentures. Upon completion of the proposed transaction,the new debt securities would become direct unsecured obligations of NSR andCSXT, respectively, and would rank equally with all existing and future seniorunsecured debt obligations, if any, of NSR and CSXT. These new debt securities will have maturitydates, interest rates and principal and interest payment dates identical tothose of the respective series of Conrail's unsecured debentures. In addition, these new debt securities willhave covenants substantially similar to those of the publicly traded debtsecurities of NS and CSX, respectively.

 

Conrail'ssecured debt and lease obligations will remain obligations of Conrail and areexpected to be supported by new leases and subleases which, upon completion ofthe proposed transaction, would be the direct lease and sublease obligations ofNSR or CSXT.

 

NS,CSX and Conrail are diligently working to complete all steps necessary toconsummate the Conrail corporate reorganization in 2004. NS Rail expects to record the proposedtransaction at fair value as a contribution to its capital from NS. As a result, the assets and liabilities ofPRR will be reflected in their respective line items in NS Rail's ConsolidatedBalance Sheet, and any amounts due to PRR would be extinguished. On the Consolidated Income Statement, ConrailRents and Services will be reduced to reflect only the expenses associated withthe

 

7

 

SharedAssets Areas, and other expenses, primarily the depreciation related to the PRRassets, will be reflected in their respective line items.

 

### Saleof Accounts Receivable

 

NS Rail sells, withoutrecourse, to a bankruptcy-remote special-purpose NS subsidiary, a pool ofaccounts receivable. NS Rail servicesand collects the sold receivables; however, no servicing asset or liability hasbeen recognized because the benefits of servicing are estimated to be justadequate to compensate NS Rail for its responsibilities. Payments collected from sold receivables areremitted to the special-purpose NS subsidiary, which, in turn, reinvests theamounts by purchasing new receivables from NS Rail. NS Rail has no retained interest in the soldreceivables. Underthe terms of the new sale agreement, the receivables are treated as sold and,accordingly, $597 million atMarch 31, 2004, and $528million atDec. 31, 2003, of sold receivables are not included onthe NS Rail Consolidated Balance Sheets. Fees associated with the sale, which are based on historical dilutionand prevailing interest rates, are included in "Other income (expense) -net."

** **

**Noncash Dividend**

 

NSR declared and issuedto NS a noncash dividend of $291 million in the first quarter of 2004, whichwas settled by reduction of NSR's interest-bearing advances due from NS. Noncash dividends are excluded from theConsolidated Statements of Cash Flows.

 

**IntercompanyAccounts**

 

|                                      | **March 31, 2004****** | **Dec. 31, 2003****** |
|-------------------------------------------|------------------------|-----------------------|
|                                      | ** **             | ** **            | **Average** | ** ** | ** ** | Average |
|                                      | ** **             | ** **            | **Interest** | ** ** | ** ** | **Interest** |
|                                      | **Balance**            | **Rate**              | **Balance** | **Rate** |
|                                      | *($  in millions)*     |
|                                      |                   |                  |   |   |   |   |
|   Advances  due from NS         | $                      | 68               | 2% | $ | 68  | 2% |
|                                      |                   |                  |   |   |   |   |
|   Advances  and notes due to NS |                   | (833)                 | 2% |   | (849) | 2% |
|                                      |                   |                  |   |   |   |   |
|   Due  to NS - net              | $                      | (765)                 |   | $ | (781) |   |

 

Interestis applied to certain advances at the average NS yield on short-terminvestments and to the notes at specified rates. NS Rail's results for the three months endedMarch 31 include interest income of $2 million in 2004 and in 2003 and interestexpense of $2 million in 2004 and in 2003 related to these intercompanyaccounts. These amounts are included in"Other income (expense) - net."

 

### IntercompanyFederal Income Tax Accounts

 

Inaccordance with the NS Tax Allocation Agreement, intercompany federal incometax accounts are recorded between companies in the NS consolidated group. NS Rail had long-term intercompanyfederal income tax payables (which are included in "Deferred incometaxes" in the Consolidated Balance Sheets) of $997 million atMarch 31, 2004,and $994 million atDec. 31, 2003..

 

**2. Derivative Financial Instruments**

 

NS Rail usesderivative financial instruments to reduce the risk of volatility in its dieselfuel costs and to manage its overall exposure to fluctuations in interestrates. NS Rail does not engage in thetrading of derivatives. Management hasdetermined that its derivative financial instruments qualify as eitherfair-value or cash-flow hedges, having values which highly correlate with theunderlying hedged exposures, and has designated such instruments as hedgingtransactions. Credit risk related to thederivative financial instruments is considered to be minimal and is managed byrequiring high credit standards for counterparties and periodic settlements.

 

8

 

**DieselFuel Hedging**

 

NS Rail has a program to hedge a significant portionof its diesel fuel consumption. The intent 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. In order tominimize this risk, NS Rail has a continuous hedging strategy using a series ofswaps in order to lock in the purchase prices of some of its diesel fuel.Management has designated these derivative instruments as cash-flow hedges ofthe exposure to variability in expected future cash flows attributable tofluctuations in diesel fuel prices.

 

Following is a summary of NS Rail's dieselfuel swaps:

 

|                                                                                                    |              | First  Quarter |
|---------------------------------------------------------------------------------------------------------|-------------------|----------------|
|                                                                                                    |              | **2004**       | **2003** |
| Number of swaps entered into during the first  quarter                                                  |              | 72             | 72 |
| Approximate number of gallons hedged  (millions)                                                        |              | 92             | 94 |
| Approximate average price per gallon of Nymex                                                           |              |           |   |
|    No. 2 heating oil                                                                     |              | $0.83          |    $0.74 |
|                                                                                                    | **Remainder  of** |           |   |
|                                                                                                    | **2004**          | **2005**       | **2006** |
| Percent of estimated future diesel fuel consumption

   covered as ofMarch 31, 2004 | 67%               | 31%            | 2% |
|                                                                                                         |                   |                |  |  |  |

 

Hedges are placed each month by competitivebid among selected counterparties. The goal of this hedging strategy is toaverage fuel costs over an extended period of time while minimizing the incrementalcost of hedging. The program provides that NS Rail will not enter into any fuelhedges with a duration of more than 36 months, and

that no more than 80% of NS Rail's averagemonthly fuel consumption will be hedged for any month within any 36‐monthperiod. Diesel fuel costs represented 8% of NS Rail's operating expenses for eachof the first quarters of 2004 and 2003.

 

NS Rail's fuel hedging activity resulted in netdecreases in diesel fuel expense of $23 million for first quarter 2004 and $26million for first quarter 2003. 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 transactions, was approximately $3 million for the firstquarter of 2004 and $1 million for the first quarter of 2003.

 

**Interest Rate Hedging**

 

NS Rail managesits overall exposure to fluctuations in interest rates by issuing both fixedand floating-rate debt instruments, and by entering into interest rate hedgingtransactions. NS Rail had $177 million,or 33%, and $186 million, or 34%, of its fixed rate debt portfolio hedgedatMarch 31, 2004,andDec. 31, 2003,respectively, using interest rate swaps that qualify for and are designated asfair-value hedge transactions. Theseswaps have been effective in hedging the changes in fair value of the relateddebt arising from changes in interest rates, and accordingly, there has been noimpact on earnings resulting from ineffectiveness associated with thesederivative transactions.

 

**FairValues**

 

The fair valuesof NS Rail's diesel fuel derivative instruments atMarch 31, 2004andDec. 31, 2003,were determined based upon current fair market values as quoted by third partydealers. Fair values of interest rateswaps were determined based upon the present value of expected future cashflows discounted 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"Stockholder's equity," included unrealized gains of $50 million and$40 million (pretax) at March 31, 2004, and Dec. 31, 2003, respectively,related to the fair value of derivative fuel hedging transactions that willterminate within twelve months of the respective dates.

 

9

 

The asset andliability positions of NS Rail's outstanding derivative financial instrumentswere as follows:

 

|                                                | **March  31,**     | **Dec.  31,** |
|-----------------------------------------------------|--------------------|---------------|
|                                                | **2004**           | **2003**      |
|                                                | *($  in millions)* |
| Interest rate hedges:                               |               |          |   |   |
|   Gross fair market asset position        | $                  | 16       | $ | 16  |
|   Gross fair market (liability)  position |               | --       |   | --  |
|                                                |               |          |   |   |
| Fuel hedges:                                        |               |          |   |   |
|   Gross fair market asset position        |               | 59       |   | 45  |
|   Gross fair market (liability)  position |               | (1)           |   | --  |
|                                                |               |          |   |   |
| Total net asset position                            | $                  | 74       | $ | 61  |

 

**3. Pensions and Other Postretirement Benefits**

** **

NorfolkSouthern and certain subsidiaries have both funded and unfunded defined benefitpension plans covering principally salaried employees. NorfolkSouthern and certain subsidiaries also provide specified health care and deathbenefits to eligible retired employees and their dependents. Under the present plans, which may be amendedor terminated at NS' option, a defined percentage of health care expenses iscovered, reduced by any deductibles, copayments, Medicare payments and, in somecases, coverage provided under other group insurance policies. The following relates to the combined NSplans.

** **

**Pensionand Other Postretirement Benefit Cost Components**

 

|                                         | **Three months ended March 31,** |
|----------------------------------------------|----------------------------------|
|                                         | **2004**                         | **2003** | **2004** | **2003** |
|                                         | **Pension Benefits**             | **Other Benefits** |
|                                         |                             |   |   |   |   |   |   |   |
| Service cost                                 | $                                | 4  | $ | 5  | $ | 4  | $ | 3  |
| Interest cost                                |                             | 22  |   | 22  |   | 11  |   | 8  |
| Expected return on plan assets               |                             | (37) |   | (40) |   | (4) |   | (3) |
| Amortization of prior service cost (benefit) |                             | 1  |   | 1  |   | (3) |   | (1) |
| Recognized net actuarial gains (losses)      |                             | 1  |   | 1  |   | --  |   | --  |
| Amortization of unrecognized net (gain) loss |                             | --  |   | --  |   | 4  |   | 4  |
|    Net (benefit) cost         | $                                | (9) | $ | (11) | $ | 12  | $ | 11  |

 

**Contributionsfor Pension and Other Postretirement Benefits**

 

NS previously disclosed in its consolidatedfinancial statements for the year endedDec. 31, 2003, that it expected tocontribute $7 million to its unfunded pension plans and $42 million to itsother postretirement benefit plans in 2004. For the three months endedMarch 31, 2004, $1 millionand $10 million of contributions have been made to its unfunded pension plansand its other postretirement benefit plans, respectively. NS presently anticipates contributing anadditional $6 million to its unfunded pension plans for a total of $7 millionand an additional $32 million to fund its postretirement benefit plans in2004 for a total of $42 million.

 

**4. Changes in Accounting Principles in 2003**

 

NS Rail adopted Financial Accounting StandardsBoard (FASB)Statement No. 143, "Accounting for Asset Retirement Obligations," (SFAS No.143) effective Jan. 1, 2003, and recorded a $100 million net adjustment($165 million before taxes) for the cumulative effect of this change inaccounting on years prior to 2003. Pursuant to SFAS No. 143, the cost to remove crossties must berecorded as an expense when incurred; previously these removal costs wereaccrued as a component of depreciation.

 

10

 

NS Rail also adoptedFASBInterpretation No. 46, "Consolidation of Variable Interest Entities," (FIN No.46) effective Jan. 1, 2003, and recorded a $4 million net adjustment($6 million before taxes) for the cumulative effect of this change inaccounting 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 atJan. 1, 2003,included $169 million of locomotives and $157 million of debt related to theirpurchase as well as a $6 million minority interest liability.

 

**5. Comprehensive Income**

 

 

NS Rail'stotal comprehensive income was as follows:

 

|                               | Three Months Ended |
|------------------------------------|--------------------|
|                               | **March  31,**     |
|                               | **2004**           | **2003** |
|                               | *($  in millions)* |
|                               |               |   |   |   |
| Net  income                        | $                  | 143  | $ | 184  |
| Other  comprehensive income (loss) |               | (15) |   | (20) |
|                               |               |   |   |   |
| Total  comprehensive income        | $                  | 128  | $ | 164  |

 

ForNS Rail, "Other comprehensive income (loss)" is the unrealized gainsand losses on certain investments in debt and equity securities, principally NScommon stock, and net fair value adjustments to certain derivative financialinstruments.

 

**6. Commitments and Contingencies**

 

**Lawsuits**

 

NSR and certain subsidiaries are defendants innumerous lawsuits and other claims relating principally to railroad operations.When management concludes that it is probable that a liability has beenincurred and the amount of the liability can be reasonably estimated, it isaccrued through a charge to expenses. While the ultimate amount of liability incurred in any of these lawsuitsand claims is dependent on future developments, in management's opinion therecorded liability is adequate to cover the future payment of such liabilityand claims. However, the final outcomeof any of these lawsuits and claims cannot be predicted with certainty, andunfavorable or unexpected outcomes could result in additional accruals thatcould be significant to results of operations in a particular year orquarter. Any adjustments to recordedliability will be reflected in expenses in the periods in which suchadjustments are known.

 

**Casualty Claims**

 

NSRail is generally self-insured for casualty claims. NS Rail has insurance,subject to limits, for catastrophic events. The casualty claims liability isdetermined actuarially, based upon claims filed and an estimate of claimsincurred but not yet reported. While the ultimate amount of claims incurred isdependent on future developments, in management's opinion, the recordedliability is adequate to cover the future payments of claims. However, it ispossible that the recorded liability may not be adequate to cover the futurepayments of claims. Adjustments to the recorded liability are reflected inoperating expenses in the periods in which such adjustments are known.

 

**Environmental Matters**

 

NSRail is subject to various jurisdictions' environmental laws and regulations.It is NS Rail's policy to record a liability where such liability or loss isprobable and its amount can be estimated reasonably. Claims, if any, againstthird parties for recovery of cleanup costs incurred by NS Rail are reflectedas receivables (when collection is probable) in the balance sheet and are notnetted against the associated NS Rail liability. Environmental engineersregularly participate in ongoing evaluations of all identified sites and indetermining any necessary adjustments to liability estimates. NS Rail also hasestablished an Environmental Policy Council, composed of senior managers, tooversee and interpret its environmental policy.

 

11

 

NSRail's balance sheets included liabilities for environmental exposures in theamount of $24 million atMarch 31, 2004, and $25 million atDec. 31, 2003(of which $8 million was accounted for as a current liability for each period).AtMarch 31, 2004,the liability represented NS Rail's estimate of the probable cleanup andremediation costs based on available information at 112 identified locations.On that date, 10 sites accounted for $12 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 bepaid out over a longer period.

 

At some of the 112locations, certain NS Rail subsidiaries, usually in conjunction with a numberof other parties, have been identified as potentially responsible parties bythe Environmental Protection Agency (EPA) or similar state authorities underthe Comprehensive Environmental Response, Compensation and Liability Act of1980, or comparable state statutes, which often impose joint and severalliability for cleanup costs.

 

Withrespect to known environmental sites (whether identified by NS Rail or by theEPA or comparable state authorities), estimates of NS Rail's ultimate potentialfinancial exposure 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.

 

Therisk of incurring environmental liability -- for acts and omissions, past,present and future -- is inherent in the railroad business. Some of the commoditiesin NS Rail's traffic mix, particularly those classified as hazardous materials,can pose special risks that NS Rail and its subsidiaries work diligently tominimize. In addition, several NS Rail subsidiaries own, or have owned, landused as operating property, or which is leased or may have been leased andoperated by others, or held for sale. Because environmental problems may existon these properties that are latent or undisclosed, there can be no assurancethat NS Rail will not incur environmentally related liabilities or costs withrespect to one or more of them, the amount and materiality of which cannot beestimated reliably at this time. Moreover, lawsuits and claims involving theseand potentially other now-unidentified environmental sites and matters arelikely to arise from time to time. The resulting liabilities could have asignificant effect on financial condition, results of operations or liquidityin a particular year or quarter.

 

However,based on its assessments of the facts and circumstances now known, managementbelieves that it has recorded the probable costs for dealing with thoseenvironmental matters of which the Corporation is aware. Further, managementbelieves that it is unlikely that any identified matters, either individuallyor in the aggregate, will have a material adverse effect on NS Rail's financialposition, results of operations or liquidity.

 

**Purchase Commitments**

 

AtMarch 31, 2004, NS Rail had outstandingpurchase commitments of approximately $270 million in connection with its 2004capital program, including purchases of locomotives and equipment.

12**Independent Accountants' Review Report**

 

 

The Board of Directors

NorfolkSouthern Railway Company:

 

We have reviewed the accompanying consolidatedbalance sheet of Norfolk Southern Railway Company and subsidiaries as ofMarch 31, 2004,and the related consolidated statements of income and cash flows for thethree-month periods endedMarch 31, 2004 and 2003. These consolidated financial statements arethe responsibility of the Company's management.

 

We conducted our reviews in accordance withstandards established by the American Institute of Certified PublicAccountants. A review of interimfinancial information consists principally of applying analytical proceduresand making inquiries of persons responsible for financial and accountingmatters. It is substantially less inscope than an audit conducted in accordance with auditing standards generallyaccepted in theUnited States  of America, the objectiveof which is the expression of an opinion regarding the financial statementstaken as a whole. Accordingly, we do notexpress such an opinion.

 

Based on our reviews, we are not aware of anymaterial modifications that should be made to the consolidated financialstatements referred to above for them to be in conformity with accountingprinciples generally accepted in theUnited  States of America.. 

 

As discussed in note 4 to the consolidatedfinancial statements, the Company adopted Financial Accounting Standards BoardStatement No. 143, *Accounting for AssetRetirement Obligations,* and Financial Accounting Standards BoardInterpretation No. 46, *Consolidation ofVariable Interest Entities,* as ofJanuary 1, 2003..

 

We have previously audited, in accordance withauditing standards generally accepted in the United States of America, theconsolidated balance sheet of Norfolk Southern Railway Company and subsidiariesas of December 31, 2003, and the related consolidated statements of income,changes in stockholders' equity and cash flows for the year then ended (notpresented herein); and in our report dated January 27, 2004, we expressed anunqualified opinion on those consolidated financial statements. In our opinion, the information set forth inthe accompanying consolidated balance sheet as ofDecember 31, 2003,is fairly stated, in all material respects, in relation to the consolidatedbalance sheet from which it has been derived.

                                                                                                                                         

 

/s/ KPMG LLP

Norfolk,Virginia

April 20, 2004

 

13

 

**Item 2. Management's Discussion and Analysis ofFinancial Condition and Results of Operations.**

** **

** **

The information calledfor by Item 2 is omitted in accordance with General Instruction (H)(2)(a). However, pursuant to the same instructions,the registrant provides herein management's narrative analysis of the resultsof operations.

 

 

**MANAGEMENT'SNARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS**

** **

** **

**RESULTS OF OPERATIONS**

 

### Overview

 

First-quarter net income was $143 million in 2004,compared with $184 million in 2003. Thefollowing table shows the components of the change:

 

|                                                                                    | **First Quarter** |
|-----------------------------------------------------------------------------------------|-------------------|
|                                                                                    | ** **        | ** ** | ** ** | ** ** | **2004 vs. 2003** |
|                                                                                    | ** **        | ** ** | ** ** | ** ** | **Increase** |
|                                                                                    | **2004**          | **2003** | **(Decrease)** |
|                                                                                    | *($ in millions)* |
| Income from continuing operations

   before accounting changes          | $                 | 143 | $ | 80 | $ | 63  |
| Cumulative effect of changes in

   accounting principles, net of  taxes |              | -- |   | 104 |   | (104) |
|       Net income                                          | $                 | 143 | $ | 184 | $ | (41) |

 

The decline reflected the absence of the accountingchanges included in net income in 2003. Income from continuing operations before accounting changes increased$63 million, or 79%, in the first quarter of 2004, compared with the sameperiod of 2003. The growth resulted froma $126 million, or 8%, increase in railway operating revenues coupled with onlya slight rise in railway operating expenses, which led to strong income fromrailway operations. The revenue gain wasprimarily the result of a 7% rise in traffic volume. Expenses were up 1% as the fluidity of therailroad network resulted in an increase in efficiency as measured by averagetrain speed, terminal dwell time and cars on line.

 

### Railway Operating Revenues

 

First-quarter railwayoperating revenues were $1.65 billion in 2004, up $126 million, or 8%, comparedwith the first quarter of 2003. As shown in the following table, the increasewas the result of higher traffic volume and increased average revenues.

 

|  
 

**First  quarter**

 
 
 

**2004  vs. 2003**

 
 
 

**Increase  (Decrease)**

 

*($  in millions)*

 
 
 

 

 

 
 
Traffic volume  (carloads)

$

100

 
 
Revenue per unit/mix

 

26

 
 
     Total

$

126

 
 

14

Revenues and carloadsfor the commodity groups were as follows:

 

 

**First  Quarter**

 

Revenues

**Carloads**

**Revenue  per Unit**

 

**2004**

**2003**

**2004**

**2003**

**2004**

**2003**

 

*($  in millions)*

*(in  thousands)*

*($  per unit)*

 

 

 

 

 

 

 

 

 

 

 

 

 

Coal

$

398

$

354

 

406.3

 

395.2

$

979

$

895

General  merchandise:

 

 

 

 

 

 

 

 

 

 

 

 

   Automotive

 

248

 

242

 

166.9

 

166.4

 

1,486

 

1,453

   Chemicals

 

203

 

192

 

110.2

 

105.7

 

1,844

 

1,823

   Metals/construction

 

183

 

166

 

177.2

 

161.3

 

1,033

 

1,027

   Agr./consumer  prod./govt.

 

176

 

168

 

141.0

 

134.6

 

1,251

 

1,247

   Paper/clay/forest

 

157

 

150

 

107.3

 

106.6

 

1,459

 

1,404

 

 

 

 

 

 

 

 

 

 

 

 

 

General  merchandise

 

967

 

918

 

702.6

 

674.6

 

1,377

 

1,360

Intermodal

 

280

 

247

 

648.1

 

578.2

 

432

 

427

 

 

 

 

 

 

 

 

 

 

 

 

 

      Total

$

1,645

$

1,519

 

1,757.0

 

1,648.0

$

936

$

922

 

**Coal**

 

First-quarter coal revenues increased $44 million,or 12%, compared with last year. Totaltraffic volume (carloads) was up 3%, principally because of higher trafficvolume for utility coal, which benefited from weather-related demand coupledwith lower utility stockpiles, economic expansion and high natural gas prices(which can result in increased coal-fired electricity generation). Export coal volume increased 2%, as theeffects of higher global demand were somewhat constrained by tight supplies. Domestic metallurgical coal, coke and ironore shipments declined 5%, as shortages in raw materials hampered the abilityto meet increased demand. Industrialcoal shipments rose 16%, a result of the expanding economy and newbusiness. Average revenue per carloadfor coal increased 9%, showing the effects of higher rates, including theeffects of favorable developments in the coal rate cases (see discussionbelow), as well as an increase in the proportion of longer length of haul (andtherefore higher rated) traffic.

 

In2002, two of NS Rail's utility customers, Duke Energy (Duke) and Carolina Power& Light (CP&L), filed rate reasonableness complaints at the STBalleging that NS Rail's tariff rates for the transportation of coal wereunreasonable. In the Duke proceeding theSTB initially found NS Rail's rates to be reasonable in November 2003, butsubsequently issued technical corrections in February 2004 finding that incertain years some portion of the rates was unreasonable. The case is currently stayed while the STBconsiders both parties' petitions for reconsideration, and the STB has not yetordered any rate relief. In the CP&Lproceeding the STB found NS Rail's rates to be unreasonable in December 2003,but upheld a significant portion of NS Rail's tariff increase. Both of the STB's rate decisions remain subjectto appeal. NS Rail is currentlyrecognizing revenues based on the rates upheld or prescribed by the STB. Future developments in the two cases mayresult in adjustments that could have a significant impact on results ofoperations in a particular quarter. Overthe long term, Management believes the STB decisions in the Duke and CP&Lproceedings will help support improved pricing for coal transportationservices.

 

Coalrevenues are expected to continue to show growth for the remainder of the year,reflecting higher utility volume, driven by the replenishment of depletedstockpiles (which may be affected by weather-related demand), and acontinuation of the favorable market conditions for export and domesticmetallurgical coal, coke and iron ore coupled with an easing of the supplyconstraints seen in the first quarter.

 
General Merchandise
 

First-quarter general merchandise revenues increased$49 million, or 5%, compared with last year. Total traffic volume was up 4%, as all five commodity groups postedincreases. The metals and constructiongroup posted the

 

15

 

largest volume increase, up 10% on strongconstruction traffic, supported by increased public and commercial constructionprojects, and increased domestic steel production, reflecting a soft market forimported steel. Agriculture, consumerproducts and government traffic volume rose 5% on higher traffic volume forsweeteners, ethanol, fertilizer and wheat. Corn volumes declined reflecting a return to normal sourcing patterns inthe East. Chemicals traffic volumeincreased 4%, a result of strong demand for petroleum-related products, andmore shipments of chlorine, industrial intermediates and plastics. The paper, clay and forest products andautomotive groups posted modest gains. General merchandise average revenue per carload increased 1%, reflectingimproved pricing and a higher proportion of longer-haul (higher revenue percarload) business.

 

General merchandise revenues are expected tocontinue to compare favorably with the prior year as 2004 progresses; however,a continuation of this trend is less certain in the fourth quarter due to thestrength of the fourth quarter of last year.

 
Intermodal
 

First-quarter intermodal revenues increased $33million, or 13%, compared with last year. Total traffic volume (units) grew 12%, reflecting strength in all linesof business. Container traffic volumeincreased 10%, trailer traffic volume rose 28% and Triple Crown ServicesRoadRailer® traffic volume grew 8%. Container and trailer traffic volumes benefited from the conversion ofshipments from highway to rail, as strong demand, higher fuel costs for motorcarriers and the early effect of new hours of service laws combined to increaseshipments. International traffic volumegrew by 7%, reflecting strength inU.S. foreign trade.Intermodal average revenue per unit rose 1%, a result of increased rates and alarger proportion of higher rated trailer and RoadRailer® traffic volume.

 

Intermodal revenues are expected to continue to showgrowth during 2004, provided the retail and manufacturing sectors continue toexpand.** **

 
Railway Operating Expenses
 

First-quarter railway operating expenses were $1.34billion in 2004, up $13 million, or 1%, compared with $1.33 billion in2003.

 

Compensation and benefits expenses increased $20million, or 5%, primarily driven by higher wage rates, less in pension incomeand increased costs for health and welfare benefits.

 

Materials, services and rents decreased $5million, or 1%, reflecting a lower management fee charged by NS (see Note 1)and lower equipment rents, which were offset in part by higher volume-relatedintermodal purchased services and an increase in locomotive and freight carmaintenance expenses.

 

Conrail rents and services expenses decreased $3million, or 3%, reflecting lower costs in the Shared Assets Areas.

 

Diesel fuel expenses increased $3 million, or 3%,as a 6% rise in consumption was partially offset by a 3% decline in the averageprice per gallon. Expenses in 2004included a $23 million benefit from the hedging program, compared with a $26million benefit in the first quarter of 2003. For the remainder of the year, as ofMarch 31, 2004, 240 milliongallons, or about 67% of expected consumption has been hedged at an averageprice per gallon of 80 cents.

 

Casualties and other claims expense decreased $11 million,or 22%, reflecting the absence of higher derailment costs and accruals forpersonal injury claims development that burdened expenses in the first quarterof 2003.

 

Other expense increased $6 million, or 8%,reflecting an increase in property taxes and the absence of a favorable salesand use tax adjustment that benefited 2003.

 

16

 
****
**Other Income (Expense) - Net**

 

Other income (expense) - net was an expense of$65 million in the first quarter of 2004, $14 million higher than the firstquarter of 2003. The increase reflectedthe absence of a favorable adjustment that benefited 2003 related to interestaccruals upon settlement of federal tax audits.

 

** **

**OTHER MATTERS**

** **

**Labor Agreements**

 

Approximately 24,000 of NS Rail's employees arecovered by collective bargaining agreements with 14 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 4,000NS Rail employees; the United Transportation Union (UTU), which representsabout 7,000 NS Rail employees; the International Brotherhood of Boilermakersand Blacksmiths (IBB), which represents about 100 NS Rail employees; theTransportation Communications International Union (TCU), which represents about4,000 NS Rail employees; the American Train Dispatchers Department (ATDD),which represents about 350 NS Rail employees; the Brotherhood of RailroadSignalmen (BRS), which represents about 1,000 NS Rail employees; and the Brotherhoodof Locomotive Engineers (BLE), which represents about 4,400 NS Railemployees. The agreement with the BLE isthrough 2009. A third tentativeagreement with the International Brotherhood of Electrical Workers (IBEW),which represents about 900 NS Rail employees, failed ratification in April 2004.

 

Health and welfare issues have been resolvedwith BMWE, TCU, BRS, BLE and UTU. Healthand welfare issues with the other organizations have not yet been resolved.

 

**MarketRisks and Hedging Activities**

 

NS Rail uses derivative financial instrumentsto reduce the risk of volatility in its diesel fuel costs and to manage itsoverall exposure to fluctuations in interest rates.

 

The intent of the diesel fuel hedging programis to assist in the management of NS Rail's aggregate risk exposure to fuelprice fluctuations, which can significantly affect NS Rail's operating marginsand profitability, through the use of one or more types of derivativeinstruments. Diesel fuel costsrepresented 8% of NS Rail's operating expenses for the first quarter of 2004.The program provides that NS Rail will not enter into any fuel hedges with aduration of more than 36 months, and that no more than 80% of NS Rail's averagemonthly fuel consumption will be hedged for any month within any 36-monthperiod.

 

As ofMarch 31, 2004,through swap transactions, NS Rail has hedged approximately 67% of expected 2004diesel fuel requirements. The effect of the hedges is to yield an average costof 80 cents per hedged gallon, including federal taxes and transportation.A 10% decrease in diesel fuel prices would reduce NS Rail's asset related tothe swaps by approximately $41 million as ofMarch 31, 2004..

 

NSRail manages its overall exposure to fluctuations in interest rates by issuingboth fixed- and floating-rate debt instruments and by entering intointerest-rate hedging transactions to achieve an appropriate mix within itsdebt portfolio.

 

AtMarch 31, 2004,NS Rail's debt subject to interest rate exposure totaled $509 million. A 1 percentage point increase in interestrates would increase NS Rail's total annual interest expense related to all itsvariable debt by approximately $5 million. Management considers it unlikely that interest rate fluctuationsapplicable to these instruments will result in a material adverse effect on NSRail's financial position, results of operations or liquidity.

 

17

 

Some of NS Rail'scapital leases, which carry an average fixed rate of 7%, were effectivelyconverted to variable rate obligations using interest rate swapagreements. OnMarch 31, 2004,the average pay rate under these agreements was 2%, and the average receiverate was 7%. The effect of the swaps wasto reduce interest expense by $2 million in each of the first quarters of 2004and 2003. A portion of the lease obligations is payable in Japanese yen. NS Rail eliminated the associated exchangerate risk at the inception of each lease with a yen deposit sufficient to fundthe yen-denominated obligation. Most ofthese deposits are held by foreign banks, primarily Japanese. As a result, NS Rail is exposed to financialmarket risk relative toJapan.. Counterparties to the interest rate swaps andJapanese banks holding yen deposits are major financial institutions believedby management to be creditworthy.

** **

 

**FORWARD-LOOKINGSTATEMENTS**

 

ThisManagement's Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements that may be identified by theuse of words like "believe," "expect,""anticipate" and "project." Forward-looking statements reflect management's good-faith evaluation ofinformation currently available. However, such statements are dependent on and, therefore, can beinfluenced by, a number of external variables over which management has littleor no control, including: domestic and international economic conditions; thebusiness environment in industries that produce and consume rail freight;competition and consolidation within the transportation industry; fluctuationin prices of key materials, in particular diesel fuel; labor difficulties,including strikes and work stoppages; legislative and regulatory developments;changes in securities and capital markets; and natural events such as severeweather, floods and earthquakes. Forward-looking statements are not, and should not be relied upon as, aguaranty of future performance or results. Nor will they necessarily prove to be accurate indications of the timesat or by which any such performance or results will be achieved. As a result,actual outcomes and results may differ materially from those expressed inforward-looking statements. The Company undertakes no obligation to update orrevise forward-looking statements.

** **

** **

**Item3. Quantitative and QualitativeDisclosures About Market Risks.**

 

           The information required by thisitem is included in Part I, Item 2, "Management's Narrative Analysis of theResults of Operations" on page 17 under the heading "Market Risks andHedging Activities."

 

 

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

 

(a) Evaluation of Disclosure Controls andProcedures.

 

NS Rail's Chief Executive Officer and ChiefFinancial Officer have evaluated the effectiveness of NS Rail's disclosurecontrols and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)under the Securities

Exchange Act of 1934, as amended (the"Exchange Act")) as ofMarch 31, 2004.. Basedon such evaluation, such officers have concluded that, as ofMarch 31, 2004,NS Rail's disclosure controls and procedures are effective in alerting them ona timely basis to material information relating to NS Rail (including itsconsolidated subsidiaries) required to be included in NS Rail's periodicfilings under the Exchange Act.

 

(b) Changes in Internal Controls.

 

During the first quarter of 2004, management hasnot identified any changes in NS Rail's internal controls over financialreporting that have materially affected, or are reasonably likely to materiallyaffect, NS Rail's internal controls over financial reporting.

 

18
****
**PART II. OTHER INFORMATION**

 

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

 

(a)       Exhibits

 

           31.       Rule 13a-14(a)/15d-14(a) Certfications

 

           32.       Section 1350 Certifications

 

(b)       Reportson Form 8-K:

 

           None.

 

** **

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 

 
NORFOLK  SOUTHERN RAILWAY COMPANY
 

 

Registrant

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

April 27, 2004

/s/  Reginald J. Chaney

 
 

 

Reginald  J. Chaney

 
 

 

Corporate  Secretary (Signature)

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

April 27, 2004

/s/Marta R. Stewart

 
 

 

Marta   R. Stewart

 

 

Vice  President and Controller

 

 

(Principal  Accounting Officer) (Signature)

 

** **

**Exhibit Index**

 
Electronic
** **

**Submission**

** **

**Exhibit**

** **

**Number**

**Description******

** **

** **

31

Rule  13a-14(a)/15d-14(a) Certfications

** **

 

32

Section 1350 Certifications

 

19 |
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