| 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**JUNE   30, 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 ofJune 30, 2004 |
| Common  Stock (par value $1.00)                                                                                    |           16,668,997 |
|                                                                                                               |   |
|                                                                                                                    |  |  |  |

TABLEOF CONTENTS

 
|           |                    |                                                     | Page   |
|----------------|-------------------------|----------------------------------------------------------|--------|
|           |                    |                                                     |   |
| Part I.        | Financial  information: |
|           |                    |                                                     |   |
|           | Item  1.                | Financial  statements:                                   |   |
|           |                    |                                                     |   |
|           |                    | Consolidated  Statements of Income                       | 3      |
|           |                    | Three  and Six Months EndedJune   30, 2004 and 2003      |
|           |                    |                                                     |   |
|           |                    | Consolidated  Balance Sheets                             | 4      |
|           |                    | June 30, 2004  andDec. 31, 2003                          |   |
|           |                    |                                                     |   |
|           |                    | Consolidated  Statements of Cash Flows                   | 5      |
|           |                    | Six  Months EndedJune   30, 2004 and 2003                |
|           |                    |                                                     |   |
|           |                    | Notes  to Consolidated Financial Statements              | 6      |
|           |                    |                                                     |   |
|           |                    | Report  of Independent Registered Public Accounting Firm | 13     |
|           |                    |                                                     |   |
|           | Item  2.                | Management's  Discussion and Analysis of                 | 14     |
|           |                    | 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                        | 19     |
|           |                    |                                                     |   |
| Signatures     |                    | 20                                                       |
|           |                    |                                                     |   |
| Exhibit  Index |                    | 21                                                       |
|                |                         |                                                          |        |  |  |

 

**PART I. FINANCIAL INFORMATION**

** **

**Item1.**** Financial Statements.**

 

** **

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

**(A Wholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Consolidated Statements of Income**

**($ in millions)**

**(Unaudited)**

 

                                                                                                                   
|                                                                                        | **Three months  Ended** | **Six Months  Ended** |
|---------------------------------------------------------------------------------------------|-------------------------|-----------------------|
|                                                                                        | **June 30,**            | **June 30,**          |
|                                                                                        | **2004**                | **2003**              | **2004** | **2003** |
|                                                                                        |                    |                  |   |   |   |   |   |   |
| ***Railway  operating revenues:***                                                          |                    |                  |   |   |   |   |   |   |
|    Coal                                                                      | $                       | 424              | $ | 389  | $ | 822  | $ | 743  |
|    General  merchandise                                                      |                    | 1,025            |   | 944  |   | 1,992  |   | 1,862  |
|    Intermodal                                                                |                    | 311              |   | 256  |   | 591  |   | 503  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|       Total  Railway Operating Revenues                       |                    | 1,760            |   | 1,589  |   | 3,405  |   | 3,108  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
| ***Railway  operating expenses:***                                                          |                    |                  |   |   |   |   |   |   |
|    Compensation  and benefits                                                |                    | 420              |   | 401  |   | 840  |   | 801  |
|    Materials,  services and rents                                            |                    | 490              |   | 487  |   | 944  |   | 946  |
|    Conrail  rents and services (Note 1)                                      |                    | 120              |   | 118  |   | 236  |   | 237  |
|    Depreciation                                                              |                    | 127              |   | 123  |   | 253  |   | 246  |
|    Diesel  fuel                                                              |                    | 106              |   | 93  |   | 213  |   | 197  |
|    Casualties  and other claims                                              |                    | 38               |   | 48  |   | 78  |   | 99  |
|    Other                                                                     |                    | 83               |   | 73  |   | 163  |   | 147  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|       Total  Railway Operating Expenses                       |                    | 1,384            |   | 1,343  |   | 2,727  |   | 2,673  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|          Income  from railway operations       |                    | 376              |   | 246  |   | 678  |   | 435  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
| Other  income (expense) - net                                                          |                    | (94)                  |   | (65) |   | (159) |   | (116) |
| Interest  expense on debt                                                                   |                    | (9)                   |   | (5) |   | (14) |   | (12) |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|          Income  before income taxes and       |                    |                  |   |   |   |   |   |   |
|             accounting  changes |                    | 273              |   | 176  |   | 505  |   | 307  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
| Provision  for income taxes                                                                 |                    | 93               |   | 68  |   | 182  |   | 119  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|          Income  before accounting changes     |                    | 180              |   | 108  |   | 323  |   | 188  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
| Cumulative  effect of changes in accounting                                                 |                    |                  |   |   |   |   |   |   |
|    principles,  net of taxes (Note 4)                                        |                    | --               |   | --  |   | --  |   | 104  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|       Net  Income                                             | $                       | 180              | $ | 108  | $ | 323  | $ | 292  |
|                                                                                        |                    |                  |   |   |   |   |   |   |
|                                                                                        |                    |                  |   |   |   |   |   |   |
| *See  accompanying notes to consolidated financial statements.*                             |

 

 

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

**(A Wholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Consolidated Balance Sheets**

**($ in millions)**

**(Unaudited)**

** **

 

|                                                                            | **June 30,** | **Dec. 31,** |
|---------------------------------------------------------------------------------|--------------|--------------|
|                                                                            | **2004**     | **2003**     |
| ***Assets***                                                                    |         |         |   |   |
| Current assets:                                                                 |         |         |   |   |
|    Cash and cash equivalents                                     | $            | 159     | $ | 257  |
|    Accounts receivable, net  (Note 1)                            |         | 131     |   | 121  |
|    Materials and supplies                                        |         | 99      |   | 91  |
|    Deferred income taxes                                         |         | 175     |   | 175  |
|    Other current assets                                          |         | 149     |   | 159  |
|       Total  current assets                       |         | 713     |   | 803  |
|                                                                            |         |         |   |   |
| Investments                                                                     |         | 879     |   | 779  |
| Properties less accumulated depreciation                                        |         | 11,489  |   | 11,346  |
| Other assets                                                                    |         | 711     |   | 684  |
| **      **Total  assets                           | $            | 13,792  | $ | 13,612  |
|                                                                            |         |         |   |   |
| ***Liabilities and Stockholder's Equity***                                      |         |         |   |   |
| Current liabilities:                                                            |         |         |   |   |
|    Accounts payable                                              | $            | 862     | $ | 890  |
|    Income and other taxes                                        |         | 182     |   | 168  |
|    Due to NS - net (Note 1)                                      |         | 863     |   | 781  |
|    Due to Conrail (Note 1)                                       |         | 80      |   | 81  |
|    Other current liabilities                                     |         | 124     |   | 112  |
|    Current maturities of  long-term debt                         |         | 102     |   | 102  |
|       Total  current liabilities                  |         | 2,213   |   | 2,134  |
|                                                                            |         |         |   |   |
| Long-term debt                                                                  |         | 750     |   | 813  |
| Other liabilities                                                               |         | 1,037   |   | 1,033  |
| Due to Conrail (Note 1)                                                         |         | 797     |   | 716  |
| Deferred income taxes                                                           |         | 4,516   |   | 4,372  |
|       Total  liabilities                          |         | 9,313   |   | 9,068  |
|                                                                            |         |         |   |   |
| Stockholder's equity:                                                           |         |         |   |   |
|    Common stock                                                  |         | 167     |   | 167  |
|    Additional paid-in capital                                    |         | 721     |   | 721  |
|    Accumulated other  comprehensive income (Note 5)              |         | 385     |   | 323  |
|    Retained income                                               |         | 3,206   |   | 3,333  |
|       Total  stockholder's equity                 |         | 4,479   |   | 4,544  |
|                                                                            |         |         |   |   |
|       Total  liabilities and stockholder's equity | $            | 13,792  | $ | 13,612  |
|                                                                            |         |         |   |   |
| *See accompanying notes to consolidated  financial statements.*                 |

** **

** **

 

** **

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

**(A Wholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Consolidated Statements of Cash Flows**

**($ in millions)**

**(Unaudited)**

** **

 

|                                                                                                                                 | Six Months  Ended |
|--------------------------------------------------------------------------------------------------------------------------------------|-------------------|
|                                                                                                                                 | **June  30,**     |
|                                                                                                                                 | **2004**          | **2003** |
| ***Cash  flows from operating activities***                                                                                          |              |   |   |   |
|    Net  income                                                                                                        | $                 | 323  | $ | 292   |
|    Reconciliation  of net income to net cash                                                                          |              |   |   |   |
|       provided  by operating activities:                                                               |              |   |   |   |
|          Net  cumulative effect of changes in accounting principles                     |              | --  |   | (104) |
|          Depreciation                                                                   |              | 254  |   |  248  |
|          Deferred  income taxes                                                         |              | 81  |   | 61  |
|          Gains  and losses on properties and investments                                |              | (1) |   | (5) |
|          Changes  in assets and liabilities affecting operations:                       |              |   |   |   |
|             Accounts  receivable                                         |              | (10) |   | (21) |
|             Materials  and supplies                                      |              | (8) |   | (6) |
|             Other  current assets                                        |              | 44  |   | 49  |
|             Income  tax liabilities                                      |              | 31  |   |  35  |
|             Other  short-term liabilities                                |              | (7) |   | (17) |
|             Other  - net                                                 |              | (23) |   | (25) |
|                Net  cash provided by operating activities |              | 684  |   |  507  |
|                                                                                                                                 |              |   |   |   |
| ***Cash  flows from investing activities***                                                                                          |              |   |   |   |
|    Property  additions                                                                                                |              | (401) |   | (244) |
|    Property  sales and other transactions                                                                             |              | 5  |   |  10  |
|    Investments,  including short-term                                                                                 |              | (44) |   | (64) |
|    Investment  sales and other transactions                                                                           |              | 2  |   |  1  |
|                Net  cash used for investing activities    |              | (438) |   | (297) |
|                                                                                                                                 |              |   |   |   |
| ***Cash  flows from financing activities***                                                                                          |              |   |   |   |
|    Dividends                                                                                                          |              | --  |   | (1) |
|    Advances  to NS                                                                                                    |              | (376) |   | (339) |
|    Advances  and repayments from NS                                                                                   |              | 7  |   |  26  |
|    Proceeds  from borrowings                                                                                          |              | 141  |   |  130  |
|    Debt  repayments                                                                                                   |              | (116) |   | (80) |
|                Net  cash used for financing activities    |              | (344) |   | (264)  |
|                                                                                                                                 |              |   |   |   |
|                Net  decrease in cash and cash equivalents |              | (98) |   | (54) |
|                                                                                                                                 |              |   |   |   |
| ***Cash  and cash equivalents***                                                                                                     |              |   |   |   |
|    At  beginning of year                                                                                              |              | 257  |   |  130  |
|                                                                                                                                 |              |   |   |   |
|    At  end of period                                                                                                  | $                 | 159  | $ |  76  |
| *** ***                                                                                                                         |              |   |
| ***Supplemental  disclosures of cash flow information***                                                                             |              |   |
|    Cash  paid during the period for:                                                                                  |              |   |   |   |
|       Interest  (net of amounts capitalized)                                                           | $                 | 13  | $ | 21   |
|       Income  taxes                                                                                    | $                 | 46  | $ | 22   |
|                                                                                                                                 |              |   |   |   |
| *See  accompanying notes to consolidated financial statements.*                                                                      |

 

 

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

**(A Wholly Owned Subsidiary of****Norfolk****Southern Corporation)**

**Notesto Consolidated Financial Statements**

**(Unaudited)**

 

 

In the opinion ofmanagement, the accompanyingunaudited interimfinancial statements contain all adjustments (consisting of normal recurringaccruals) necessary to present the Company's financial position as of June 30,2004, its results of operations for the three and six months ended June 30, 2004and 2003, and its cash flows for the six months ended June 30, 2004 and 2003,in conformity with U.S. generally accepted accounting principles.

 

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 the Company's latest Annual Reporton Form 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. Thisfee amounted to $144 million and $146 million in the second quarters of 2004and 2003, respectively (including a $9 million and $10 million mark-up in eachquarter, respectively) and $272 million and $280 million for the first sixmonths of 2004 and 2003, respectively (including a $17 million and $18 millionmark-up in each period, respectively). In addition, NS charges NS Rail a revenue-based licensing fee foruse of certain intangible assets owned by NS. This fee amounted to $27 million and $25 million in the second quartersof 2004 and 2003, respectively, and $51 million and $46 million for the firstsix months of 2004 and 2003, respectively.

 

NS Railowns 20,973,125 shares of NS common stock.

 

## OperationsOver 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), the 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 and assets of another CRC subsidiary (NYC)under comparable terms.

 

**Operationsof Conrail's Lines** -- The June 1999 Operating Agreementbetween NSR and PRR governs substantially all track assets operated by NSRand has an initial 25-year term, renewable at the option of NSR for twofive-year terms. Payments under theOpera-ting Agreement are subject to adjustment every six years to reflectchanges in values. NSR also has leasedor subleased equipment for varying terms from PRR. Costs necessary to operate and maintain thePRR assets, including leasehold improvements, are borne by NSR. NSR receives all freight revenues on the PRRlines.

 

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 CSXTpay 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 CRC to operate the Shared Assets Areas.

 

NS Rail's Consolidated Balance Sheet atJune 30, 2004, includes $23 million of liabilities related to theConrail transaction, principally for contractual obligations to Conrailemployees imposed by the Surface Transportation Board when it approved thetransaction. ThroughJune 30, 2004, NS Rail has paid $160 million of these costs.

 

NS Rail provides certain general and administrativesupport functions to Conrail, the fees for which are billed in accordance withseveral service-provider arrangements and amount to approximately $7 millionannually.

 

"Conrail rents and services" includes expenses foramounts due to PRR and CRC for use by NSR of operating properties and equipmentand operating 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 1.96% atJune 30, 2004.. The currentbalance "Due to Conrail" is composed of amounts related to expenses included in"Conrail rents and services," as discussed above.

 

**Conrail Corporate Reorganization**

 

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 AssetsAreas. Conrail would continue to own,manage and operate the Shared Assets Areas as previously approved by theSurface Transportation 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, to carry outthe transaction, NS, CSX and Conrail must obtain the consent of Conrail's debtholders (or seek additional rulings from the STB) and obtain a valuation of PRRand 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 debtholders; or (ii) propose further proceedings to determine fair, just andreasonable terms for the Conraildebtholders if NS,CSX and Conrail elect to proceed with the exchange. NSR and CSXT have filed registrationstatements on Form S-4 with the SEC which became effective onJuly 26, 2004,to 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 $300 million. Guaranteed debt securities of two newlyformed corporate subsidiaries of NSR and CSXT will be offered in a 58%/42% ratioin exchange for Conrail's unsecured debentures. Upon completion of the transaction as proposed, the new debt securitieswould become direct unsecured obligations of NSR and CSXT, respectively, andwould rank equally with all existing and future senior unsecured debtobligations, if any, of NSR and CSXT. These new debt securities would have maturity dates, interest rates andprincipal and interest payment dates identical to those of the respectiveseries of Conrail's unsecured debentures. In addition, these new debt securities would have covenantssubstantially similar to those of the publicly traded debt securities of NS andCSX, 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 of thetransaction as proposed, 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 as expeditiously as possible. 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 Shared Assets Areas, and other expenses, primarily the depreciation relatedto the PRR assets, will be reflected in their respective line items.

 

### Sales of Accounts Receivable

 

NS Rail sells, withoutrecourse, to a bankruptcy-remote special-purpose NS subsidiary, a pool ofaccounts receivable. NS Rail servicesand collects 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 saleagreement, the receivables are treated as sold and,accordingly, $601 million atJune 30, 2004, and $528 million atDec. 31, 2003,of sold receivables are not included on the NS Rail Consolidated BalanceSheets. Fees associated with the sale,which are based on historical dilution and prevailing interest rates, areincluded in "Other income (expense) - net."

** **

**Intercompany****Accounts**

 

|                                      | **June 30, 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 |                  | (931)                 | 2% |   | (849) | 2% |
|                                      |                  |                  |   |   |   |   |
|   Due  to NS - net              | $                     | (863)                 |   | $ | (781) |   |

 

Interest is applied tocertain advances at the average NS yield on short-term investments and to thenotes at specified rates. NS Rail'sresults for the six months ended June 30 include interest income of $4 millionin 2004 and $5 million in 2003 and interest expense of $4 million in 2004 and in2003 related to theseintercompany accounts. These amounts are included in "Otherincome (expense) - net."

 

**Noncash****Dividend**

 

NS Rail declared andissued to NSnoncash dividends in March and June2004, totaling $450 million, which were settled by reduction of NS Rail'sinterest-bearing advances due from NS. Noncash dividends are excluded from the ConsolidatedStatements of Cash Flows.

 

### Intercompany Federal Income Tax Accounts

 

Inaccordance with the NS Tax Allocation Agreement,intercompanyfederal income tax accounts are recorded between companies in the NSconsolidated group. NS Rail hadlong-termintercompany federal income tax payables(which are included in "Deferred income taxes" in the ConsolidatedBalance Sheets) of $1 billion atJune 30, 2004, and $994 millionatDec. 31, 2003..

 

**2. Derivative Financial Instruments**

 

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. NS Rail does not engagein the trading of derivatives. NS Rail'smanagement has determined that its derivative financial instruments qualify aseither fair-value or cash-flow hedges, having values which highly correlatewith the underlying hedged exposures, and has designated such instruments ashedging transactions. Credit riskrelated to the derivative financial instruments is considered to be minimal andis managed by requiring high credit standards for counterparties and periodicsettlements.

 

**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 to minimize this risk, NS Rail has enteredinto a series of swaps in order to lock in the purchase prices of some of itsdiesel fuel. Management has designatedthese derivative instruments as cash-flow hedges of the exposure to variabilityin expected future cash flows attributable to fluctuations in diesel fuelprices.

 

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

 

|                                                                                                    |              | Second  quarter         |
|---------------------------------------------------------------------------------------------------------|-------------------|-------------------------|
|                                                                                                    |              | **2004**                | **2003** |
| Number of swaps entered into during the second  quarter                                                 |              | 48            | 72 |
| Approximate number of gallons hedged (millions)                                                         |              | 65            | 94 |
| Approximate average price per gallon ofNymex                                                            |              |  $0.91   |  $0.70 |
|    No. 2 heating oil                                                                     |              |                    |   |
|                                                                                                    | **Remainder  of** |                    |   |
|                                                                                                    | **2004**          | **2005**                | **2006** |
| Percent of estimated future diesel  fuel consumption

   covered as ofJune 30, 2004 | 69%               | 38%                     | 4% |
|                                                                                                         |                   |                         |  |  |  |

 

Hedges are placed periodically by competitive bidamong selected counterparties. The goal of this hedging strategy is to averagefuel costs over an extended period of time while minimizing the incrementalcost of hedging. The program providesthat NS Rail will not enter into any fuel hedges withaduration of more than 36 months, and that no more than 80% of NSRail's average monthly fuel consumption will be hedged for any month within the36‐month period. Diesel fuel costs represented 8% of NS Rail's operatingexpenses for the second quarter of 2004 and 7% for the second quarter of 2003.

 

NS Rail's fuel hedgingactivity had the following effects on diesel fuel expense: for the second quarter, decreases of $26million and $8 million for 2004 and 2003, respectively, and for the first sixmonths, decreases of $49 million and $34 million for 2004 and 2003,respectively. Ineffectiveness, or theextent to which changes in the fair values of the heating oil contracts do notoffset changes in the fair values of the expected diesel fuel oil transactions,was approximately $3 million for the first six months of 2004 and $1 millionfor the same period of 2003.

 

**Interest Rate Hedging**

 

NSRail manages its overall exposure to fluctuations in interest rates by issuingboth fixed and floating-rate debt instruments, and by entering into interestrate hedging transactions. NS Rail had $169million, or 33%, and $186 million, or 34%, of its fixed rate debtportfolio hedged atJune 30, 2004, andDec. 31, 2003, respectively, using interestrate swaps that qualify for and are designated as fair-value hedgetransactions. These swaps have beeneffective in hedging the changes in fair value of the related debt arising fromchanges in interest rates, and accordingly, there has been no impact onearnings resulting from ineffectiveness associated with these derivativetransactions.

 

**FairValues**

 

Thefair values of NS Rail's diesel fuel derivative instruments atJune 30, 2004,andDec. 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"Stockholders' equity," included unrealized gains of $73 million(pretax) at June 30, 2004, and $40 million (pretax) at Dec. 31, 2003,related to the fair value of derivative fuel hedging transactions that willterminate within twelve months of the respective dates. Any future gain or loss actually realizedwill be based on the fair value of the derivative fuel hedges at the time oftermination.

 

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

 

|                                                | **June  30,**      | **Dec.  31,** |
|-----------------------------------------------------|--------------------|---------------|
|                                                | **2004**           | **2003**      |
|                                                | *($  in millions)* |
| Interest rate hedges:                               |               |          |   |   |
|   Gross fair market asset position        | $                  | 11            | $ | 16 |
|   Gross fair market (liability)  position |               | --            |   | -- |
|                                                |               |          |   |   |
| Fuel hedges:                                        |               |          |   |   |
|   Gross fair market asset position        |               | 85            |   | 45 |
|   Gross fair market (liability)  position |               | --            |   | -- |
|                                                |               |          |   |   |
| Total net asset position                            | $                  | 96            | $ | 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 expensesis covered, reduced by any deductibles,copayments,Medicare payments and, in some cases, coverage provided under other groupinsurance policies. The followingrelates to the combined NS plans.

** **

**Pensionand Other Postretirement Benefit Cost Components**

 

|                                         | **Three months ended June 30,** |
|----------------------------------------------|---------------------------------|
|                                         | **2004**                        | **2003** | **2004** | **2003** |
|                                         | **Pension Benefits**            | **Other Benefits** |
|                                         | *($ in millions)*               |
|                                         |                            |   |   |   |   |   |   |   |
| Service cost                                 | $                               | 5  | $ | 5  | $ | 4  | $ | 5  |
| Interest cost                                |                            | 23  |   | 22  |   | 11  |   | 10  |
| Expected return on plan assets               |                            | (37) |   | (40) |   | (4) |   | (3) |
| Amortization of prior service cost (benefit) |                            | --  |   | 1  |   | (3) |   | (1) |
| Recognized net actuarial gains (losses)      |                            | --  |   | --  |   | --  |   | --  |
| Amortization of unrecognized net (gain) loss |                            | --  |   | --  |   | 4  |   | 4  |
|    Net (benefit) cost         | $                               | (9) | $ | (12) | $ | 12  | $ | 15  |

 

|                                         | **Six months ended June 30,** |
|----------------------------------------------|-------------------------------|
|                                         | **2004**                      | **2003** | **2004** | **2003** |
|                                         | **Pension Benefits**          | **Other Benefits** |
|                                         | *($ in millions)*             |
|                                         |                          |   |   |   |   |   |   |   |
| Service cost                                 | $                             | 9  | $ | 10  | $ | 8  | $ | 8  |
| Interest cost                                |                          | 45  |   | 44  |   | 22  |   | 18  |
| Expected return on plan assets               |                          | (74) |   | (80) |   | (8) |   | (6) |
| Amortization of prior service cost (benefit) |                          | 1  |   | 2  |   | (6) |   | (2) |
| Recognized net actuarial gains (losses)      |                          | 1  |   | 1  |   | --  |   | --  |
| Amortization of unrecognized net (gain) loss |                          | --  |   | --  |   | 8  |   | 8  |
|    Net (benefit) cost         | $                             | (18) | $ | (23) | $ | 24  | $ | 26  |

** **

**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 six months endedJune 30, 2004, $3 million and $22 million ofcontributions have been made to its unfunded pension plans and its otherpostretirement benefit plans, respectively. NS presently anticipates contributing an additional $4 million to itsunfunded pension plans for a total of $7 million and an additional $20 millionto fund its postretirement benefit plans in 2004 for a total of$42 million.

 

**4. Changes in Accounting Principles**

 

NS Rail adoptedFinancial Accounting Standards Board (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.

 

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 millionbefore taxes) for the cumulative effect of this change in accounting on yearsprior to 2003. Pursuant to FIN No. 46,NS Rail has consolidated a special-purpose entity that leases certainlocomotives to NS. Thisentity's assets and liabilities atJan. 1, 2003, included $169 million of locomotives and $157 million ofdebt related to their purchase as well as a $6 million minority interestliability.

 

**5. Comprehensive Income**

 

 

NS Rail'stotal comprehensive income was as follows:

 

|                               | **Three  months Ended** | Six months Ended |
|------------------------------------|-------------------------|------------------|
|                               | **June  30,**           | **June  30,**    |
|                               | **2004**                | **2003**         | **2004** | **2003** |
|                               | *($  in millions)*      |
|                               |                    |             |   |   |   |   |   |   |
| Net  income                        | $                       | 180              | $ | 108 | $ | 323 | $ | 292  |
| Other  comprehensive income (loss) |                    | 77               |   | 13 |   | 62 |   | (7) |
|                               |                    |             |   |   |   |   |   |   |
| Total  comprehensive income        | $                       | 257              | $ | 121 | $ | 385 | $ | 285  |

 

"Othercomprehensive income (loss)" is the unrealized gains and losses on certaininvestments in debt and equity securities, principally NS commonstock, and net fair value adjustments to certain derivativefinancial instruments.

 

**6. Commitments and Contingencies**

 

**Lawsuits**

 

NSR and certainsubsidiaries are defendants in numerous lawsuits and other claims relatingprincipally to railroad operations. Whenmanagement concludes that it is probable that a liability has been incurred andthe amount of the liability can be reasonably estimated, it is accrued througha charge to expenses. While the ultimateamount of liability incurred in any of these lawsuits and claims is dependenton future developments, in management's opinion the recorded liability isadequate to cover the future payment of such liability and claims. However, the final outcome of any of theselawsuits and claims cannot be predicted with certainty, and unfavorable orunexpected outcomes could result in additional accruals that could besignificant to results of operations in a particular year or quarter. Any adjustments to recorded liability will bereflected in expenses in the periods in which such adjustments are known.

 

**Casualty Claims**

 

NSRail is generally self-insured for casualty claims. NS Rail has insurance, subject to limits, forcatastrophic events. The casualty claims liability is determined actuarially,based upon claims filed and an estimate of claims incurred but not yetreported. While the ultimate amount ofclaims incurred is dependent on future developments, in management's opinion,the recorded liability is adequate to cover the future payments of claims. However, it is possible that the recordedliability may not be adequate to cover the future payments of claims. Adjustments to the recorded liability arereflected in operating expenses in the periods in which such adjustments areknown.

 

**Environmental Matters**

** **

NSRail is subject to various jurisdictions' environmental laws andregulations. It is NS Rail's policy torecord a liability where such liability or loss is probable and its amount canbe estimated reasonably. Claims, if any, against third parties for recovery of cleanup costsincurred by NS Rail are reflected as receivables (when collection is probable)in the balance sheet and are not netted against the associated NS Railliability. Environmentalengineers regularly participate inongoing evaluations of all known sites and indetermining any necessary adjustments to liability estimates. NS Rail also has established an EnvironmentalPolicy Council, composed of senior managers, to oversee and interpret itsenvironmental policy.

 

NSRail's balance sheets included liabilities for environmental exposures in theamount of $23 million atJune 30, 2004, and $25 million atDec. 31, 2003(of which $8 million was accounted for as a current liability in eachperiod). AtJune 30, 2004,the liability represented NS Rail's estimate of the probable cleanup andremediation costs based on available information at 114 known locations. On that date, 10 sites accounted for $12million of the liability, and no individual site was considered to bematerial. NS Rail anticipates that muchof this liability will be paid out over five years; however, some costs will bepaid out over a longer period.

 

Atsome of the 114 locations, certain NS Rail subsidiaries, usually in conjunctionwith a number of other parties, have been identified as potentially responsibleparties by the Environmental Protection Agency (EPA) or similar stateauthorities under the Comprehensive Environmental Response, Compensation andLiability Act of 1980, or comparable state statutes, which often impose jointand several liability 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 areunavoidably 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 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. In addition, several NS Rail subsidiariesown, or have owned, land used as operating property, or which is leased or mayhave been leased and operated by others, or held for sale. Because environmental problems that arelatent or undisclosed may exist on these properties, there can be no assurancethat NS Rail will not incur environmental liabilities or costs with respect toone or more of them, the amount and materiality of which cannot be estimatedreliably at this time. Moreover,lawsuits and claims involving these and potentially other unidentifiedenvironmental sites and matters are likely 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 assessment of the facts and circumstances now known, managementbelieves it has recorded the probable costs for dealing with thoseenvironmental matters of which the Company is aware. Further, management believes that it isunlikely that any known matters, either individually or in the aggregate, willhave a material adverse effect on NS Rail's financial position, results ofoperations or liquidity.

** **

**Purchase Commitments**

 

AtJune 30, 2004,NS Rail had outstanding purchase commitments of approximately $219 million inconnection with its 2004 capital program, including locomotives and equipment.

 

** **

** **

**Report of Independent Registered Public AccountingFirm**

 

 

The Board of Directors

NorfolkSouthern Railway Company:

 

We have reviewed theaccompanying consolidated balance sheet of Norfolk Southern Railway Company andsubsidiaries as ofJune 30, 2004, the related consolidated statements ofincome for the three-month and six-month periods endedJune 30, 2004and 2003 and the related consolidated statements of cash flows for thesix-month periods endedJune 30, 2004 and 2003. These consolidated financial statements arethe responsibility of the Company's management.

 

We conducted ourreviews in accordance with the standards of the Public Company AccountingOversight Board (United States). A review of interim financial informationconsists principally of applying analytical procedures and making inquiries ofpersons responsible for financial and accounting matters. It is substantially less in scope than anaudit conducted in accordance with the standards of the Public CompanyAccounting Oversight Board (United  States), the objective ofwhich is the expression of an opinion regarding the financial statements takenas a whole. Accordingly, we do notexpress such an opinion.

 

Based on our reviews,we are not aware of any material modifications that should be made to theconsolidated financial statements referred to above for them to be inconformity withU.S.generally accepted accounting principles.

 

As discussed in Note 4to the consolidated financial statements, the Company adopted Financial AccountingStandards Board Statement No. 143, *Accounting for Asset RetirementObligations,* and Financial Accounting Standards Board Interpretation No.46, *Consolidation of Variable Interest Entities,* as ofJanuary 1, 2003..

 

We have previouslyaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of NorfolkSouthern Railway Company and subsidiaries as of December 31, 2003, and therelated consolidated statements of income, changes in stockholders' equity andcash flows for the year then ended (not presented herein); and in our reportdated January 27, 2004, we expressed an unqualified opinion on thoseconsolidated financial statements. Inour opinion, the information set forth in the accompanying consolidated balancesheet as ofDecember 31, 2003, is fairly stated, in all materialrespects, in relation to the consolidated balance sheet from which it has beenderived.

 

 

 

 

/s/ KPMG LLP

Norfolk,Virginia

July 27, 2004

 

 

**Item 2.**** Management's Discussion andAnalysis of Financial 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'snarrative analysis of the results of operations.

** **

** **

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

** **

** **

**RESULTS OF OPERATIONS**

 

### Net Income

 

Second-quarter netincome was $180 million in 2004, compared with $108 million in 2003. The increase was primarily the result of a$130 million, or 53%, increase in income from railway operations, which wasdriven by an 11% rise in revenues. Railway operating expenses rose only 3% despite an 8% increase incarloads, reflecting increased operating leverage as the railroad networkremained fluid.

 

For the first sixmonths, net income was $323 million in 2004, compared with $292 million in2003. The following table shows thecompenents of the change.

 

|                                                                                    | **First Six Months** |
|-----------------------------------------------------------------------------------------|----------------------|
|                                                                                    | ** **           | ** ** | ** ** | ** ** | **2004 vs. 2003** |
|                                                                                    | ** **           | ** ** | ** ** | ** ** | **Increase** |
|                                                                                    | **2004**             | **2003** | **(Decrease)** |
|                                                                                    | *($ in millions)*    |
| Income before accounting changes                                                        | $                    | 323 | $ | 188 | $ | 135 |
| Cumulative effect of changes in

   accounting principles, net of  taxes |                 | -- |   | 104 |   | (104) |
|       Net income                                          | $                    | 323 | $ | 292 | $ | 31 |

###  

Incomebefore accounting changes increased $135 million, or 72%, compared with thesame period last year. The growthresulted from a $297 million, or 10%, increase in railway operating revenuescoupled with a 2% rise in railway operating expenses, which led to higherincome from railway operations.

 

### Railway Operating Revenues

 

Second-quarter railway operatingrevenues were $1.8 billion in 2004, up $171 million, or 11%, compared with thesecond quarter of last year. For thefirst six months, revenues were $3.4 billion, up $297 million, or 10%. As shown in the following table, theincreases were the result of higher traffic volume and increased averagerevenues.

 

|                                | Second  quarter                  | **First  six months**            |
|-------------------------------------|----------------------------------|----------------------------------|
|                                | **2004  vs. 2003**               | **2004  vs. 2003**               |
|                                | **Increase  (Decrease)**         | **Increase  (Decrease)**         |
|                                | *($ in millions)*                |
|                                |                             |                             |
| Traffic volume (carloads)           | $  128                 | $   228           |
| Revenue per unit/mix                |      43 |      69 |
|      Total | $  171                 | $  297                 |

 

Revenues,carloads and average revenue per unit for the commodity groups were as follows:

 

|                                          | **Second  Quarter** |
|-----------------------------------------------|---------------------|
|                                          | **Revenues**        | **Carloads** | **Revenue  per Unit** |
|                                          | **2004**            | **2003** | **2004** | **2003** | **2004** | **2003** |
|                                          | *($  in millions)*  | *(in  thousands)* | *($  per unit)* |
|                                          |                |   |   |   |   |   |   |   |   |   |   |   |
| Coal                                          | $                   | 424  | $ | 389 |   | 427  |   | 420 | $ | 992  | $ | 927 |
| General merchandise:                          |                |   |   |   |   |   |   |   |   |   |   |   |
|    Automotive                  |                | 252  |   | 242 |   | 170  |   | 169 |   | 1,480  |   | 1,433 |
|    Chemicals                   |                | 214  |   | 190 |   | 113  |   | 105 |   | 1,908  |   | 1,809 |
|    Metals/construction         |                | 209  |   | 175 |   | 204  |   | 184 |   | 1,024  |   | 954 |
|    Agr../consumer prod./govt.. |                | 182  |   | 175 |   | 140  |   | 137 |   | 1,292  |   | 1,278 |
|    Paper/clay/forest           |                | 168  |   | 162 |   | 113  |   | 113 |   | 1,490  |   | 1,433 |
|                                          |                |   |   |   |   |   |   |   |   |   |   |   |
| General  merchandise                          |                | 1,025  |   | 944 |   | 740  |   | 708 |   | 1,385  |   | 1,334 |
| Intermodal                                    |                | 311  |   | 256 |   | 708  |   | 608 |   | 440  |   | 421 |
|                                          |                |   |   |   |   |   |   |   |   |   |   |   |
|       Total     | $                   | 1,760  | $ | 1,589 |   | 1,875  |   | 1,736 | $ | 939  | $ | 916 |

 

|                                          | **First  Six Months** |
|-----------------------------------------------|-----------------------|
|                                          | Revenues              | **Carloads** | **Revenue  per Unit** |
|                                          | **2004**              | **2003** | **2004** | **2003** | **2004** | **2003** |
|                                          | *($  in millions)*    | *(in  thousands)* | *($  per unit)* |
|                                          |                  |   |   |   |   |   |   |   |   |   |   |   |
| Coal                                          | $                     | 822  | $ | 743 |   | 833  |   | 816 | $ | 986  | $ | 911 |
| General merchandise:                          |                  |   |   |   |   |   |   |   |   |   |   |   |
|    Automotive                  |                  | 500  |   | 484 |   | 337  |   | 335 |   | 1,483  |   | 1,443 |
|    Chemicals                   |                  | 417  |   | 382 |   | 223  |   | 211 |   | 1,876  |   | 1,816 |
|    Metals/construction         |                  | 392  |   | 341 |   | 381  |   | 345 |   | 1,028  |   | 988 |
|    Agr../consumer prod./govt.. |                  | 358  |   | 343 |   | 281  |   | 271 |   | 1,272  |   | 1,262 |
|    Paper/clay/forest           |                  | 325  |   | 312 |   | 221  |   | 220 |   | 1,475  |   | 1,419 |
|                                          |                  |   |   |   |   |   |   |   |   |   |   |   |
| General  merchandise                          |                  | 1,992  |   | 1,862 |   | 1,443  |   | 1,382 |   | 1,381  |   | 1,347 |
| Intermodal                                    |                  | 591  |   | 503 |   | 1,356  |   | 1,186 |   | 436  |   | 424 |
|                                          |                  |   |   |   |   |   |   |   |   |   |   |   |
|       Total     | $                     | 3,405  | $ | 3,108 |   | 3,632  |   | 3,384 | $ | 937  | $ | 918 |

 

**Coal**

 

Coal revenuesincreased $35 million, or 9%, in the second quarter and $79 million, or11%, in the first six months, compared with the same periods last year. Total traffic volume (carloads) handledincreased 2% in the quarter and 2% for the first six months, primarily becauseof higher export coal volume. Exportcoal volume increased 49% in the quarter and 24% for the first six months,supported by increased demand forU.S. coal. Reduced exports fromChina have resulted in more shipments toEuropean steelmakers. Shipments ofutility coal declined 1% in the quarter, but increased 1% for the first sixmonths. Utility stockpiles remained lowat some plants. Increased demand fromother markets and other factors could be drawing volume out of the utilitymarket. Domestic metallurgical coal,coke and iron ore volume declined 9% in the second quarter and 7% for the firstsix months, mostly because of reduced iron ore shipments. Average revenue per carload was up 7% in thesecond quarter and 8% for the first six months, reflecting a favorable changein the mix of traffic (the rate of increase in longer haul traffic exceededthat of shorter haul traffic), higher rates for export coal and the favorableeffects of a fuel surcharge.

 

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 Dukeproceeding the STB initially found NS Rail's rates to bereasonable in November 2003, but subsequently issued technical corrections inFebruary 2004 finding that in certain years some portion of the rates wasunreasonable. The case is currentlystayed while the STB considers both parties' petitions for reconsideration, andthe STB has not yet ordered any rate relief. In the CP&Lproceeding the STB found NSRail's rates to be unreasonable in December 2003, but upheld a significantportion of NS Rail's tariff increase. Both of theSTB's rate decisions remainsubject to 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,supported by higher export and utility coal volumes and increased averagerevenue per shipment.

 

### General Merchandise

 

General merchandise revenues increased $81million, or 9%, in the second quarter and $130 million, or 7%, in thefirst six months, compared with the same periods last year. Both increases reflected higher trafficvolume, particularly for metals and construction and chemicals, and higheraverage revenues. Metals andconstruction volume benefited from continued strength in construction activityand increased domestic steel production. Chemicals traffic volume benefited from manufacturing expansion andhigher plant operating rates. Agriculture, consumer products and government volume reflected moreshipments of corn, increased volume for fertilizer and more shipments for themilitary. General merchandise averagerevenue per carload increased 4% in the second quarter and 3% for the first sixmonths reflecting fuel surcharges, increased rates and longer lengths of haul.

 

General merchandise revenues are expected tocontinue to compare favorably with the prior year as 2004 progresses; however,the extent of the increase could lessen in the fourth quarter due to thestrength of the fourth quarter of last year.

 

### Intermodal

 

Intermodal revenues increased $55 million, or 21%,in the second quarter and $88 million, or 17%, in the first six months,compared with the same periods last year. Traffic volume (units) increased 16% in the second quarter and 14% forthe first six months reflecting very strong trailer and container volume. Intermodal trafficvolume continued to benefit from increased international and domestic truckloadbusiness as well as the conversion of truck traffic to rail. Intermodal revenue per unit increased 5% forthe quarter and 3% for the first six months, as the favorable effects of rateincreases and fuel surcharges were somewhat offset by an increase in lower-ratedtraffic.

 

Intermodalrevenues are expected to continue to show growth during 2004, provided retailand manufacturing sectors continue to expand.****

 

### Railway Operating Expenses

 

Second-quarter railway operating expenses were $1.4billion in 2004, up $41 million, or 3%, compared with last year. For the first six months, expenses were $2.7 billion,up $54 million, or 2%. For bothperiods, most of the increase was the result of higher compensation andbenefits and higher diesel fuel prices.

 

Compensation and benefits expenses increased $19million, or 5%, in the second quarter and $39 million, or 5%, in the firstsix months, compared with the same periods last year. Both periods reflected higher wage rates,including higher incentive compensation for locomotive engineers, and highervolume-related train and engine payroll expenses.

 

Materials,services and rents increased $3 million, or 1%, in the second quarter and decreased$2 million for the first six months, compared with the same periods lastyear. Higher locomotive and freight carmaintenance expenses and increased volume-relatedintermodalpurchased services were partially offset for the second quarter and fullyoffset for the first six months by reduced management service fees.

 

Conrail rents and services expenses increased $2million, or 2%, in the second quarter and decreased $1 million for thefirst six months, compared with the same periods last year. Higher rental payments were partially offsetin the second quarter and fully offset for the first six months by lowerexpenses in the shared assets area.

 

Diesel fuel expenses increased $13 million, or 14%,in the second quarter and $16 million, or 8%, in the first six months,compared with the same periods last year, reflecting higher average prices and higherconsumption. The hedging programproduced benefits of $26 million and $49 million in the secondquarter and first six months of 2004, compared with benefits of $8 millionand $34 million for the same periods of 2003, respectively.

 

Casualties and other claims expense decreased $10 million,or 21%, in the second quarter and $21 million, or 21%, in the first sixmonths, compared with the same periods last year. The decreases reflected the absence ofunfavorable personal injury claims development, lower derailment-relatedexpenses and lower insurance premiums.

 

Other expense increased$10 million, or 14%, in the second quarter and $16 million, or 11%, in thefirst six months, compared with the same periods of last year. The increases were largely the result ofhigher property taxes as last year benefited from a favorable property taxsettlement.

 

**Other Income (Expense) - Net**

 

Other income (expense) - net was an expense of$94 million in the second quarter and $159 million in the first six monthsof 2004, compared with expenses of $65 million and $116 million, respectively,for the same periods of 2003. Both increasesreflected lower investment returns on corporate-owned life insurance, highercosts for receivable sales and expenses related to new investments.

 

In June 2004, NS Rail purchased a 40.5%membership interest in a limited liability company (LLC) that owns and operatesfacilities that produce synthetic fuel from coal. The production of synthetic fuel results intax credits as well as expenses related to the investments. The expenses are recorded as a component of"Other income (expense) - net," and the tax credits, as well as tax benefitsrelated to the expenses, are reflected in the provision for income taxes.

 

** **

**OTHER MATTERS**

** **

**Labor Agreements**

 

Approximately 24,000 of NS Rail's employeesare covered by collective bargaining agreements with several labor unions. These agreements remain in effect untilchanged pursuant to the Railway Labor Act. Moratorium provisions in these agreements permitted NS Rail and theunions to propose such changes in late 1999; negotiations at the national levelcommenced shortly thereafter.

 

Agreements have been reached with theBrotherhood of Maintenance of WayEmployes, whichrepresents about 4,000 NS Rail employees; the United Transportation Union,which represents about 7,000 NS Rail employees; the International Brotherhoodof Boilermakers and Blacksmiths, which represents about 100 NS Rail employees;the Transportation Communications International Union, which represents about4,000 NS Rail employees; the American Train Dispatchers Association (ATDA),which represents about 350 NS Rail employees; the Brotherhood of RailroadSignalmen, which represents about 1,000 NS Rail employees; and the Brotherhoodof Locomotive Engineers (BLE), which represents about 4,600 NS Rail employees. The agreements with the BLE and ATDA arethrough 2009; the other agreements are through 2004. 

 

The railroads and the InternationalBrotherhood of Electrical Workers, which represents about 900 NS Rail employees,have agreed to resolve their negotiations through arbitration. Agreements have not yet been reached with theInternational Association of Machinists and Aerospace Workers, which representsabout 1,000 NS Rail employees; the Sheet Metal Workers InternationalAssociation, which represents about 250 NS Rail employees; the NationalConference of Firemen andOilers, which representsabout 400 NS Rail employees; and the International Longshoreman Association,which represents about 50 NS Rail employees. 

 

Negotiations for the next round of nationalbargaining will commence with most rail labor unions on or shortly afterNov. 1, 2004..

 

**MarketRisks and Hedging Activities**

 

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.

 

The intent of the diesel fuel hedging program is toassist in the management of NS Rail's aggregate risk exposure to fuel pricefluctuations, which can significantly affect NS Rail's operating margins andprofitability, through the use of one or more types of derivative instruments. Diesel fuel costs represented 8% of NS Rail'soperating expenses for the second quarter of 2004. The program provides that NS Rail will notenter into any fuel hedges witha duration of morethan 36 months, and that no more than 80% of NS Rail's average monthly fuelconsumption will be hedged for any month within any 36-month period.

 

However, with fuel prices near historic highs andfuel surcharges being collected under certain tariffs and contracts, NS Rail isnot currently entering into additional hedges at today's market levels. Consequently, NS Rail is modifying itsfuel-hedging strategy on a go-forward basis, and the past pattern of enteringinto regular monthly swaps may not be indicative of future hedging activity.

 

As ofJune 30, 2004, through swap transactions,NS Rail has hedged approximately 69% of expected diesel fuel requirements forthe remainder of 2004, and 38% and 4% of expected requirements for 2005 and 2006,respectively. The effect of the hedgesis to yield an average cost of 83 cents per hedged gallon, includingfederal taxes and transportation. A 10%decrease from current diesel fuel prices would reduce NS Rail's asset relatedto the swaps by approximately $43 million as ofJune 30, 2004..

 

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

 

AtJune 30, 2004,NS Rail's debt subject to interest rate exposure totaled $499 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.

 

Someof NS Rail's capital leases, which carry an average fixed rate of 7%, wereeffectively converted to variable rate obligations using interest rate swapagreements. OnJune 30, 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 both the second quarters of 2004and 2003 and by $4 million for the first six months of 2004 and 2003. A portion of the lease obligations is payablein Japanese yen. NS Rail eliminated theassociated exchange rate risk at the inception of each lease with a yen depositsufficient 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 toJapan.. Counterparties to the interest rate swaps andJapanese banks holding yen deposits are major financial institutions believedby management to be creditworthy.

** **

** **

**FORWARD-LOOKINGSTATEMENTS**

 

This Management's Narrative Analysis of the 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, aguarantee 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 Companyundertakes no obligation to update or revise forward-looking statements.

 

 

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

 

Theinformation required by this item is included in Part I, Item 2,"Management's Narrative Analysis of the Results of Operations" onpage 18 under the heading "Market Risks and Hedging Activities."

 

 

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

 

(a) Evaluation ofDisclosure 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-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended (the "Exchange Act")) as of June 30, 2004. Based on such evaluation, such officers haveconcluded that, as ofJune 30, 2004, NS Rail's disclosure controls andprocedures are effective in alerting them on a timely basis to materialinformation relating to NS Rail (including its consolidated subsidiaries)required to be included in NS Rail's periodic filings under the Exchange Act.

 

(b) Changes inInternal Controls.

 

During the first sixmonths of 2004, management has not identified any changes in NS Rail's internalcontrols over financial reporting that have materially affected, or arereasonably likely to materially affect, NS Rail's internal controls overfinancial reporting.

 

 

 

** **

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

 

 

**Item 6.**** Exhibits and Reports on Form 8-K**

 
| (a)    | Exhibits:

              |
|--------|-------------------------------|
|   | 10(o)                         | Amendment  No. 3, dated as of June 1, 1999, and executed in April 2004, to the  Transaction Agreement, dated June 10, 1997, by and among CSX Corporation, CSX  Transportation, Inc., Norfolk Southern Corporation, Norfolk Southern Railway  Company, Conrail Inc., Consolidated Rail Corporation and CRR Holdings LLC, is  filed herewith.

  |
|   | 15                            | Letter  regardingunaudited interim financial information.

  |
|   | 31                            | Certifications  of the CEO and CFO pursuant to Exchange Act Rule 13a-14(a) or Rule 15d-14(a).

  |
|   | 32                            | Certifications  of the CEO and CFO required by Rule 13a-14(b) or Rule 15d-14(b) and Section  1350 of Chapter 63 of Title 18 of the U. S. Code.

  |
| (b)    | Reports  on Form 8-K:

  |
|   | None.                         |   |

** **

**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:  | July 30, 2004 | /s/  Reginald J. Chaney           |  
 

 

Reginald  J. Chaney

 

 

Corporate  Secretary (Signature)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

July 30, 2004

/s/Marta R. Stewart

 
 

 

Marta   R. Stewart

 

 

Vice  President and Controller

 

 

(Principal  Accounting Officer) (Signature)

 
****
**Exhibit Index******

 

 

** **
Electronic
** **

** **

**Submission**

** **

** **

**Exhibit**

** **

** **

**Number**

**Description******

** **

** **

** **

** **

10(o)

Amendment  No. 3 to the Transaction Agreement

 

 

 

 

15

Letter  regardingunaudited interim financial information.

 

 

 

 

31

Certifications of  the CEO and CFO pursuant to Exchange Act Rule 13a-14(a)

 

 

or Rule 15d-14(a).

 

 

 

 

32

Certifications of  the CEO and CFO required by Rule 13a-14(b) or Rule 15d-14(b)

 

** **

and Section 1350 of  Chapter 63 of Title 18 of the U. S. Code.

** **

** **

 

** **

 

  |