TABLE OF CONTENTS

PART I.   FINANCIAL INFORMATION

Item 1. Financial Statements.

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

($ in millions except per share amounts)

(Unaudited)

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

($ in millions)

(Unaudited)

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

($ in millions)

(Unaudited)

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly Norfolk Southern Corporation and subsidiaries' (NS) financial position as of March 31,June 30, 2005, and its results of operations for the three and six months ended June 30, 2005 and 2004, and its cash flows for the threesix months ended March 31,June 30, 2005 and 2004, in conformity with U.S. generally accepted accounting principles.

These Consolidated Financial Statements should be read in conjunction with the financial statements and notes included in NS' latest Annual Report on Form 10‑K.

Certain amounts have been reclassified to conform to current presentation.   Specifically, $112 million of auction rate securities held at Dec. 31, 2004 , previously classified as cash equivalents have been reclassified as short-term investments.   These securities were sold in the first quarter of 2005 at market value, which was equal to their carrying cost, and accordingly are included in "Investment sales and other transactions" in the Consolidated Statements of Cash Flows.   There were no auction rate securities held at the beginning of 2004.   In addition, the following items shown in the Consolidated Balance Sheet as of Dec. 31, 2004, have been reclassified to conform to the current presentation in the Consolidated Balance Sheets filed herewith: (1) "Investment in Conrail" and the amount of investments included in "Other assets" have been reclassified and comprise "Investments" and (2) "Due to Conrail" has been reclassified and is included in the amount shown for "Accounts payable."

1.   Stock-Based Compensation

During the first quarter of 2005, a committee of nonemployee directors of NS' Board granted stock options, performance share units (PSUs) and restricted shares pursuant to the stockholder-approved Long-Term Incentive Plan.   Options to purchase 1,353,600 shares were granted with an option price of $34.10, which was the fair market value of Common Stock on the date of grant.   The options have a term of ten years, but may not be exercised prior to the third anniversary of the date of grant.   PSUs granted totaled 1,344,400 and will be awarded based on achievement of certain predetermined corporate performance goals at the end of a three-year cycle.   One-half of any PSUs earned will be paid in the form of shares of Common Stock with the other half to be paid in cash.   Restricted shares granted totaled 576,240 and have a five-year vesting and restriction period unless certain predetermined stock performance goals are met at the end of three years, in which case the shares become fully vested and the restrictions are lifted.

NS applies the intrinsic value recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock-based employee compensation plans.   As a result, the grants of PSUs and restricted shares resultresulted in charges to net income, while the stock-option grant did not result in a charge to net income.   The portion of the restricted stock that has not yet been earned is shown as a reduction of stockholders' equity on NS' Consolidated Balance Sheet.

The following table illustrates the effect on net income and earnings per share if NS had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" to stock-based employee compensation:

2.   Investments

Investment in Conrail

Through a limited liability company, Norfolk Southern and CSX Corporation (CSX) jointly own Conrail Inc. (Conrail), whose primary subsidiary is Consolidated Rail Corporation (CRC).   NS has a 58% economic and 50% voting interest in the jointly owned entity, and CSX has the remainder of the economic and voting interests.   NS applies the equity method of accounting to its investment in Conrail.  

On August 27, 2004 , NS, CSX and Conrail completed a reorganization of Conrail (Conrail Corporate Reorganization), which established direct ownership and control by Norfolk Southern Railway (NSR) and CSX Transportation Inc. (CSXT) of two former CRC subsidiaries, Pennsylvania Lines LLC (PRR) and New York Central Lines LLC (NYC), respectively.   Prior to the Conrail Corporate Reorganization, NSR operated the routes and assets of PRR, and CSXT operated the routes and assets of NYC, each in accordance with operating and lease agreements.   Pursuant to the Conrail Corporate Reorganization, the operating and lease agreements were terminated and PRR and NYC were merged into NSR and CSXT, respectively.   As a part of the Conrail Corporate Reorganization, Conrail restructured its existing unsecured and secured public indebtedness, with the consent of Conrail's debtholders.   As a result of the transaction NSR and CSXT issued new unsecured debt securities in exchange for Conrail debentures and entered into leases and subleases with Conrail to support its secured debt obligations in proportion to their economic ownership percentages.

CRC continues to own and operate certain properties (the Shared Assets Areas) for the joint and exclusive benefit of NSR and CSXT.   The costs of operating the Shared Assets Areas are borne by NSR and CSXT based on usage.   In addition, NSR and CSXT pay CRC a fee for access to the Shared Assets Areas.   After the Conrail Corporate Reorganization, "Conrail rents and services" reflects only the expenses associated with the Shared Assets Areas, and other expenses (primarily the depreciation related to the former PRR assets) are reflected in their respective line items.   Accordingly, "Conrail rents and services" includes:   (1) expenses for amounts due to PRR for use by NSR of operating properties and equipment prior to the Conrail Corporate Reorganization, (2) NS' equity in the earnings of Conrail, net of amortization, prior to the Conrail Corporate Reorganization, and (3) expenses for amounts due to CRC for operation of the Shared Assets Areas.   NS' equity in the earnings of Conrail, net of amortization, after the reorganization is included in "Other income - net."

"Accounts payable" includes $86$89 million at March 31,June 30, 2005 , and $78 million at Dec. 31, 2004 , due to Conrail for the operation of the Shared Assets Areas.   In addition, "Other liabilities" includes a $32 million long-term advance from Conrail, maturing 2035, entered into in the first quarter of 2005 andthat bears interest at 4.5%.

Prior to the Conrail Corporate Reorganization, a significant portion of the payments made to PRR under the operating and lease agreements was borrowed back from a subsidiary of PRR, and this note was effectively extinguished by the reorganization in 2004.   TheseNS' net cash flow from these borrowings amounted to $69$81 million in the first threesix months of 2004.

3.  Derivative Financial Instruments

NS uses derivative financial instruments to reduce the risk of volatility in its diesel fuel costs and to manage its overall exposure to fluctuations in interest rates.   NS does not engage in the trading of derivatives.   Management has determined that its derivative financial instruments qualify as either fair-value or cash-flow hedges, having values that highly correlate with the underlying hedged exposures, and has designated such instruments as hedging transactions.   Credit risk related to the derivative financial instruments is considered to be minimal and is managed by requiring high credit standards for counterparties and periodic settlements.

Diesel Fuel Hedging

NS has hedged a significant portion of its diesel fuel consumption.consumption although the percentage of diesel fuel hedged has been declining.   The intent of the hedges is to assist in the management of NS' aggregate risk exposure to fuel price fluctuations, which can significantly affect NS' operating margins and profitability.   In order to minimize this risk, NS has entered into a series of swaps in order to lock in the purchase prices of some of its diesel fuel.   Management has designated these derivative instruments as cash-flow hedges of the exposure to variability in expected future cash flows attributable to fluctuations in diesel fuel prices.

Following is a summary of NS' diesel fuel swaps:

Hedges are entered into periodically by competitive bid among selected counterparties; however, no hedges have been placed since May 2004.   The goal of this hedging strategy is to average fuel costs over an extended period of time while minimizing the incremental cost of hedging. The program provides that NS will not enter into any fuel hedges with a duration of more than 36 months, and that no more than 80% of NS' average monthly fuel consumption will be hedged for any month within any 36-month period. After taking into account the effect of the hedges, diesel fuel costs represented 10% and 8% of NS' operating expenses in the firstsecond quarters of 2005 and 2004, respectively.

NS' fuel hedging activity resulted in net decreases in diesel fuel expense of $40 million for firstsecond quarter 2005 and $23$80 million for the first quartersix months, compared with $26 million and $49 million for the same periods, respectively, in 2004.   Ineffectiveness, or the extent to which changes in the fair values of the heating oil contracts do not offset changes in the fair values of the expected diesel fuel transactions, was a $2 million expense in the second quarter of 2005 compared with less than a $1 million benefit in 2004, and a $3 million expense in the first quartersix months of 2005 andcompared with a $3 million benefit in the first quarter of 2004.

Interest Rate Hedging

NS manages its overall exposure to fluctuations in interest rates by issuing both fixed and floating-rate debt instruments, and by entering into interest rate hedging transactions.   NS had $141$133 million and $151 million, or about 2%, of its fixed rate debt portfolio hedged at March 31,June 30, 2005 , and Dec. 31, 2004 , respectively, using interest rate swaps that qualify for and are designated as fair-value hedge transactions. NS' interest rate hedging activity resulted in decreases in interest expenses of $1 million and $2 million for second quarter 2005 and 2004, respectively, and $2 million and $4 million for the first quartersix months of 2005 and 2004, respectively.   These swaps have been effective in hedging the changes in fair value of the related debt arising from changes in interest rates, and accordingly, there has been no impact on earnings resulting from ineffectiveness associated with these derivative transactions.

Fair Values

The fair values of NS' diesel fuel derivative instruments at March 31,June 30, 2005 and Dec. 31, 2004 , were determined based upon current fair market values as quoted by independent third party dealers.   Fair values of interest rate swaps were determined based upon the present value of expected future cash flows discounted at the appropriate implied spot rate from the spot rate yield curve.   Fair value adjustments are noncash transactions, and accordingly, are excluded from the Consolidated Statement of Cash Flows.   "Accumulated other comprehensive loss," a component of "Stockholders' equity," included unrealized gains (pretax) of $115$79 million and $75 million at March 31,June 30, 2005, and Dec. 31, 2004, respectively, relating to an increase in the fair value of derivative fuel hedging transactions that will terminate within twelve months of the respective dates.   Any future gain or loss actually realized will be based on the fair value of the derivative fuel hedges at the time of termination.

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

4.   Pensions and Other Postretirement Benefits

NSNorfolk Southern and certain subsidiaries have both funded and unfunded defined benefit pension plans covering principally salaried employees.   NS and certain subsidiaries also provide specified health care and death benefits to eligible retired employees and their dependents.   Under the present plans, which may be amended or terminated at NS'Norfolk Southern's option, a defined percentage of health care expenses is covered, reduced by any deductibles, copayments, Medicare payments and, in some cases, coverage provided under other group insurance policies.

Pension and Other Postretirement Benefit Cost Components

Contributions for Pension and Other Postretirement Benefits

NS previously disclosed in its consolidated financial statements for the year ended Dec. 31, 2004 , that it expected to contribute $7 million to its unfunded pension plans and $44 million to its other postretirement (medical and life insurance) benefit plans in 2005.   For the threesix months ended March 31,June 30, 2005 , $1$3 million and $11$23 million of contributions have been made to its unfunded pension plans and its other postretirement benefit plans, respectively.   NS presently anticipates contributing an additional $6$4 million to its unfunded pension plans for a total of $7 million and an additional $33$21 million to fund its other postretirement benefit plans in 2005 for a total of $44 million.

5.   Income Taxes

In the second quarter, Ohio enacted tax legislation that phases out its Corporate Franchise Tax, which was generally based on federal taxable income, and phases in a new gross receipts tax called the Commercial Activity Tax, which is based on current year sales and rentals.   The elimination of the Corporate Franchise Tax resulted in a reduction in NS' deferred income tax liability in the second quarter, as required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which decreased deferred tax expense by $96 million.

6. Long-Term Debt

In the second quarter, NS issued $717 million of new unsecured notes ($350 million at 5.64% due 2029 and $367 million at 5.59% due 2025) and paid $218 million of premium in exchange for $717 million of its previously issued unsecured notes ($350 million at 7.8% due 2027, $200 million at 7.25% due 2031, and $167 million at 9.0% due 2021).   The $218 million cash premium payment is reflected as a reduction of debt in the Consolidated Balance Sheet and Statement of Cash Flows and will be amortized as additional interest expense over the terms of the new debt.

On March 11, 2005, NS issued $300 million of 6% Senior Notes due March 2105 under its shelf registration statement on Form S-3 filed with the SEC in September 2004.   At March 31,June 30, 2005 , there is $700 million isof available capacity for future issuance under this registration statement.

NS has commenced offers to exchange existing notes for new notes and cash as described in the registration statement on Form S-4 and the related prospectuses filed with the SEC in April 2005.   The purpose of the exchange offers is to improve NS' debt maturity profile.

6.7.  Earnings Per Share

The following table sets forth the reconciliation of the number of weighted-average shares outstanding used in the calculations of basic and diluted earnings per share:

The calculations exclude options whose exercise price exceeded the average market price of Common Stock for the period as follows: in 2005, 5 million in the second quarter and none in 2005the first quarter, and in 2004, 15 million in the second quarter and 22 million in 2004.the first quarter.   There are no adjustments to "Net income" for the diluted earnings per share computations.

7.8.  Comprehensive Income

NS' total comprehensive income was as follows:

For NS, "Other comprehensive income"income (loss)" reflects primarily the fair value adjustments, net of tax, to certain derivative financial instruments.

8.9.    Commitments and Contingencies

Lawsuits

Norfolk Southern and certain subsidiaries are defendants in numerous lawsuits and other claims relating principally to railroad operations.   When management concludes that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, it is accrued through a charge to earnings.   While the ultimate amount of liability incurred in any of these lawsuits and claims is dependent on future developments, in management's opinion, the recorded liability is adequate to cover the future payment of such liability and claims.   However, the final outcome of any of these lawsuits and claims cannot be predicted with certainty, and unfavorable or unexpected outcomes could result in additional accruals that could be significant to results of operations in a particular year or quarter.   Any adjustments to the recorded liability will be reflected in earnings in the periods in which such adjustments are known.

Casualty Claims

Casualty claims include employee personal injury and occupational claims as well as third-party claims.   NS engages an independent consulting actuarial firm to aid in valuing its liability for these claims.   Job-related accidental injury and occupational claims are subject to the Federal Employers' Liability Act (FELA), which is applicable only to railroads.   FELA's fault-based system produces results that are unpredictable and inconsistent as compared with a no-fault workers' compensation system.   The variability inherent in this system could result in actual costs being very different from the liability recorded.   While the ultimate amount of claims incurred is dependent on future developments, in management's opinion, the recorded liability after considering applicable insurance coverage is adequate to cover the future payments of claims and is supportedsupport ed by the most recent actuarial study.   In all cases, NS records a liability when the expected loss for the claim is both probable and estimable.

In the first quarter of 2005, NS recorded a liability related to the Jan. 6, 2005 derailment in Graniteville , SC.   The liability, which includes a current and long-term portion, represents NS' best estimate based on current facts and circumstances.   The estimate includes amounts related to business property damage and other economic losses, personal injury and individual property damage claims as well as third-party response costs.   NS' commercial insurance policies are expected to cover substantially all expenses related to this derailment above NS' self-insured retention, including NS' response costs and legal fees.   Accordingly, the Consolidated Balance Sheet reflects a current and long-term receivable for estimated recoveries from NS' insurance carriers.   First-quarter expensesSecond quarter and the first six months 2005 expense include approximately $35$2 million and $37 million, respectively, related to this incident, which represents NS' retention under its insurance policies and other uninsured costs.   While it is reasonable to expect that the liability for covered losses could differ from the amount recorded, such a change would be offset by a corresponding change in the insurance receivable.   As a result, NS does not believe that it is reasonably likely that its totalnet loss (the difference between the liability and future recoveries) will be materially different than the loss recorded in the first quartersix months of 2005.   NS expects at this time that insurance coverage is adequate to cover potential claims and settlements above its self-insurance retention.

Employee personal injury claims - The largest component of casualties and other claims expense is employee personal injury costs.   The actuarial firm engaged by NS provides quarterly studies to aid in valuing its employee personal injury liability and estimating its employee personal injury expense.   The actuarial firm studies NS' historical patterns of reserving for claims and subsequent settlements, taking into account relevant outside influences.   The actuary uses the results of these analyses to estimate the ultimate amount of the liability, which includes amounts for incurred but unasserted claims.   NS adjusts its liability to the actuarially determined amount on a quarterly basis.   The estimate of loss liabilitiessuch liability is subject to inherent limitationlimitations given the difficulty of predicting such future events such as jury decisions, court interpretations or legislative changes and as such the actual loss may vary from the actuarial estimate.

Occupational claims - - Occupational claims (including asbestosis and other respiratory diseases, as well as repetitive motion) are often not caused by a specific accident or event but rather result from a claimed exposure over time.   Many such claims are being asserted by former or retired employees, some of whom have not been employed in the rail industry for decades.   The actuarial firm provides an estimate of the occupational claims liability based upon NS' history of claim filings, severity, payments and other pertinent facts.   The liability is dependent upon management's judgments made as to the specific case reserves as well as judgments of the consulting actuarial firm in the periodic studies.   The actuarial firm's estimate of ultimate loss includes a provision for those claims that have been incurred but not reported.   This provision is derived by analyzing industry data and projecting NS' experience into the future as far as can be reasonably determined.   NS adjusts its liability to the actuarially determined amount on a quarterly basis.   However, it is possible that the recorded liability may not be adequate to cover the future payment of claims.   Adjustments to the recorded liability are reflected in operating expenses in the periods in which such adjustments become known.

Third-party claims - - NS records a liability for third-party claims including those for highway crossing accidents, trespasser and other injuries, automobile liability, property damage and lading damage.   The actuarial firm assists with the calculation of potential liability for third-party claims, except lading damage, based upon NS' experience including number and timing of incidents, amount of payments, settlement rates, number of open claims and legal defenses.   The actuarial estimate includes a provision for claims that have been incurred but have not yet been reported.   Each quarter NS adjusts its liability to the actuarially determined amount.   Given the inherent uncertainty in regard to the ultimate outcome of third-party claims, it is possible that future settlement costs may differ from the estimated liability recorded.

Environmental Matters

NS is subject to various jurisdictions' environmental laws and regulations.   It is NS' policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably.   Claims, if any, against third parties for recovery of cleanup costs incurred by NS are reflected as receivables (when collection is probable) on the balance sheet and are not netted against the associated NS liability.   Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates.   NS also has an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy.

NS' Consolidated Balance Sheets included liabilities for environmental exposures in the amount of $64$62 million at  March 31,June 30, 2005 , and $64 million at Dec. 31, 2004 (of which $12 million was accounted for as a current liability in each period).   At March 31,June 30, 2005 , the liability represented NS' estimate of the probable cleanup and remediation costs based on available information at 206201 known locations.   On that date, 1516 sites accounted for $32 million of the liability, and no individual site was considered to be material.   NS anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period.

At some of the 206201 locations, certain NS subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs.

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

The risk of incurring environmental liability - for acts and omissions, past, present and future - is inherent in the railroad business.   Some of the commodities in NS' traffic mix, particularly those classified as hazardous materials, can pose special risks that NS and its subsidiaries work diligently to minimize.   In addition, several NS subsidiaries own, or have owned, land used as operating property, or which is leased and operated by others, or held for sale.   Because environmental problems may exist on these properties that are latent or undisclosed, there can be no assurance that NS will not incur environmental liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably at this time.   Moreover, lawsuits and claims involving these and potentially other unidentified environmental sites and matters are likely to arise from time to time.   The resulting liabilities could have a significant effect on financial condition, results of operations or liquidity in a particular year or quarter.

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

Insurance

NS obtains on behalf of itself and its subsidiaries commercial insurance for potential losses for third-party liability and first-party property damages.   Specified levels of risk are retained on a self-insurance basis (up to $25 million per occurrence for bodily injury and property damage to third parties and $12.5 million per occurrence for property owned by NS or in NS' care, custody or control).

Purchase Commitments

As of March 31,June 30, 2005 , NSR had outstanding purchase commitments of approximately $481$475 million in connection with its 2005 and 2006 capital programs, including 102 locomotives in 2005 and 183 locomotives in 2006.   In addition, Norfolk Southern has committed to purchase telecommunications services totaling $23$21 million through 2007.

Report of Independent Registered Public Accounting Firm

The Stockholders and Board of Directors

Norfolk Southern Corporation:

We have reviewed the accompanying consolidated balance sheet of Norfolk Southern Corporation and subsidiaries as of March 31,June 30, 2005 , the related consolidated statements of income for the three-month and six-month periods ended June 30, 2005 and 2004 and the related consolidated statements of income and cash flows for the three-monthsix-month periods ended March 31,June 30, 2005 and 2004.   These consolidated financial statements are the responsibility of the Company's management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board ( United States ).   A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.   It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board ( United States ), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.   Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.  

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Norfolk Southern Corporation and subsidiaries as of December 31, 2004, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the year then ended (not presented herein); and in our report dated February 28, 2005, we expressed an unqualified opinion on those consolidated financial statements.   In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2004 , is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP

Norfolk , Virginia

AprilJuly 26, 2005

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

NORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS

Overview

First-quarterSecond-quarter net income was $194$424 million in 2005, compared with $158$213 million in 2004.   The 2005 quarter includes a $96 million increase in net income related to state tax law changes and a $24 million increase related to the settlement of two coal rate cases.   The remaining $91 million rise in net income was driven by higher income from railway operations.   Railway operating revenues increased $341 million, or 19%, reflecting higher rates, increased fuel surcharges, higher traffic volume, and the rate case settlements.   Railway operating expenses rose $174 million, or 13%, reflecting higher fuel prices, a 4% increase in traffic volume that was driven by an 8% rise in intermodal units, and increased maintenance and hiring activities.

For the first six months, net income was $618 million in 2005, compared with $371 million in 2004.   Results reflected the second quarter tax adjustment and rate case settlements that contributed to increase net income by $120 million, but also included $37 million of pretax costs related to the first quarter derailment in Graniteville , SC , which reduced net income by $23 million.   The remaining $150 million rise in net income was primarily the result of higher income from railway operations.   The growth benefited from a $57$609 million, or 16%17%, increase in income from railway operations, whichoperating revenues reflecting higher rates, fuel surcharges, increased traffic volume and the rate case settlements.   Railway operating expenses rose $385 million, or 14%, and reflected higher diesel fuel prices, a 5% increase in traffic volume that was driven by a 16%10% rise in revenues, which reflectedintermodal units, increased volumes as well as higher ratesmaintenance and fuel surcharges.   Railway operating expenses rose 16%, reflecting increased traffic volume, higher diesel fuel priceshiring activities and the costs arising fromassociated with the derailment in Graniteville SC (see Note 8), which amounted to approximately $35 million and reduced net income by $21 million.derailment.

Railway Operating Revenues

First-quarterSecond-quarter railway operating revenues were a record $1.96$2.2 billion in 2005, up $268$341 million, or 16%19%, compared with the firstsecond quarter of 2004.   For the first six months, revenues were $4.1 billion, up $609 million, or 17%.   As shown in the following table, the increase wasincreases were the result of increased average revenues and higher traffic volume.

Traffic volume increased 4% in the second quarter and 5% year-to-date.   Revenue per unit increased 14% for the second quarter and 12% for the year-to-date, of which about a third related to increased fuel surcharges in both periods.   Fuel surcharge provisions cover slightly more than 80% of total revenues.

During the second quarter, NS entered into settlement agreements with two utility customers that resolved their rail transportation rate cases before the Surface Transportation Board (STB).   In 2002, Duke Energy (Duke) and Carolina Power & Light (CP&L) each filed rate reasonableness complaints with the STB.   In October 2004, the STB found NS' rates to be reasonable in both cases, and at the STB's invitation, Duke and CP&L each initiated proceedings to determine if phasing constraints should apply.   As a result of the settlement of these cases, NS recognized $55 million of additional coal revenue related to the period in dispute and which, net of associated compensation expenses and income taxes, increased second-quarter net income by $24 million, or 6 cents per diluted share.

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

Coal

First-quarter coalCoal revenues increased $69$154 million, or 17%36%, in the second quarter and $223 million, or 27%, in the first six months, compared with the same periods last year.   TotalBoth increases reflected higher rates, fuel surcharges, increased traffic volume was up 4%, principally due to higherand the effect of the rate case settlements.   Volumes increased 3% in both the quarter and for the first six months, primarily because of utility and exportdomestic metallurgical coal volume.   Utilityvolumes.   Shipments of utility coal volume roseincreased 4% in the quarter and 3% for the first six months due to increased demand for coal firedcoal-fired generation caused bywhich reflected high, volatile natural gas prices in addition toas well as the first quarterongoing shut down for maintenance of five nuclear power plants for maintenance.   Export coal volume increased 19%, due to sustained global demand for metallurgical coal and coke.in NS' service region.   Domestic metallurgical coal, shipments rose 9%coke and iron ore volume increased 5% in the second quarter and 4% for the first six months due to increased demand for the production of coke for the steel market ..   Export coal volume decreased 11% in the quarter, but increased 3% for the first six months - reflecting coal supply constraints caused by a fire at a coal mine and a strong domestic metallurgical market.   AverageCoal average revenue per carload was up 13%, reflecting increased rates, a favorable change32% in the mix of traffic (thesecond quarter and 23% for the first six months, reflecting higher rates, the rate of increase in longer haul traffic exceeded that of shorter haul traffic)case settlements and thefavorable effects of a fuel surcharge.

NS is involved in rate cases with two of its utility customers, Duke Energy (Duke) and Carolina Power & Light (CP&L).   In 2002, Duke and CP&L filed rate reasonableness complaints at the STB alleging that NS' tariff rates for the transportation of coal were unreasonable.   On Oct. 20, 2004 , in a consolidated decision, the STB found NS' rates to be reasonable in both cases.   At the STB's invitation, Duke and CP&L each initiated proceedings to determine whether phasing constraints should apply.   As the STB has explained, the phasing constraint is an independent constraint relating not to the reasonableness of a rate, but to the reasonableness of collecting it immediately.   The Interstate Commerce Commission (the predecessor to the STB) had previously issued guidelines for phasing.   These guidelines indicate that phasing of a rate increase will only be required where the party seeking such relief demonstrates the need for it with specificity.   In balancing the equities of the particular phasing request, the STB will consider factors including the requirements of the railroads, the magnitude of the proposed increase, the magnitude of past increases, the dependence of the utility on coal, the economic conditions in the final destination market and the economic conditions in the coal supply area.  

The phasing constraint has never been invoked by a complainant utility in a rate case, and the STB has never applied it.   Therefore, it is unknown how the STB would balance the above factors, whether it would find the phasing constraint applicable, and if it did, whether phasing would be ordered retroactively or prospectively or both.   Additionally, Duke and CP&L have appealed the October 2004 STB decision on reconsideration to the D.C. Circuit Court of Appeals.   Although management has made an estimate of the ultimate resolution of these cases, due to these uncertainties, future developments in the Duke case and(or) the CP&L case may result in adjustments that could have a favorable or unfavorable material impact on results of operations in a particular quarter or year.   Over the long term, management believes the STB decisions in the Duke and CP&L proceedings will help support improved pricing for coal transportation services.surcharges.

Coal revenues are expected to remain strong for the remainderrest of the year, reflecting higher utility coal demand as utilities replenish lower than normal stockpiles and a continuation of the favorable market conditions for export and domestic metallurgical coal.

General Merchandise

First-quarter generalGeneral merchandise revenues increased $119$123 million, or 12%, in the second quarter and $242 million, or 12%, in the first six months, compared with the same periods last year.   The increase reflected higher traffic volume, particularly for metals and construction, and paper, clay and forest products, in addition toBoth increases were primarily the result of higher average revenues.   Metalsrevenues and constructionincreased fuel surcharges.   Traffic volume benefited from increased importrose 1% for both the quarter and domestic slab shipments.   Paper, clay and forest products benefited from increased shipments of pulp board as demand for paper products strengthened and lumber volume benefited from increased housing starts.   Chemicals traffic volume reflected higher plastics and industrial intermediates shipments in response to improved manufacturing conditions and diversions from the highway.six-month period.   Agriculture, consumer products and government volume reflectedrose 5% for the quarter and 4% for the first six months, reflecting higher shipments of sweeteners and soybeans, and for the first six months, higher shipments of fertilizers soybeans and feed.   Paper and forest traffic volume rose 3% and 4%, respectively, benefiting from increased shipments of pulpboard as demand for paper products continued.   Chemicals traffic volume increased 4% and 3%, respectively, reflecting higher petroleum product shipments, plastics and industrial intermediates shipments (in response to improved manufacturing conditions) and diversions from the highway ..   Metals and construction volume decreased 1% for the quarter, principally due to reduced production at NS-served steel mills, but increased 2% for the year-to-date.   Automotive volumes were down 4% for both periods due to reductions by Ford and General Motors, partially offset by plant expansions forincreased production at Honda and Toyota , BMW and DaimlerChrysler.   General merchandise average..   Average revenue per carload increased 10%,11% in the second quarter and first six months reflecting increased rates, fuel surcharges improved pricing and a higher proportionlonger lengths of longer-haul (higher revenue per carload) business.haul.

General merchandise revenues are expected to continue to compare favorably with the prior year as 2005 progresses, subject to continued expansionprogresses; however, the extent of the increase could lessen in manufacturing, conversions from the highwaythird and pricingfourth quarters due to the market.strength of those periods last year.

Intermodal

First-quarter intermodalIntermodal revenues increased $80$64 million, or 24%18%, in the second quarter and $144 million, or 21%, in the first six months, compared with the same periodperiods last year.   TotalBoth increases reflected higher traffic volume, (units) grew 12%,increased revenue per unit and higher fuel surcharges.   Traffic volume increased 8% in the second quarter and 10% for the first six months reflecting strength in allthe International and Triple Crown Services lines of business.   Intermodal traffic volume benefited from increased consumer spending and international trade, in addition to truck capacity shortages.business ..   International traffic volume grew by 17%14% in the quarter and domestic traffic rose 9%15% for the first six months, reflecting strength in U.S. consumer markets.   Truckload volume increased 15% over last year, reflecting new business with traditional truckload companies.   Triple Crown Services Company volume grew 9% for the quarter and 8%, for the first six months, due in part to expanded geographic coverage.   Intermodal average revenue per unit rose 11%,increased 9% for the quarter and 10% for the first six months, a result of increased ratesrate increases and fuel surcharges.

Intermodal revenues are expected to continue to show growth during 2005, driven by strong international tradeprovided the retail and market expansion.manufacturing sectors continue to expand.

Railway Operating Expenses

First-quarterSecond-quarter railway operating expenses were $1.6 billion in 2005, up $211$174 million, or 16%13%, compared with last year.   For the same periodfirst six months, expenses were $3.1 billion, up $385 million, or 14%.   For both periods, most of 2004.   Thethe increase was the result of higher expenses for materials, services and rents,rents; compensation and benefits,benefits; and diesel fuel.

Compensation and benefits expenses increased $59 million, or 10%, in the second quarter and $118 million, or 11%, primarily driven byin the first six months, compared with the same periods last year.   Both periods reflected higher volume-related payroll which added $24including trainees and maintenance activities (up $23 million for the quarter and $47 million for the first six months), increased wage rates which added(up $11 million for the quarter and $23 million for the first six months), increased pension, postretirement and health and welfare benefit costs (up $12 million higher stock-based compensation, up $10for the quarter and $18 million increasedfor the first six months) and higher payroll taxes up $6(up $5 million as well as lower pension incomefor the quarter and $11 million for the first six months).   NS continues to hire and train additional post-retirement costs that added $6 million.workers in order to meet the requirements of forecasted volumes in light of the demographics of the workforce.

Materials, services and rents increased $71$57 million, or 19%15%, reflecting $41in the second quarter and $128 million, moreor 17%, in the first six months, compared with the same periods last year.   Both periods reflected increased volume-related purchased services of which $26(up $20 million was volume-related;for the quarter and $46 million for the first six months) and higher maintenance expenses, primarily for locomotive and freight car maintenance expenses,cars (up $20 million for the quarter and $33 million for the first six months) ..   Equipment rents were up $13 million;$14 million for the quarter and $25 million for the first six months, reflecting higher equipment rents, up $11 million.   The rise in equipment rents reflectedtraffic volume as well as leases from the Conrail Corporate Reorganization as well as higher traffic volume.Reorganization.

Conrail rents and services decreased $67$70 million, or 66%69%, in the second quarter and $137 million, or 67%, in the first six months, due to the effects of the Conrail Corporate Reorganization (see Note 2), which resulted in the consolidated reporting of individual components of Conrail equity earnings, principally depreciation, equipment rents and interest expense, and which more than offset an additional $5$1 million and $6 million in Shared Assets Areas expenses.expenses for the second quarter and first six months, respectively.   NS' share of equity earnings of Conrail is now included in "Other income - - net."

Depreciation expense increased $64 million, or 50%49%, in the second quarter and $128 million, or 49%, in the first six months, principally due to reporting effects resulting from the Conrail Corporate Reorganization.

Diesel fuel expense increased $43$56 million, or 40%53%, asin the second quarter and $99 million, or 46%, in the first six months, compared with the same periodperiods last year, reflecting higher average prices (up 35%)49% for the quarter and increased42% for the first six months) and slightly higher consumption (up 4%)3% for both periods).   Expenses in 2005 included areflected hedging program benefits of $40 million benefit fromand $80 million in the hedging program,second quarter and first six months of 2005, compared with a $23benefits of $26 million benefit inand $49 million for the first quartersame periods of 2004.2004, respectively.   No new hedges have been entered into since May of 2004.   Accordingly, if diesel fuel prices remain at their current levels, or increase further, diesel fuel expense will be higher going forward.   (See Note 3 for the percentage of estimated future diesel fuel consumption hedged.)   Legislation enacted in the first quarter repeals the 4.3¢4.3 cents per gallon excise tax on railroad diesel fuel and inland waterway fuel by 2007, with the following phased reductions in 2005 and 2006:   by 1¢1 cents per gallon from Jan. 1, 2005 through June 30, 2005; 2¢2 cents per gallon from July 1, 2005 through Dec. 31, 2006; and by the full 4.3¢4.3 cents thereafter.   NS consumes approximately 500 million gallons of diesel fuel per year.

Casualties and other claims expensesexpense increased by $38$2 million, or 95%5%, largely due toin the second quarter and $40 million, or 51%, in the first six months, compared with the same periods last year.   The increase for the first six months resulted from expenses related to the Graniteville derailment (see Note 8) as well as to adverse9), higher insurance costs and unfavorable personal injury claims development.   For the remainder of the year, NS expects to incur about $6$4 million of additional Graniteville-related costs, which includes higher insurance expenses.

Other expenses rose $3expense increased $6 million, or 5%10%, principally due toin the second quarter, and $9 million, or 8%, in the first six months, compared with the same periods of last year.   The increases for both periods were largely the result of higher property and sales and use taxes.

Other Income - Net

Other income - net was $8increased $9 million or 80%, lowerin the second quarter and $1 million in the first quartersix months of 2005, compared with the same periodperiods of 2004.   The declineincreases reflected $23 million more expense associated with tax credit investments partially offset by (1) equity in earnings of Conrail of $6($8 million for the quarter and $14 million for the first six months), (2) increased gains on sales of properties and investments of $6($8 million for the quarter and $14 million year-to-date), (3) higher interest income of $4 million.($7 million and $11 million respectively), and (4) more coal royalties ($4 million and $7 million respectively), that were partially offset by more expense associated with tax credit investments--$17 million for the quarter and $40 million for the first six months.

NS has membership interests in companies that own and operate facilities that produce synthetic fuel from coal.   The production of synthetic fuel results in tax credits as well as expenses related to the investments.   The expenses are recorded as a component of "Other income - net," and the tax credits, as well as tax benefits related to the expenses, are reflected in the provision for income taxes.

Provision for Income Taxes

The first-quartersecond-quarter effective income tax rate was 30.0%10.7% in 2005, compared with 32.8%29.9% last year.   For the first six months, the effective rate was 17.8% in 2005, compared with 31.2% in 2004.   The decline wasdeclines for both periods were largely the result of increasedbenefits associated with the recently enacted Ohio tax credits fromlegislation (see Note 5) and the synthetic fuel-related investments.   In 2004, the effective rate was reduced by a favorable resolution of Section 29 alternative fuel tax credit issues and by NS' equity in Conrail's after-tax earnings.   As a result of the 2004 Conrail Corporate Reorganization, the 2005 effective income tax rate is no longer significantly affected by NS' equity in Conrail's after-tax earnings.

The consolidated federal income tax returns for 2000 through 2003 are being audited by the Internal Revenue Service (IRS).   The IRS examination for the 2000 and 2001 years is expected to be completed in the next few months.

NS' interests in synthetic fuel credits are subject to reduction if the average priceReference Price of a barrel of oil for the year falls within an inflation-adjusted phase-out range specified by the tax code.   The Reference Price for a year is the annual average wellhead price per barrel of unregulated domestic crude oil as determined by the Secretary of the Treasury by April 1 of the following year.   In 2004, the phase-out range was $51.35 to $64.47.   The phase-out range for 2005 and later years will be adjusted for inflation, however, no phase out is considered likely in 2005.

NS cannot predict with certainty the Reference Price of a barrel of oil for 2005 and later years.   If the Reference Price for a year exceeds a certain amount as determined under the tax laws.   Given current oil market conditions, it is possibleapplicable phase-out range for that these taxyear, NS' synthetic fuel credits could be reduced for 2005 or future years. Such a reduction ineliminated.   However, an indemnification arrangement substantially limits NS' exposure if tax credits would be accompanied by a reduction in the expense included in "Other income - - net" relatedare reduced due to the investment, although the net effect would be to reduce the projected return on the investment.oil prices.

FINANCIAL CONDITION AND LIQUIDITY

Cash provided by operating activities, NS' principal source of liquidity, was $408$860 million in the first threesix months of 2005, compared with $258$626 million in the first threesix months of 2004.   The improvement reflected the $224 million increase in income from railway operations as well as the effects of the Conrail Corporate Reorganization (see Note 2).   Prior to the Conrail Corporate Reorganization, a significant portion of the payments made to PRR under the operating and lease agreements (which were included in "Conrail Rents and Services" and, therefore, were a use of cash in "Cash provided by operating activities"), was borrowed back from a subsidiary of PRR under a note due in 2032, and therefore, was a source of cash in "Proceeds from borrowings."   This note was effectively extinguished by the reorganization in 2004.   Subsequent to the Conrail Corporate Reorganization, payments under "Conrail rents and services" have declined, depreciation charges have increased and the net borrowings have been terminated.   Accordingly, NS' cash provided by operating activities after the Conrail Corporate Reorganization has increased.   NS' net cash flow from these borrowings amounted to $81 million in the first six months of 2004.

NS had working capital of $418$350 million at March 31,June 30, 2005 , compared with a working capital deficit of $234 million at Dec. 31, 2004 ..   The improvement reflected higher cash provided by operating activities, as well as $194a $547 million net increasereduction in current maturities of long-term borrowings.debt.   NS expects that cash on hand combined with cash flow from operations will be sufficient to meet its ongoing obligations.   This expectation is based on a view that the economy will continue at a moderate growth rate through 2005.

Except as disclosed herein in the Notes to Consolidated Financial Statements or elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations, there have been no material changes to the contractual obligations disclosure contained in NS' Dec. 31, 2004, Form 10-K.   In addition, NS did not renew its accounts receivable securitization program which expired in May 2005 and which was NS' only off balance sheet arrangement at year end 2004.

Cash used for investing activities was $227$385 million in the first threesix months of 2005, compared with $193$443 million in the first threesix months of 2004.   The increasedecrease was principally the result of purchases of short-term investments offset in part by lower property additions.  

Capital expenditures for the full year 2005 are expected to be at about the same level as 2004.   D uringDuring the first quarter, NS made additional commitments to purchase locomotives and other equipment in 2005, of approximately $84 million (see Note 8)9).   Even with this increase in spending, it is likely that NS will make all of its capital expenditures with internally generated funds.   In addition, investing activities in 2005 reflect NS' investment in a membership interest in a limited liability company that owns and operates facilities that produce synthetic fuel from coal.fuel-related investments.  

Cash provided byused for financing activities was $216$511 million in the first threesix months of 2005, compared with cash used of $242$264 million in the same period of 2004.   The change resulted fromIn the issuance in March 2005 offirst quarter, NS issued a $300 million aggregate principal amount of 6% Senior Notes due March 2105, and in the second quarter, NS issued $717 million of new unsecured notes ($350 million at 5.64% due 2029 and $367 million at 5.59% due 2025) and paid $218 million of premium in exchange for $717 million of its previously issued unsecured notes ($350 million at 7.8% due 2027, $200 million at 7.25% due 2031, and $167 million at 9.0% due 2021) (see Note 5)6).   Additionally, 2005 had lowerThe $218 million cash premium payment is reflected as a reduction of debt repaymentsin the Consolidated Balance Sheet and Statement of Cash Flows and will be amortized as compared with 2004.additional interest expense over the terms of the new debt.   NS' debt-to-total capitalization ratio was 48.2%44.8% at March 31,June 30, 2005 , and 48.5% at Dec. 31, 2004 ..   On July 18, 2005 , Standard & Poor's upgraded its ratings on NS' secured debt from BBB to BBB+.   Moody's rating remains at Baa1.

NS currently has in place and available a $1 billion, five-yearfive year credit agreement which provides for borrowing at prevailing rates and includes financial covenants.   There were no amounts outstanding under this facility at March 31,June 30, 2005 .., and NS is in compliance with all of the financial covenants.   NS also has in place a shelf registration statement on Form S-3 filed with the SEC in September 2004 with $700 million of available capacity.   NS does not intend to renew its accounts receivable securitization program.

As described in the registration statement on Form S-4 and related prospectuses filed with the SEC, NS has commenced offers to exchange existing notes for new notes and cash.   The purpose of the exchange offers is to improve NS' debt maturity profile.

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.   These estimates and assumptions may require significant judgment about matters that are inherently uncertain, and future events are likely to occur that may require management to change them.   Accordingly, management regularly reviews these estimates and assumptions based on historical experience, changes in the business environment and other factors that management believes to be reasonable under the circumstances.   Management discusses the development, selection and disclosures concerning critical accounting estimates with the Audit Committee of its Board of Directors.   Except as disclosed herein in the Notes to Consolidated Financial Statements or elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations, there have been no significant changes to the Application of Critical Accounting Estimates disclosure contained in NS' Form 10‑K as of Dec. 31, 2004 ..

OTHER MATTERS

Labor Agreements

Approximately 24,000,26,000, or about 85%, of NS' railroad employees are covered by collective bargaining agreements with various labor unions.  These agreements remain in effect until changed pursuant to the Railway Labor Act.  NS largely bargains in concert with other major railroads. Moratorium provisions in the labor agreements govern when the railroads and the unions may propose labor agreement changes.  Such proposals were made in late 1999 and, since that time, NS has reached agreements with almost all of the major rail labor organizations to settle that round of bargaining.  These agreements cover approximately 96% of NS contract employees.   A 1999 bargaining roundtentative agreement, subject to ratification, has not yetalso been reached with the International Association of Machinists.   If mediation is concluded without an agreement, the next step would be either arbitration, or a Presidential Emergency Board or a strike. 

On or after November 1, 2004 , the railroads and the rail labor unions served new proposals to begin the next bargaining round.   Industry issues include train crew staffing and employee contributions for health care benefits.  Negotiations on these proposals continue.Seven rail unions (Brotherhood of Locomotive Engineers and Trainmen, Brotherhood of Maintenance of Way Employees, American Train Dispatchers Association, Brotherhood of Railroad Signalmen, International Brotherhood of Blacksmiths and Boilermakers, National Conference of Firemen and Oilers, and Sheet Metal Workers International Association) are bargaining together under the auspices of the Rail Labor Bargaining Coalition (RLBC).   The railroads have filed for mediation with the United Transportation Union (UTU) and with the RLBC unions.    The outcome of the negotiations cannot be determined at this point.

Locomotive Engineers on NS are represented by the Brotherhood of Locomotive Engineers and Trainmen (BLET) while ground service employees (Conductors and Trainmen) are represented by the UTU.   BLET recently began soliciting authorization cards from ground service employees.   Should BLET obtain sufficient authorization cards, the National Mediation Board would then schedule an election to determine the representative of NS' ground service employees.   

Market Risks and Hedging Activities

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

The intent of the diesel fuel hedging program is to assist in the management of NS' aggregate risk exposure to fuel price fluctuations, which can significantly affect NS' operating margins and profitability, through the use of one or more types of derivative instruments.   Diesel fuel costs represented 10% of NS' operating expenses for the firstsecond quarter of 2005. The program provides that NS will not enter into any fuel hedges with a duration of more than 36 months, and that no more than 80% of NS' average monthly fuel consumption will be hedged for any month within any 36-month period.

As of March 31,June 30, 2005 , through swap transactions, NS has hedged approximately 32%27% of remaining expected 2005 diesel fuel requirements. The effect of the hedges is to yield an average cost of 8284 cents per hedged gallon, including federal taxes and transportation.   A 10% decrease in diesel fuel prices would reduce NS' asset related to the swaps by approximately $23$15 million as of March 31,June 30, 2005 ..

NS manages its overall exposure to fluctuations in interest rates by issuing both fixed- and floating-rate debt instruments and by entering into interest-rate hedging transactions to achieve an appropriate mix within its debt portfolio.

At March 31,June 30, 2005 , NS' debt subject to interest rate fluctuations totaled $449$302 million.   A 1% increase in interest rates would increase NS' total annual interest expense related to all its variable debt by approximately $4$3 million. Management considers it unlikely that interest rate fluctuations applicable to these instruments will result in a material adverse effect on NS' financial position, results of operations or liquidity.

Some of NS' capital leases, which carry an average fixed rate of 7%, were effectively converted to variable rate obligations using interest rate swap agreements. On March 31,June 30, 2005 , the average pay rate under these agreements was 3%4%, and the average receive rate was 7%. The effect of the swaps was to reduce interest expense by $1 million in the second quarter and $2 million for the first quartersix months of 2005, and bycompared with $2 million inand $4 million for the first quarter ofsame periods, respectively, in 2004. A portion of the lease obligations is payable in Japanese yen. NS eliminated the associated exchange rate risk at the inception of each lease with a yen deposit sufficient to fund the yen-denominated obligation. Most of these deposits are held by foreign banks, primarily Japanese. As a result, NS is exposed to financial market risk relative to Japan .. Counterparties to the interest rate swaps and Japanese banks holding yen deposits are major financial institutions believed by management to be creditworthy.

Environmental Matters

NS is subject to various jurisdictions' environmental laws and regulations.   It is NS' policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably.   Claims, if any, against third parties for recovery of cleanup costs incurred by NS are reflected as receivables (when collection is probable) in the balance sheetConsolidated Balance Sheet and are not netted against the associated NS liability.   Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates.   NS also has an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy.