Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

TERMS USED BY CSX

When used in this report, unless otherwise indicated by the context, these terms are used to mean the following:

Car hire - A charge paid by one railroad for its use of cars belonging to another railroad or car owner.

Class I freight railroad - One of the largest line haul freight railroads as determined based on operating revenue; the exact revenue required to be in each class is periodically adjusted for inflation by the Surface Transportation Board. Smaller railroads are classified as Class II or Class III.

Common carrier mandate - A federal mandate that requires U.S. railroads to accommodate reasonable requests from shippers to carry any freight, including hazardous materials.

Demurrage - A charge assessed by railroads for the use of rail cars by shippers or receivers of freight beyond a specified free time.

Department of Transportation ("DOT") - A U.S Government agency with jurisdiction over matters of all modes of transportation.

Depreciation study (also referred to as a "life study") - A periodic statistical analysis of fixed asset service lives, salvage values, accumulated depreciation, and other factors for group assets along with a comparison of similar asset groups at other companies conducted by a third-party specialist.

Double-stack - Stacking containers two-high on specially equipped cars.

Drayage - The pickup or delivery of intermodal shipments by truck.

Federal Railroad Administration ("FRA") - The branch of the DOT that is responsible for developing and enforcing railroad safety regulations, including safety standards for rail infrastructure and equipment.

Free cash flow - The calculation of a non-GAAP measure by using net cash provided by operating activities and adjusting for property additions and certain other investing activities. Free cash flow is a measure of cash available for paying dividends, share repurchases and principal reduction on outstanding debt.

Group-life method - A type of depreciation in which assets with similar useful lives and characteristics are aggregated into groups. Instead of calculating depreciation for individual assets, depreciation is calculated for each group.

Highway-to-rail - An initiative to assist new and existing customers in identifying freight moves that would benefit from converting from a highway-only move to one that utilizes intermodal containers on rail and local drayage by truck.

Incidental revenue - Revenue for switching, demurrage, storage, etc.

Intermodal - A flexible way of transporting freight over water, highway and rail without being removed from the original transportation equipment, namely a container or trailer.

Mainline - The main track thoroughfare, exclusive of terminals, yards, sidings and turnouts.

CSX 2016 Form 10-K p. 24

CSX CORPORATION

PART II

National Gateway - A multi-phase construction initiative aimed at increasing intermodal capacity on the CSX network by clearing key corridors between mid-Atlantic ports and the Midwest for double-stack trains. Construction on National Gateway projects is funded by CSX, the federal government, and individual states.

Revenue adequacy - The achievement of a rate of return on investment at least equal to the cost of investment capital, as measured by the STB.

Shipper - A customer shipping freight via rail.

Siding - Track adjacent to the mainline used for passing trains.

Staggers Act of 1980 - Congressional law which significantly deregulated the rail industry, replacing the regulatory structure in existence since the 1887 Interstate Commerce Act. Where previously rates were controlled by the Interstate Commerce Commission, the Staggers Act allowed railroads to establish their own rates for shipments, enhancing their ability to compete with other modes of transportation.

Surface Transportation Board ("STB") - An independent governmental adjudicatory body administratively housed within the DOT, responsible for the economic regulation of interstate surface transportation within the United States.

Switching - Putting cars in a specific order, placing cars for loading, retrieving empty cars or adding or removing cars from a train at an intermediate point.

Terminal - A facility, typically owned by a railroad, for the handling of freight and for the breaking up, making up, forwarding and servicing of trains.

TTX Company ("TTX") - A Company that provides its owner-railroads with standardized fleets of intermodal, automotive and general use railcars at time and mileage rates. CSX owns about 20 percent of TTX's common stock, and the remainder is owned by the other leading North American railroads and their affiliates.

Turnout - A track that diverts trains from one track to another.

Yard - A system of tracks, other than main tracks and sidings, used for making up trains, storing cars and other purposes.

CSX 2016 Form 10-K p. 25

CSX CORPORATION

PART II

STRATEGIC OVERVIEW

CSX provides rail-based freight transportation services including traditional rail service, the transport of intermodal containers and trailers, as well as other transportation services such as rail-to-truck transfers and bulk commodity operations. The Company and the rail industry provide customers with access to an expansive and interconnected transportation network that plays a key role in North American commerce and is critical to the long-term economic success and improved global competitiveness of the United States. In addition, freight railroads provide the most economical and environmentally efficient means to transport goods over land.

CSX's transportation solutions connect industries and population centers across the United States with each other and with global markets through access to over 70 port facilities allowing the Company to meet the dynamic transportation needs of manufacturers, industrial producers, construction companies, farmers and feed mills, wholesalers and retailers, energy producers and the U.S. Armed Forces. Through its network, the Company transports a diverse portfolio of commodities and products to meet the country's needs. These products range from agricultural goods, such as grains, to chemicals, automobiles, metals, building materials, paper, consumer products, and energy sources like coal, ethanol and liquefied petroleum gas. The Company categorizes these products into three primary lines of business: merchandise, intermodal and coal.

To support long-term growth and value creation consistent with the evolving trends in freight transportation, CSX has launched a new strategic initiative known as the CSX of Tomorrow: a safe, highly automated, resource-efficient railroad enabling Service Excellence, profitable growth and improved cash flow. The CSX of Tomorrow is comprised of four distinct strategic pillars and builds on the Company’s vision, purpose and core values.

CSX of Tomorrow Strategic Initiatives

Network of Tomorrow

The CSX of Tomorrow relies on the reach, capability and efficiency of the Company’s rail network to safely and effectively meet the demands of the evolving marketplace and provide increasingly flexible and responsive service to more diverse customers. To facilitate future productivity and growth, CSX is implementing a fundamentally new approach to the network—transforming the railroad into two interconnected networks: a primary network and a local network. The Company is expanding capacity in its primary network to enable increasingly dense traffic while providing improved service for customers and enabling future growth. Further, the Company’s capacity investments along the primary network will allow for additional train lengthening, improving efficiency and profitability. The local network will be operated at lower density and speed and will better allow for new customer site development as a result of easier access to the local network and the Company’s enhanced focus on local pickup and delivery of freight to customers.

Expanding capacity on U.S. rail networks provides substantial public benefits including job creation, increased business activity at U.S. ports, reduced highway congestion and lower air emissions. Therefore, CSX and its government partners are jointly working to invest in multi-year rail infrastructure projects. These public-private partnerships are a critical part of the Network of Tomorrow strategy for the Company. An example of one of these initiatives is the National Gateway, which is a public-private partnership that will increase intermodal capacity and create substantial environmental and efficiency advantages by clearing key corridors between mid-Atlantic ports and the Midwest for double-stack intermodal trains.

CSX 2016 Form 10-K p. 26

CSX CORPORATION

PART II

The modernization of the Virginia Avenue Tunnel in Washington, D.C. is the capstone project for the second, and final phase, of the National Gateway. This project improves the flow of freight traffic through the District of Columbia and eliminates a rail traffic bottleneck that also impacts commuter and passenger trains in the region. CSX completed the first of two new double-stack-cleared tunnels in 2016, and the second tunnel will be finished in late 2018. With the completion of the first tunnel, 95% of CSX intermodal freight now moves in double-stack service. Going forward, CSX will continue to explore other opportunities to partner with the public sector to maximize the many public benefits of freight rail.

Going forward, CSX will continue to explore other opportunities to partner with the public sector to maximize the many public benefits of freight rail. The Network of Tomorrow, along with enhanced operational efficiency, will allow CSX to continue to improve safety, lower the cost structure and provide superior service to customers.

Service Excellence

Service Excellence has long been a core component of CSX’s culture that engages all employees to focus on delivering value to customers through improved service levels, communications tools and advanced technologies. As part of the CSX of Tomorrow, the Company will continually strive to consistently meet, or exceed, customer commitments while ensuring all interactions with customers result in a positive experience. Improving the customer experience will allow CSX to continue delivering a safe, reliable and competitive product while enhancing the ability to profitably grow the business and continue to value price its service product. In addition, Service Excellence across the Network of Tomorrow will enable additional volume growth opportunities with new and existing customers, especially in the Company’s intermodal and merchandise businesses.

For example, CSX’s intermodal network connects all major population centers east of the Mississippi River and positions the Company to capture a significant share of the growing domestic intermodal market opportunity, currently estimated at nine million truckloads in the eastern United States that move over 550 miles. The company’s highway-to-rail initiative assists in growing this traffic by helping customers identify new conversion opportunities for both domestic intermodal moves and the U.S. portion of international intermodal moves.

To further enhance the Company’s intermodal offering and support future growth, CSX announced a new terminal in eastern North Carolina, known as the Carolina Connector, to capture local, regional, national and international intermodal freight movement opportunities prevalent in the vibrant mid-Atlantic market. This new terminal will be poised to replicate and leverage the success of the Northwest Ohio intermodal terminal by expanding the reach of the Company’s hub and spoke network strategy to provide further profitable growth, network connectivity and density, especially in smaller and mid-sized markets.

CSX continues to proactively seek the right opportunities to profitably grow the merchandise business. The Company will continue capitalizing on new opportunities to locate industries on the CSX network, especially on the local network where network connectivity costs will generally be the lowest for customers. Through industrial development, the Company helps new and existing customers grow their business and target new markets by providing access to pre-certified locations as well as project management services.

The Company’s coal markets have shifted dramatically over the past several years and continue to rapidly evolve. Domestic utility coal demand decreased again in 2016 relative to previous years while export coal remains subject to a high degree of volatility as a result of changes in the global economy, competition from foreign producers and regulatory impacts on coal mining in the United States. Longer-term, downward pressure on domestic utility coal volumes will likely persist as a result of continued low natural gas prices while global coal demand will likely be mixed as developing countries become more urbanized and industrialized countries continue to use an increasing amount of alternative fuels, other than coal, for electrical power generation. CSX will continue to provide a competitive service product amid coal’s market shifts while efficiently capitalizing on short-term demand fluctuations.

CSX 2016 Form 10-K p. 27

CSX CORPORATION

PART II

Highly Automated Railroad

For many years, CSX has utilized technology to enhance operational performance and decision-making. The CSX of Tomorrow will build upon this expertise and increasingly leverage technology (focusing on automation, advanced analytics and the use of mobility tools), innovation and process improvement. CSX is accelerating its technology investments to improve safety, resource efficiency, asset reliability and service levels for customers. Several key initiatives aimed at generating long-term value are focused on automating and optimizing critical operations across the Company. CSX will continue to implement specific workforce and regulatory strategies to ensure the safe, effective adoption of new technologies as the Company progresses towards becoming a Highly Automated Railroad.

Team of Tomorrow

CSX’s approximately 27,000 dedicated employees are the driving force behind the CSX of Tomorrow, contributing to the successful development and implementation of all strategic initiatives. As the CSX of Tomorrow requires an increasingly diverse skillset, the Team of Tomorrow will be a highly-capable, flexible, collaborative team, relentlessly focused on safety, service and value creation. To attract, retain and motivate the best talent in the marketplace, CSX will continue to provide a compelling value proposition for its employees. The Company is going to further enhance its investment in employee development, provide career opportunities, have market-competitive employee benefits and continue to reward the creation of customer and employee excellence. Through the Team of Tomorrow initiative, CSX strives to align our people with a culture that embraces the Company’s vision, purpose and core values, to safely and efficiently serve our customers and help ensure the successful implementation of the CSX of Tomorrow.

Balanced Approach to Cash Deployment

CSX remains highly committed to delivering value to shareholders through a balanced approach to deploying cash that includes investments in the business, dividend growth and share repurchases. In 2016, the Company invested $2.7 billion to further enhance the safety, reliability, efficiency, flexibility and capability of its network and its overall business. In addition, during 2016, CSX repaid $1.4 billion in outstanding debt to capitalize on the lower interest rate environment.

The Company continues to return value to its shareholders in the form of dividends and share repurchases. During 2016, the Company paid a quarterly cash dividend of $0.18 per common share, with total dividends paid to shareholders of $680 million for the year. Also in 2016, CSX continued share repurchases under its $2.0 billion program which began in 2015 and is expected to be completed by April 2017. CSX repurchased $1.1 billion, or 38 million shares, during 2016 under this program. As part of this balanced approach, the Company is committed to maintaining a credit profile consistent with a BBB+ rating by Standard & Poor’s and a Baa1 rating by Moody’s Investment Services.

Summary

The strategic initiatives and opportunities, as well as the strategic investments discussed above, provide a foundation for volume growth, continued value pricing, productivity improvement, enhanced customer service and continued advancements in the safety and reliability of operations. To continue these types of investments, the Company must be able to operate in a balanced regulatory environment in which it can generate adequate returns and drive shareholder value. These investments will enable the Company to deliver the CSX of Tomorrow: a safe, highly automated, resource-efficient railroad enabling Service Excellence, profitable growth and improved cash flow.

CSX 2016 Form 10-K p. 28

CSX CORPORATION

PART II

2016 HIGHLIGHTS

Revenue of $11.1 billion decreased $742 million or six percent versus the prior year.
Expenses of $7.7 billion decreased $547 million or seven percent year over year.
Operating income of $3.4 billion decreased $195 million or five percent year over year.
Operating ratio of 69.4 percent improved 30 basis points from 69.7 percent.


•	Earnings per diluted share of $1.81 decreased $0.19 or 10 percent year over year.

RESULTS OF OPERATIONS

2016 vs. 2015 Results of Operations (a)



	Fiscal Years
	2016			2015			$ Change			% Change
(Dollars in Millions)
Revenue	$	11,069		$	11,811		$	(742	)	(6	)%
Expense
Labor and Fringe	3,159			3,290			131			4
Materials, Supplies and Other	2,069			2,336			267			11
Fuel	713			957			244			25
Depreciation	1,301			1,208			(93		)	(8	)
Equipment and Other Rents	438			436			(2		)	—
Total Expense	7,680			8,227			547			7
Operating Income	3,389			3,584			(195		)	(5	)
Interest Expense	(579		)	(544		)	(35		)	(6	)
Debt Repurchase Expense	(115		)	—			(115		)	(100	)
Other Income - Net	46			98			(52		)	(53	)
Income Tax Expense	(1,027		)	(1,170		)	143			12
Net Earnings	$	1,714		$	1,968		$	(254	)	(13	)
Earnings Per Diluted Share:
Net Earnings	$	1.81		$	2.00		$	(0.19	)	(10	)%
Operating Ratio	69.4		%	69.7		%				30		bps

(a) CSX follows a 52/53 week fiscal reporting calendar. Fiscal year 2016 included 53 weeks and fiscal year 2015 included 52 weeks. All 2016 information presented in Results of Operations is on a 53-week basis, under Generally Accepted Accounting Principles ("GAAP").

CSX 2016 Form 10-K p. 29

CSX CORPORATION

PART II

2016 vs. 2015 Results of Operations, continued



Volume and Revenue (Unaudited) (b)
Volume (Thousands of units); Revenue (Dollars in Millions); Revenue Per Unit (Dollars)
	Volume				Revenue						Revenue Per Unit
	2016	2015	% Change		2016		2015		% Change		2016		2015		% Change
Agricultural
Agricultural and Food Products (a)	477	503	(5	)%	$	1,286	$	1,345	(4	)%	$	2,696	$	2,674	1	%
Fertilizers (a)	300	301	—		463		489		(5	)	1,543		1,625		(5	)
Industrial
Chemicals (a)	700	726	(4	)	2,191		2,284		(4	)	3,130		3,146		(1	)
Automotive	482	450	7		1,261		1,175		7		2,616		2,611		—
Metals and Equipment (a)	259	284	(9	)	704		723		(3	)	2,718		2,546		7
Housing and Construction
Minerals (a)	310	306	1		464		459		1		1,497		1,500		—
Forest Products	274	290	(6	)	773		796		(3	)	2,821		2,745		3
Total Merchandise	2,802	2,860	(2	)	7,142		7,271		(2	)	2,549		2,542		—
Coal	838	1,063	(21	)	1,833		2,300		(20	)	2,187		2,164		1
Intermodal	2,811	2,838	(1	)	1,726		1,762		(2	)	614		621		(1	)
Other	—	—	—		368		478		(23	)	—		—		—
Total	6,451	6,761	(5	)%	$	11,069	$	11,811	(6	)%	$	1,716	$	1,747	(2	)%

(a) In order to better align markets with the Company's business strategy, changes were made to the categorization of certain lines of business during the third quarter 2016. Prior periods have been reclassified to conform to the current presentation and are posted on the Company's website at csx.com under the investors section.


•	Agricultural and Food Products includes the combination of the previous Agricultural Products and Food and Consumer markets.


•	Fertilizers was previously named Phosphates and Fertilizers.


•	Metals and Equipment includes the Equipment portion of the previous Waste and Equipment market.


•	Chemicals includes the Waste portion of the previous Waste and Equipment market. Chemicals also includes fly ash for remediation purposes (a form of waste) which was previously included within the Minerals market.

(b) CSX follows a 52/53 week fiscal reporting calendar and 2016 included 53 weeks. The revenue impact of the extra week was $178 million.

CSX 2016 Form 10-K p. 30

CSX CORPORATION

PART II

Revenue

In 2016, revenue decreased $742 million, or six percent, due to a five percent decline in volume (including the $178 million positive impact of an extra week of volume) and a significant decline in fuel recoveries, partially offset by pricing strength.

Merchandise

Agricultural

Agricultural and Food Products - Volume declined as the strong U.S. dollar continued to support import grain and a robust Southeastern crop spurred additional local truck sourcing, displacing grain shipments by rail. Additionally, ethanol market dynamics shifted to favor the Gulf region for storage and export, precluding CSX from participation in shipments from Western origins to the Gulf.

Fertilizers - Volume was flat as the strong U.S. dollar, which drove high levels of imported sulfur, displaced rail transport, and nitrogen demand fell in anticipation of further commodity price deterioration. This offset growth in phosphate rock, driven by operational efficiency that allowed for additional rail traffic conversion that would otherwise move by truck.

Industrial

Chemicals - Volume declined as energy market headwinds significantly reduced crude oil and frac sand shipments. This reduction was partially offset by the ramp up of a fly ash remediation project and a modest increase in core chemical markets.

Automotive - Volume increased as a result of strong North American light vehicle production and growth across several customers. Additionally, movement of trucks and SUVs continued to outpace passenger cars, consistent with customer buying patterns.

Metals and Equipment - Volume was down as the strong U.S. dollar allowed for continued high levels of steel imports, which led to reduced domestic steel production, mill closures and the loss of associated rail moves. These declines were partially offset by strength in the wind-energy and power generation markets.

Housing and Construction

Minerals - Volume was up slightly due to strong gains in aggregates (which include crushed stone, sand and gravel), particularly for highway and non-residential construction in southern markets. The growth was partially offset by headwinds in salt and lime, reflecting mild winter weather and steel production challenges, respectively.

Forest Products - Volume declined as headwinds from electronic substitution and reduced paper products demand drove industry consolidation that reduced rail volume. Further, excess truck capacity in 2016 captured some volume that traditionally moved by rail.

Coal

Domestic - Volume declined as mild winter weather in the beginning of the year and low natural gas prices reduced utility coal burn rates and resulted in inflated coal stockpiles. Further, the weak domestic integrated steel market drove volume decreases in coke.

Export - Volume was down in both metallurgical and thermal coal as a result of the strong U.S. dollar and global oversupply which impacted U.S. competitiveness in the world market, particularly in the first half of the year.

CSX 2016 Form 10-K p. 31

CSX CORPORATION

PART II

Intermodal

Domestic - Volume increased as secular growth from the highway-to-rail conversion program and new service offerings were partially offset by excess truck capacity headwinds and a short-haul competitive loss.

International - Volume declined as headwinds from competitive losses more than offset moderate growth across other customers.

Other

Other revenue decreased $110 million versus prior year primarily due to payments received in 2015 from customers that did not meet volume commitments. Further decreases in incidental revenue as well as lower coal revenue from affiliates were partially offset by adjustments to revenue reserves.

CSX 2016 Form 10-K p. 32

CSX CORPORATION

PART II

Expense

In 2016, total expenses decreased $547 million, or seven percent, compared to prior year. Descriptions of each expense category as well as significant year-over-year changes are described below. Year-over-year changes related to the extra week are estimated incremental expenses of $116 million incurred for the week of December 24 through December 30, 2016.

Labor and Fringe expenses include employee wages and related payroll taxes, health and welfare costs, pension, other post-retirement benefits and incentive compensation. These expenses decreased $131 million due to the following items:


•	Efficiency savings of $249 million were driven by lower T&E and operating support costs as a result of structural changes, reduced crew training and the Company's train length initiative that began in the second quarter of 2015.


•	Volume-related costs were $116 million lower.


•	Incentive compensation was $111 million higher reflecting the expected award payouts on existing plans.


•	Inflation resulted in $106 million of additional cost driven by increased health and welfare costs.


•	The extra week resulted in $51 million of additional cost.


•	Restructuring costs decreased $37 million due to the 2015 workforce reduction initiatives costs that nearly all occurred in 2015.


•	Various other costs increased $3 million.

Materials, Supplies and Other expenses consist primarily of contracted services to maintain infrastructure and equipment, terminal and coal pier services and professional services. This category also includes costs related to materials, travel, casualty claims, environmental remediation, train accidents, property and sales tax, utilities and other items. Total materials, supplies and other expenses decreased $267 million driven by the following:


•	Real estate gains increased $98 million primarily related to a current year gain of $115 million related to the sale of an operating property and other related income partially offset by a prior year real estate gain.


•	Efficiency savings of $95 million were primarily related to lower operating support costs driven by structural changes and broad cost containment.


•	Train accident and casualty costs were $70 million lower due to the continuing declines in the severity of train accidents as well as injuries.


•	Inflation resulted in $34 million of additional costs.


•	The extra week resulted in $18 million of additional cost.


•	Volume-related costs were $11 million lower.


•	Various other costs decreased $45 million.

Fuel expense includes locomotive diesel fuel as well as non-locomotive fuel. This expense is largely driven by the market price and locomotive consumption of diesel fuel. Fuel expense decreased $244 million driven by the following:


•	Average fuel price per gallon decreased 18 percent, from $1.80 to $1.48 per gallon versus the prior year, which reduced expenses by $137 million.


•	Efficiency savings of $60 million were primarily related to locomotive fuel reduction technology and process improvement.


•	Volume-related costs were $58 million lower.


•	The extra week resulted in $15 million of additional cost.


•	Various other costs decreased $4 million.

CSX 2016 Form 10-K p. 33

CSX CORPORATION

PART II

Depreciation expense primarily relates to recognizing the costs of a capital asset, such as locomotives, railcars and track structure, over its useful life. This expense is impacted primarily by the capital expenditures made each year. Depreciation expense increased $93 million due to a larger asset base and the $25 million impact of the extra week in 2016.

Equipment and Other expenses include rent paid for freight cars owned by other railroads or private companies, net of rents received by CSXT for use of its equipment. This category of expenses also includes lease expenses for locomotives, railcars, containers and trailers, offices and other rentals. These expenses increased $2 million driven by the following:


•	Inflation resulted in $18 million of additional cost primarily related to rates on automotive freight cars.


•	Volume related costs were $14 million higher due primarily to growth in automotive volume.


•	The extra week resulted in $7 million of additional cost.


•	Efficiency savings of $23 million were due to improved car cycle times.


•	Net other costs decreased $14 million.

Interest Expense increased $35 million to $579 million due to higher average debt balances in addition to $11 million of additional expense related to the extra week in 2016, partially offset by lower average interest rates.

Debt Repurchase Expense increased to $115 million due to the repurchase of certain notes that were expected to mature in 2017, 2018 and 2019.

Other Income (Expense) - net decreased $52 million to $46 million primarily due to a prior year $59 million gain on a sale of non-operating easements and reimbursement of environmental costs of $21 million related to this sale. This decrease was partially offset by other non-operating items, none of which were individually significant.

Income Tax Expense decreased $143 million to $1.0 billion primarily due to lower earnings.

Net Earnings decreased $254 million to $1.7 billion, and earnings per diluted share decreased $0.19 to $1.81 due to the factors mentioned above. Lower average shares outstanding resulting from higher share repurchase activity had a positive impact on earnings per diluted share.

CSX 2016 Form 10-K p. 34

CSX CORPORATION

PART II

2015 vs. 2014 Results of Operations



	Fiscal Years
	2015			2014			$ Change			% Change
(Dollars in Millions)
Revenue	$	11,811		$	12,669		$	(858	)	(7	)%
Expense
Labor and Fringe	3,290			3,377			87			3
Materials, Supplies and Other	2,336			2,484			148			6
Fuel	957			1,616			659			41
Depreciation	1,208			1,151			(57		)	(5	)
Equipment and Other Rents	436			428			(8		)	(2	)
Total Expense	8,227			9,056			829			9
Operating Income	3,584			3,613			(29		)	(1	)
Interest Expense	(544		)	(545		)	1			—
Debt Repurchase Expense	—			(16		)	16			125
Other Income - Net	98			(8		)	106			(1,325	)
Income Tax Expense	(1,170		)	(1,117		)	(53		)	(5	)
Net Earnings	$	1,968		$	1,927		$	41		2
Earnings Per Diluted Share:
Net Earnings	$	2.00		$	1.92		$	0.08		4	%
Operating Ratio	69.7		%	71.5		%				180		bps

CSX 2016 Form 10-K p. 35

CSX CORPORATION

PART II

2015 vs. 2014 Results of Operations, continued



Volume and Revenue (Unaudited)
Volume (Thousands of units); Revenue (Dollars in Millions); Revenue Per Unit (Dollars)
	Volume				Revenue						Revenue Per Unit
	2015	2014	% Change		2015		2014		% Change		2015		2014		% Change
Agricultural
Agricultural and Food Products (a)	503	513	(2	)%	$	1,345	$	1,395	(4	)%	$	2,674	$	2,719	(2	)%
Fertilizers (a)	301	330	(9	)	489		534		(8	)	1,625		1,618		—
Industrial
Chemicals (a)	726	728	—		2,284		2,375		(4	)	3,146		3,262		(4	)
Automotive	450	435	3		1,175		1,213		(3	)	2,611		2,789		(6	)
Metals and Equipment (a)	284	331	(14	)	723		824		(12	)	2,546		2,489		2
Housing and Construction
Minerals (a)	306	288	6		459		448		2		1,500		1,556		(4	)
Forest Products	290	307	(6	)	796		819		(3	)	2,745		2,668		3
Total Merchandise	2,860	2,932	(2	)	7,271		7,608		(4	)	2,542		2,595		(2	)
Coal	1,063	1,262	(16	)	2,300		2,849		(19	)	2,164		2,258		(4	)
Intermodal	2,838	2,728	4		1,762		1,790		(2	)	621		656		(5	)
Other	—	—	—		478		422		13		—		—		—
Total	6,761	6,922	(2	)%	$	11,811	$	12,669	(7	)%	$	1,747	$	1,830	(5	)%


•	Agricultural and Food Products includes the combination of the previous Agricultural Products and Food and Consumer markets.


•	Fertilizers was previously named Phosphates and Fertilizers.


•	Metals and Equipment includes the Equipment portion of the previous Waste and Equipment market.


•	Chemicals includes the Waste portion of the previous Waste and Equipment market. Chemicals also includes fly ash for

remediation purposes (a form of waste) which was previously included within the Minerals market.

CSX 2016 Form 10-K p. 36

CSX CORPORATION

PART II

Revenue

In 2015, revenue decreased $858 million, or seven percent, mostly due to the decline in fuel surcharge of $646 million. Additionally, the decline in volume of two percent and unfavorable mix were partially offset by pricing strength.

Merchandise

Agricultural

Agricultural and Food Products - Volume declined due to challenging world market conditions and a strong U.S. dollar. Specifically, high levels of imported ethanol reduced rail moves to Eastern markets and the strong dollar hampered export grain competitiveness. Additionally, excess truck capacity led to lower shipments of food products. These declines were partially offset by strength in feed grain and domestic soybean moves, reflecting the record 2014-2015 harvest.

Fertilizers - Volume was down, reflecting weak demand driven by oversupply of fertilizer, low corn prices and a challenged export market due to strength of the U.S. dollar.

Industrial

Chemicals - Volume was flat as strong gains in LPG and petroleum products were offset by the slowdown in crude oil and frac sand due to low oil prices and the conclusion of major waste remediation projects.

Automotive - Volume increased as gains in auto movement, especially SUVs and trucks, resulted from strong North American light vehicle production and consumer demand.

Metals and Equipment - Volume declined primarily due to high levels of steel imports which resulted from the strength of the U.S. dollar and led to lower production of domestic steel.

Housing and Construction

Minerals - Volume growth reflects strength in aggregates (which include crushed stone, sand and gravel) due to increased highway and non-residential construction activity.

Forest Products - Volume declines reflect high inventories of building products in the housing sector as well as declining demand due to electronic substitution in paper products.

Coal

Domestic - Volume declined as a result of mild weather, high stockpiles and low natural gas prices favoring natural gas power generation.

Export - Reductions in both metallurgical and thermal coal volume resulted from ongoing weak market conditions due to global oversupply and the strength of the U.S. dollar.

Intermodal

Domestic - Domestic volume increased 12 percent due to customer growth, continued success with CSX’s highway-to-rail conversion program and new service offerings.

International - Competitive losses resulted in a five percent international volume decline during a volatile year marked by West Coast port disruption, a subsequent volume surge and then a weak peak season.

Other

Other revenue increased $56 million as a result of higher revenue from customers who did not meet

minimum contractual volumes as well as higher incidental revenue.

CSX 2016 Form 10-K p. 37

CSX CORPORATION

PART II

Expense

In 2015, total expenses decreased $829 million, or nine percent, compared to prior year. Descriptions of each expense category as well as significant year-over-year changes are described below.


•	Inflation resulted in $128 million of additional cost driven by increased wages partially offset by reduced health and welfare costs.


•	Incentive compensation was $97 million lower reflecting reduced award payouts on existing plans.


•	Efficiency savings of $84 million were primarily a result of reduced crew starts due to the Company's train length initiatives, lower operating support costs and reduced management headcount.


•	Volume-related costs were $66 million lower.


•	Restructuring costs were $2 million higher versus prior year. See Note 1, Nature of Operations and Significant Accounting Policies under the caption, “Workforce Reduction Plans, Separation and Other Costs.”


•	Various other costs increased $30 million.

Materials, Supplies and Other expenses consist primarily of contracted services to maintain infrastructure and equipment, terminal services at automotive facilities and professional services. This category also includes costs related to materials, travel, casualty claims, environmental remediation, train accidents, property and sales tax, utilities and other items. Total materials, supplies and other expenses decreased

$148 million driven by the following:


•	Efficiency savings of $91 million were driven by a reduction in professional costs as well as lower operating support costs.


•	Volume-related costs were $52 million lower.


•	Real estate gains were $23 million higher primarily related to the sale of operating rail corridor.


•	Inflation resulted in $47 million of additional costs.


•	Various other costs decreased $29 million.


•	Average fuel price per gallon decreased 39 percent, from $2.95 to $1.80 per gallon, versus the prior year which reduced expenses by $560 million.


•	Volume-related costs were $66 million lower.


•	Other fuel savings of $33 million were primarily due to lower non-locomotive fuel price.

CSX 2016 Form 10-K p. 38

CSX CORPORATION

PART II

Equipment and Other includes rent paid for freight cars owned by other railroads or private companies, net of rents received by CSXT for use of its equipment. This category of expenses also includes lease expenses for locomotives, railcars, containers and trailers, offices and other rentals. These expenses increased $8 million driven by the following:


•	Inflation resulted in $16 million of additional cost related to rates on automotive and intermodal cars.


•	Efficiency savings of $15 million were due to improved car cycle times.


•	Net other costs increased $7 million.

Interest Expense decreased $1 million to $544 million due to lower average interest rates partially offset by higher average debt balances.

Debt Repurchase Expense decreased $16 million associated with costs incurred in 2014 related to the early redemption of long-term debt did not repeat in the current year.

Other Income (Expense) - net increased $122 million to $98 million primarily due to a $59 million gain on a sale of non-operating easements and a reimbursement of environmental costs of $21 million related to this sale. Additionally, 2015 environmental costs were $21 million lower than 2014.

Income Tax Expense increased $53 million to $1.2 billion primarily due to higher earnings as well as prior year favorable state legislative changes that did not repeat in the current year.

Net Earnings increased $41 million to $2.0 billion, and earnings per diluted share increased $0.08 to $2.00 due to the factors mentioned above. Lower average shares outstanding resulting from higher share repurchase activity also had a positive impact on earnings per diluted share.

CSX 2016 Form 10-K p. 39

CSX CORPORATION

PART II

Operating Statistics (Estimated)



	Fiscal Years
	2016		2015		Improvement/ (Deterioration)
Safety and Service Measurements
FRA Personal Injury Frequency Index	1.02		0.94		(9	)%
FRA Train Accident Rate	2.62		2.61		—
On-Time Train Originations	84	%	67	%	25
On-Time Destination Arrivals	65	%	51	%	27
Dwell	25.7		25.8		—
Train Velocity	20.8		20.5		1
Cars-On-Line	207,943		206,078		(1	)

Certain operating statistics are estimated and can continue to be updated as actuals settle.

Key Performance Measures Definitions

FRA Personal Injury Frequency Index - Number of FRA-reportable injuries per 200,000 man-hours.

FRA Train Accident Rate - Number of FRA-reportable train accidents per million train-miles.

On-Time Train Originations - Percent of scheduled road trains that depart the origin yard on-time or ahead of schedule.

On-Time Destination Arrivals - Percent of scheduled road trains that arrive at the destination yard on-time or earlier to two hours late (30 minutes for intermodal trains).

Dwell - Average amount of time in hours between car arrival at and departure from the yard. It does not include cars moving through the yard on the same train.

Train Velocity - Average train speed between terminals in miles per hour (does not include locals, yard jobs, work trains or passenger trains).

Cars-On-Line - An average count of all cars on the network (does not include locomotives, cabooses, trailers, containers or maintenance equipment).

The Company measures and reports safety and service performance. The Company strives for continuous improvement in these measures through training, innovation and investment. CSX's safety and train accident prevention programs rely on the latest tools, programs and employee participation that are designed to continuously strengthen the safety culture. Increased investment in training and technology also is designed to allow CSX employees to have an additional layer of protection that can detect and avoid many types of human factor incidents. The Company's safety programs are designed to prevent incidents that can adversely impact employees, customers and communities.

Continued capital investment in the Company's assets, including track, bridges, signals, equipment and detection technology also supports safety performance. CSX has established formal relationships with industry groups, leading universities and suppliers to develop, implement and deploy the latest technology that can detect infrastructure problems before they happen. To illustrate, through a waiver granted by the FRA, CSX is using advanced continuous rail testing methods that are being adopted by other railroads as the system’s value is proven.

The Company constantly collaborates with the FRA and industry organizations as well as federal, state and local governments on safety innovations and initiatives. For example, CSX and other freight railroads have actively worked with the U.S. DOT and other key stakeholders to evaluate and implement far-reaching safety enhancements for transportation of certain flammable materials, including essential energy products, on the nation’s freight railroad network.

CSX 2016 Form 10-K p. 40

CSX CORPORATION

PART II

At CSX, operational success is built on employee commitment to maintaining a constant focus on safety. Although the number of FRA reportable personal injuries decreased 10 percent year-over-year, the FRA reportable personal injury frequency index increased 9 percent to 1.02 due to a 17 percent decrease in labor hours versus 2015. While the reported FRA train accident frequency rate has remained flat year-over-year at 2.62, both overall FRA train accidents and train miles have decreased 14 percent year-over-year.

The Company made strong improvements to network reliability and service measures in 2016 while delivering a record level of productivity. On-time originations improved 25 percent year-over-year to 84 percent, and on-time arrivals increased 27 percent year-over-year to 65 percent. Terminal dwell remained flat at 25.7 hours versus 2015 and average train velocity increased one percent to 20.8 miles per hour.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is a company’s ability to generate adequate amounts of cash to meet both current and future needs for obligations as they mature and to provide for planned capital expenditures, including those to address regulatory and legislative requirements. To have a complete picture of a company’s liquidity, its balance sheet, sources and uses of cash flow and external factors should be reviewed.

Material Changes in the Consolidated Balance Sheets and Significant Cash Flows

Consolidated Balance Sheets

CSX's balance sheet reflects its strong capital base and the impact of CSX's balanced approach in deploying capital for the benefit of its shareholders, which includes investments in infrastructure, dividend payments and share repurchases.

Total assets as well as total liabilities and shareholders' equity increased $669 million from prior year. The increase in assets was driven by higher net properties of $976 million resulting from capital investments, partially offset by payments of about $300 million made on debt related to assets purchased in 2015 under seller financing. The increase in total liabilities and shareholders' equity combined was driven by an increase in net borrowings of about $450 million (including payments made on debt for assets purchased in 2015 under seller financing) and an increase in deferred income tax liabilities of $417 million. Partially offsetting these increases was a reduction in other long-term liabilities due to voluntary pension contributions of $250 million.

Significant cash flows

The following charts present net cash provided by (used in) operating, investing and financing activities for full years 2014, 2015 and 2016.

CSX 2016 Form 10-K p. 41

CSX CORPORATION

PART II

Sources of Cash

The Company has multiple sources of cash. First, the Company generates cash from operations. In 2016, the Company generated $3.0 billion of cash from operating activities which was $329 million lower than prior year primarily driven by $250 million in voluntary contributions to the Company's qualified pension plans. In 2015, the Company generated $3.4 billion of cash from operating activities which was $27 million higher than 2014 primarily driven by higher collections of freight account receivables.

Second, CSX has access to numerous financing sources including a $1 billion five-year unsecured revolving credit facility that expires in May 2020. As of the date of this filing, the Company has no outstanding balances under this facility. See Note 9, Debt and Credit Agreements for more information.

Third, CSX filed a new shelf registration statement with the SEC in February 2016 which is unlimited as to amount and may be used to issue debt or equity securities at CSX’s discretion, subject to market conditions and CSX Board authorization. While CSX seeks to give itself flexibility with respect to cash requirements, there can be no assurance that market conditions would permit CSX to sell such securities on acceptable terms at any given time, or at all.

Uses of Cash

CSX continued to invest in its business to create long-term value for shareholders. In 2016, net cash used in investing activities was $1.8 billion, a decrease of $1.1 billion from the prior year primarily driven by lower net purchases of short-term investments and lower property additions. In 2015, net cash used in investing activities was $2.9 billion, an increase in net investing of $709 million from 2014 primarily driven by fewer net sales of short-term investments.

The Company is committed to maintaining and improving its existing infrastructure and to positioning itself for long-term growth through expanding network and terminal capacity. Funds used for property additions are further described below.



	Fiscal Years
Capital Expenditures (Dollars in Millions)	2016		2015		2014
Track	$	714	$	866	$	750
Bridges, Signals and Other	433		491		538
Total Infrastructure	1,147		1,357		1,288
Freight Cars	82		218		329
Capacity and Commercial Facilities	406		295		452
Regulatory (including PTC)	313		341		321
Locomotives	409		337		51
Public-Private Partnerships - net (a)	41		14		8
Total Property Additions	2,398		2,562		2,449
Cash paid for new assets using seller financing (b)	307		$	—	$	—
Total Capital Expenditures (a)	$	2,705	2,562		2,449

(a)

Total capital expenditures shown above include investments related to reimbursable public-private partnerships. These partnership investments are for projects that are partially or wholly reimbursed to CSX through either government grants or other funding sources such as cash received from a property sale. These reimbursements may not be fully received in a given year; therefore the timing of receipts may differ from the timing of the investment.


(b)	In 2016, CSX made payments related to locomotive purchases made in 2015 using seller financing of $307 million.

CSX 2016 Form 10-K p. 42

CSX CORPORATION

PART II

Planned capital investments for 2017 are expected to be $2.2 billion, including about $270 million for PTC. This $2.2 billion excludes investments related to partially or wholly reimbursable public-private partnerships where reimbursements may not be fully received in the year the reimbursement obligation arises. Approximately half of the 2017 investment will be used to sustain the core infrastructure. The remaining amounts will be allocated to locomotives, freight cars and high return projects supporting long-term profitable growth, productivity initiatives and service improvements to optimize performance. CSX intends to fund capital investments through cash generated from operations.

The Company expects to continue incurring significant capital costs in connection with the implementation of PTC. CSX estimates that the total multi-year cost of PTC implementation will be approximately $2.4 billion. This estimate includes costs for installing the new system along tracks, upgrading locomotives, adding communication equipment and developing new technologies. Total PTC spending through 2016 was $1.8 billion.

In addition to capital investments, the Company uses cash for scheduled payments of debt and leases, share repurchases and to pay dividends to shareholders. In 2016, net cash used in financing activities was $1.3 billion, which represents an increase in spending of $749 million from the prior year primarily driven by the repayment of seller-financed assets, higher share repurchases, and lower net debt issued. In 2015, net cash used in financing activities was $519 million, which represents a decrease in spending of $564 million from the prior year primarily driven by higher net long-term debt issued of $904 million (net of lower debt repayments) partially offset by higher share repurchases of $287 million.

CSX is continually evaluating market and regulatory conditions that could affect the Company’s ability to generate sufficient returns on capital investments. CSX may revise its future estimates for capital spending as a result of changes in business conditions, tax legislation or the enactment of new laws or regulations which could have a material adverse effect on the Company’s operations and financial performance in the future (see Risk Factors under Item 1A of this Form 10-K).

Liquidity and Working Capital

Currently, CSX is well positioned from a liquidity standpoint. The Company ended the year with $1.0 billion of cash, cash equivalents and short-term investments. CSX has a $1 billion unsecured, revolving credit facility backed by a diverse syndicate of banks. This facility expires in May 2020 and as of the date of this filing, the Company has no outstanding balances under this facility. Additionally in 2016, CSX issued a total of $2.2 billion of new long-term debt, $1.4 billion of which was used to repay outstanding debt, to capitalize on the lower interest rate environment. CSX uses current cash balances for general corporate purposes, which may include repayment of additional indebtedness outstanding from time to time, repurchases of CSX's common stock, capital investments, working capital requirements and improvements in productivity and other cost reduction initiatives. See Note 9, Debt and Credit Agreements.

In September 2016, the Company renewed and modified its existing receivables securitization facility. The facility was extended with a three-year term scheduled to expire in September 2019. It was modified to provide liquidity of up to $200 million, changed from the $250 million, along with modifications to other terms. The purpose of this facility is to provide an alternative to commercial paper and a low cost source of short-term liquidity. Under the terms of this facility, CSXT transfers eligible third-party receivables to CSX Trade Receivables, a bankruptcy-remote special purpose subsidiary. A separate subsidiary of CSX services the receivables. Upon transfer, the receivables become assets of CSX Trade Receivables and are not available to the creditors of CSX or any of its other subsidiaries. In the event CSX Trade Receivables draws under this facility, the Company will record an equivalent amount of debt on its consolidated financial statements. As of the date of this filing, the Company has no outstanding balances under this facility.

CSX 2016 Form 10-K p. 43

CSX CORPORATION

PART II

Working capital can also be considered a measure of a company’s ability to meet its short-term needs. CSX had a working capital surplus of $447 million at December 2016 and $888 million (after reclassification of current deferred taxes) at December 2015. This decrease since the prior year end is primarily due to an increase in long-term debt maturing within a year of $311 million and cash from operations used for property additions, share repurchases and dividend payments.

The Company’s working capital balance varies due to factors such as the timing of scheduled debt payments and changes in cash and cash equivalent balances as discussed above. Although the Company currently has a surplus, a working capital deficit is not unusual for CSX or other companies in the industry and does not indicate a lack of liquidity. The Company continues to maintain adequate current assets to satisfy current liabilities and maturing obligations when they come due. Furthermore, CSX has sufficient financial capacity, including its revolving credit facility, trade receivable facility and shelf registration statement to manage its day-to-day cash requirements and any anticipated obligations. The Company from time to time accesses the credit markets for additional liquidity.

Credit Ratings

Credit ratings reflect an independent agency’s judgment on the likelihood that a borrower will repay a debt obligation at maturity. The ratings reflect many considerations, such as the nature of the borrower’s industry and its competitive position, the size of the company, its liquidity and access to capital and the sensitivity of a company’s cash flows to changes in the economy. The two largest rating agencies, Standard & Poor’s Ratings Services (“S&P”) and Moody’s Investors Service (“Moody’s”), use alphanumeric codes to designate their ratings. The highest quality rating for long-term credit obligations is AAA and Aaa for S&P and Moody’s, respectively. A credit rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency.

The cost and availability of unsecured financing are materially affected by CSX's long-term credit ratings. CSX's credit ratings remained stable during 2016. As of December 2015 and December 2016, S&P's long-term rating on CSX was BBB+ (Stable), and Moody's was Baa1 (Stable). Ratings of BBB- and Baa3 or better by S&P and Moody’s, respectively, reflect ratings on debt obligations that fall within a band of credit quality considered to be investment grade. If CSX's credit ratings were to decline to below investment grade levels, the Company could experience significant increases in its interest cost for new debt. In addition, a decline in CSX’s credit ratings to below investment grade levels could adversely affect the market’s demand, and thus the Company’s ability to readily issue new debt.

CSX 2016 Form 10-K p. 44

CSX CORPORATION

PART II

Free Cash Flow (Non-GAAP Measure)

Free cash flow is considered a non-GAAP financial measure under SEC Regulation G and Reg S-K Item 10(e). Management believes that free cash flow is useful to investors as it is important in evaluating the Company’s financial performance. More specifically, free cash flow measures cash generated by the business after reinvestment. This measure represents cash available for both equity and bond investors to be used for dividends, share repurchases or principal reduction on outstanding debt. Free cash flow should be considered in addition to, rather than a substitute for, cash provided by operating activities. Free cash flow is calculated by using net cash from operations and adjusting for property additions and certain other investing activities. Free cash flow before dividends decreased $145 million year-over-year to $847 million. The decrease in free cash flow from the prior year is primarily due to voluntary contributions to the Company's qualified pension plans of $250 million in 2016, partially offset by lower property additions of $164 million.

The following table reconciles cash provided by operating activities (GAAP measure) to free cash flow (non-GAAP measure).



	Fiscal Years
	2016			2015			2014
(Dollars in Millions)
Net cash provided by operating activities	$	3,041		$	3,370		$	3,343
Property additions (a)	(2,398		)	(2,562		)	(2,449		)
Proceeds from property dispositions	195			147			62
Other investing activities	9			37			(37		)
Free Cash Flow (before payment of dividends)	$	847		$	992		$	919

(a)

Property additions include investments related to reimbursable public-private partnerships. These partnership investments of $41 million, $14 million and $8 million in 2016, 2015 and 2014, respectively, are projects that are partially or wholly reimbursed to CSX through either government grants or other funding sources such as cash received from a property sale. These reimbursements may not be fully received in a given year; therefore, the timing of receipts may differ from the timing of the investment. Also, property additions for 2016 above do not include $307 million for locomotives purchased in 2015 using seller financing with payment made in 2016.

CSX 2016 Form 10-K p. 45

CSX CORPORATION

PART II

SCHEDULE OF CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The following tables set forth maturities of the Company's contractual obligations and other significant commitments:



Type of Obligation	2017		2018		2019		2020		2021		Thereafter		Total
(Dollars in Millions) (Unaudited)
Contractual Obligations
Total Debt (See Note 9)	$	331	$	20	$	18	$	745	$	371	$	9,808	$	11,293
Interest on Debt	539		523		521		509		497		8,657		11,246
Purchase Obligations (See Note 7)	363		336		312		316		310		3,943		5,580
Other Post-Employment Benefits (See Note 8) (a)	54		43		41		40		38		165		381
Operating Leases - Net (See Note 7) (b)	48		36		32		19		10		72		217
Agreements with Conrail (See Note 12) (b)	27		27		27		27		27		74		209
Total Contractual Obligations	$	1,362	$	985	$	951	$	1,656	$	1,253	$	22,719	$	28,926

Other Commitments (c)	$	110	$	3	$	2	$	2	$	2	$	2	$	121


(a)	Other post-employment benefits include estimated other post-retirement medical and life insurance payments and payments under non-qualified pension plans which are unfunded. No amounts are included for funded pension obligations as no contributions are currently required.


(b)	Agreements with Conrail represent minimum future lease payments of $209 million under the shared asset area agreements (see Note 12, Related Party Transactions). These amounts plus total operating leases-net of $217 million above equals total net lease commitments of $426 million disclosed in Note 7, Commitments and Contingencies.

(c)

Other commitments of $121 million consisted of surety bonds, letters of credit, uncertain tax positions and public private partnerships. Surety bonds of $48 million and letters of credit of $33 million arise from assurances issued by a third-party that CSX will fulfill certain obligations and are typically a contract, state, federal or court requirement. Uncertain tax positions of $25 million, which include interest and penalties, are all included in year 2017 as the year of settlement cannot be reasonably estimated. Contractual commitments related to public-private partnerships are $15 million.

OFF-BALANCE SHEET ARRANGEMENTS

For detailed information about the Company’s guarantees, operating leases and purchase obligations, see Note 7, Commitments and Contingencies. There are no off-balance sheet arrangements that are reasonably likely to have a material effect on the Company’s financial condition, results of operations or liquidity.

CSX 2016 Form 10-K p. 46

CSX CORPORATION

PART II

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires that management make estimates in reporting the amounts of certain assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and certain revenues and expenses during the reporting period. Actual results may differ from those estimates. These estimates and assumptions are discussed with the Audit Committee of the Board of Directors on a regular basis. Consistent with the prior year, significant estimates using management judgment are made for the following areas:


•	casualty, environmental and legal reserves;


•	pension and post-retirement medical plan accounting;


•	depreciation policies for assets under the group-life method; and


•	income taxes.

Casualty, Environmental and Legal Reserves

Casualty

Casualty reserves of $229 million and $269 million for 2016 and 2015, respectively, represent accruals for personal injury, occupational disease and occupational injury claims. A majority of the casualty reserves relate to personal injuries. The Company's self-insured retention amount for these claims is $50 million per occurrence. Currently, no individual claim is expected to exceed the self-insured retention amount. In accordance with the Contingencies Topic in the ASC, to the extent the value of an individual claim exceeds the self-insured retention amount, the Company would present the liability on a gross basis with a corresponding receivable for insurance recoveries. These reserves fluctuate based upon the timing of payments as well as changes in estimate. Actual results may vary from estimates due to the number, type and severity of the injury, costs of medical treatments and uncertainties in litigation. Most of the Company's casualty claims relate to CSXT unless otherwise noted below. Defense and processing costs, which historically have been insignificant and are anticipated to be insignificant in the future, are not included in the recorded liabilities.

Personal Injury

Personal Injury reserves of $170 million and $204 million for 2016 and 2015, represent liabilities for employee work-related and third-party injuries. Work-related injuries for CSXT employees are primarily subject to FELA. In addition to FELA liabilities, employees of other current or former CSX subsidiaries are covered by various state workers’ compensation laws, the Federal Longshore and Harbor Workers’ Compensation Program or the Maritime Jones Act.

CSXT retains an independent actuary to assist management in assessing the value of personal injury claims. An analysis is performed by the actuary quarterly and is reviewed by management. The methodology used by the actuary includes a development factor to reflect growth or reduction in the value of these personal injury claims. It is based largely on CSXT's historical claims and settlement experience.

As a direct result of improvements in safety in recent years, the Company has experienced a downward trend in the severity of injuries which has resulted in a decrease in the estimate of costs per incident. During 2016, the Company reduced casualty reserves, primarily personal injury reserves, by $28 million, resulting in after-tax effect on earnings from continuing operations and net earnings of $18 million and an after-tax effect on earnings per share of $0.02. The personal injury reserve reductions were included in materials, supplies and other on the consolidated income statements. During 2015 and 2014, there were no significant changes in estimate recorded to adjust casualty reserves.

CSX 2016 Form 10-K p. 47

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

Occupational

Occupational reserves of $59 million and $65 million for 2016 and 2015, respectively, represent liabilities for occupational disease claims and occupational injury claims. Occupational disease claims arise primarily from allegations of exposure to asbestos in the workplace. Occupational injury claims arise from allegations of exposure to certain other materials in the workplace, such as solvents, soaps, chemicals (collectively referred to as “irritants”) and diesel fuels (like exhaust fumes) or allegations of chronic physical injuries resulting from work conditions, such as repetitive stress injuries. The Company has experienced a downward trend in the number of occupational claims and reserves for these claims have decreased to a level that is no longer material to the Company's financial condition, results of operations or liquidity.

Environmental

Environmental reserves were $95 million and $82 million and 2016 and 2015, respectively. The Company is a party to various proceedings related to environmental issues, including administrative and judicial proceedings involving private parties and regulatory agencies. The Company has been identified as a potentially responsible party at approximately 222 environmentally impaired sites. Many of these are, or may be, subject to remedial action under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), also known as the Superfund Law, or similar state statutes. Most of these proceedings arose from environmental conditions on properties used for ongoing or discontinued railroad operations. A number of these proceedings, however, are based on allegations that the Company, or its predecessors, sent hazardous substances to facilities owned or operated by others for treatment, recycling or disposal. In addition, some of the Company’s land holdings were leased to others for commercial or industrial uses that may have resulted in releases of hazardous substances or other regulated materials onto the property and could give rise to proceedings against the Company.

In any such proceedings, the Company is subject to environmental clean-up and enforcement actions under the Superfund Law, as well as similar state laws that may impose joint and several liability for clean-up and enforcement costs on current and former owners and operators of a site without regard to fault or the legality of the original conduct. These costs could be substantial.

In accordance with the Asset Retirement and Environmental Obligations Topic in the ASC, the Company reviews its role with respect to each site identified at least quarterly, giving consideration to a number of factors such as:


•	type of clean-up required;


•	nature of the Company’s alleged connection to the location (e.g., generator of waste sent to the site or owner or operator of the site);


•	extent of the Company’s alleged connection (e.g., volume of waste sent to the location and other relevant factors); and


•	number, connection and financial viability of other named and unnamed potentially responsible parties at the location.

CSX 2016 Form 10-K p. 48

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

Based on the review process, the Company has recorded amounts to cover contingent anticipated future environmental remediation costs with respect to each site to the extent such costs are reasonably estimable and probable. The recorded liabilities for estimated future environmental costs are undiscounted. The liability includes future costs for remediation and restoration of sites as well as any significant ongoing monitoring costs, but excludes any anticipated insurance recoveries. Payments related to these liabilities are expected to be made over the next several years. Environmental remediation costs are included in materials, supplies and other on the consolidated income statement.

Currently, the Company does not possess sufficient information to reasonably estimate the amounts of additional liabilities, if any, on some sites until completion of future environmental studies. In addition, conditions that are currently unknown could, at any given location, result in additional exposure, the amount and materiality of which cannot presently be reasonably estimated. Based upon information currently available, however, the Company believes its environmental reserves accurately reflect the cost of remedial actions currently required.

Legal

In accordance with the Contingencies Topic in the ASC, an accrual for a loss contingency is established if information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements, and the amount of loss can be reasonably estimated. If no accrual is made for a loss contingency because one or both of these conditions are not met, or if an exposure to loss exists in excess of the amount accrued, disclosure of the contingency is made when there is at least a reasonable possibility that a loss or an additional loss may have been incurred.

The Company evaluates all exposures relating to legal liabilities at least quarterly and adjusts reserves when appropriate under the guidance noted above. The amount of a particular reserve may be influenced by factors that include official rulings, newly discovered or developed evidence, or changes in laws, regulations and evidentiary standards. See Item 3. Legal Proceedings for further discussion of these items.

Pension and Post-retirement Medical Plan Accounting

The Company sponsors defined benefit pension plans principally for salaried, management personnel. For employees hired prior to 2003, the plans provide eligible employees with retirement benefits based predominantly on years of service and compensation rates near retirement. For employees hired in 2003 or thereafter, benefits are determined based on a cash balance formula, which provides benefits by utilizing interest and pay credits based upon age, service and compensation. As of December 2016, the projected benefit obligation for the Company’s pension plans was $2.9 billion.

In addition to these plans, the Company sponsors a post-retirement medical plan and a life insurance plan that provide certain benefits to full-time, salaried, management employees, hired prior to 2003, upon their retirement if certain eligibility requirements are met. Eligible retirees who are age 65 years or older (Medicare-eligible) are covered by a health reimbursement arrangement, which is an employer-funded account that can be used for reimbursement of eligible medical expenses. Eligible retirees younger than 65 years (non-Medicare eligible) are covered by a self-insured program partially funded by participating retirees. The life insurance plan is non-contributory. As of December 2016, the projected benefit obligation for the Company’s other post-retirement benefit plans was $274 million.

For information related to the funded status of the Company's pension and other post-retirement benefit plans, see Note 8, Employee Benefit Plans.

CSX 2016 Form 10-K p. 49

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

The accounting for these plans is subject to the guidance provided in the Compensation-Retirement Benefits Topic in the ASC. This rule requires that management make certain assumptions relating to the following:


•	discount rates used to measure future obligations and interest expense;


•	long-term rate of return on plan assets;


•	salary scale inflation rates; and


•	other assumptions.

The Company engages independent actuaries to compute the amounts of liabilities and expenses relating to these plans subject to the assumptions that the Company determines are appropriate based on historical trends, current market rates and future projections. These amounts are reviewed by management.

Discount Rates

Discount rates affect the amount of liability recorded and the interest expense component of pension and post-retirement expense. Discount rates reflect the rates at which pension and other post-retirement benefits could be effectively settled, or in other words, how much it would cost the Company to buy enough high quality bonds to generate cash flow equal to the Company's expected future benefit payments. The Company determines the discount rate based on the market yield as of year-end for high quality corporate bonds whose maturities match the plans' expected benefit payments.

The discount rates used by the Company to value its 2016 pension and post-retirement obligations are 4.08 percent and 3.71 percent, respectively. For 2015, the discount rate used by the Company to value its pension and post-retirement obligations was 4.30 percent and 3.85 percent, respectively. Discount rates may differ for pension and post-retirement benefits due to varying duration of the liabilities for projected payments for each plan. As of December 2016, the estimated duration of pensions and post-retirement benefits is approximately 12 years and eight years, respectively.

Each year, these discount rates are reevaluated and adjusted using the current market interest rates for high quality corporate bonds to reflect the best estimate of the current effective settlement rates. In general, if interest rates decline or rise, the assumed discount rates will change.

Long-term Rate of Return on Plan Assets

The expected long-term average rate of return on plan assets reflects the average rate of earnings expected on the funds invested, or to be invested, to provide for benefits included in the projected benefit obligation. In estimating that rate, the Company gives appropriate consideration to the returns being earned by the plan assets in the funds and the rates of return expected to be available for reinvestment as well as the current and projected asset mix of the funds. Management balances market expectations obtained from various investment managers and economists with both market and actual plan historical returns to develop a reasonable estimate of the expected long-term rate of return on assets. As this assumption is long-term, the annual review may result in less frequent adjustment than other assumptions used in pension accounting. The long-term rate of return on plan assets used by the Company to value its benefit cost for the subsequent plan year was 6.75 percent and 7 percent in 2016 and 2015, respectively.

CSX 2016 Form 10-K p. 50

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

Salary Scale Inflation Rates

Salary scale inflation rates are based on current trends and historical data accumulated by the Company. The Company reviews recent wage increases and management incentive compensation payments over the past five years in its assessment of salary scale inflation rates. The Company used a salary scale rate of 4.60 percent in both 2016 and 2015 to value its pension obligations.

Other Assumptions

The calculations made by the actuaries also include assumptions relating to health care cost trend rates, mortality rates, turnover and retirement age. These assumptions are based upon historical data, recent plan experience and industry trends and are determined by management.

2017 Estimated Pension and Post-retirement Expense

Net pension expense and post-retirement benefits expense for 2017 are each expected to be approximately $10 million, compared to $58 million and $17 million, respectively, in 2016. The decrease in expense is primarily due to a change in approach to measuring service and interest costs, the impact of $250 million in voluntary pension contributions and other favorable plan experience.

In 2017, the Company will measure the service and interest cost components of the net pension and post-retirement benefits expense by using individual spot rates matched with separate cash flows for each future year instead of a single weighted-average discount rate approach, which has been used in prior years.

The Company made this change to improve the correlation between projected pension and post-retirement benefit liability cash flows and the corresponding spot discount rates and to provide a more precise measurement of service and interest costs. Under the spot rate approach, individual spot discount rates along the same high quality corporate bonds yield curve used to measure the pension and post-retirement benefit liabilities are applied to the relevant projected cash flows at the relevant maturity. The calculated pension and post-retirement benefits liabilities are consistent under both the traditional and spot rate approaches. The Company accounted for this change on a prospective basis as a change in accounting estimate.

The following sensitivity analysis illustrates the effects of a one percent change in certain assumptions like discount rates, long-term rate of return and salaries on the 2017 estimated pension and post-retirement expense:



(Dollars in Millions)	Pension Expense		Post-Retirement Expense
Discount Rate	$	15	$	1
Long-term Rate of Return	$	26	N/A
Salary Inflation	$	9	N/A

CSX 2016 Form 10-K p. 51

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

Depreciation Policies for Assets Utilizing the Group-Life Method

The Company depreciates its rail assets, including main-line track, locomotives and freight cars, using the group-life method of accounting. Assets depreciated under the group-life method comprise 86 percent of total fixed assets of $43 billion on a gross basis at December 2016. All other assets of the Company are depreciated on a straight-line basis. The group-life method aggregates assets with similar lives and characteristics into groups and depreciates each of these groups as a whole. When using the group-life method, an underlying assumption is that each group of assets, as a whole, is used and depreciated to the end of its recoverable life.

The Company currently utilizes more than 130 different depreciable asset categories to account for depreciation expense for the railroad assets that are depreciated under the group-life method of accounting. Examples of depreciable asset categories include 18 different categories for crossties due to the different combinations of density classifications and asset types. By utilizing various depreciable categories, the Company can more accurately account for the use of its assets. All assets of the Company are depreciated on a time or life basis.

The Company believes the group-life method of depreciation closely approximates the straight-line method of depreciation. Additionally, due to the nature of most of its assets (e.g., track is one contiguous, connected asset), the Company believes that this is the most effective way to properly depreciate its assets.

Management performs a detailed review of depreciation expense and useful lives on a regular basis. Under the group-life method of accounting, the service lives and salvage values for each group of assets are determined by completing periodic depreciation studies and applying management's assumptions regarding the service lives of its properties. A depreciation study (also referred to as a life study) is the periodic review of asset service lives, salvage values, accumulated depreciation, and other related factors for group assets conducted by a third-party specialist, analyzed by the Company’s management and approved by the STB, the regulatory board that has broad jurisdiction over railroad practices. The STB requires depreciation studies be performed for equipment assets generally every three years and for road (e.g. bridges and signals) and track (e.g., rail, ties and ballast) assets generally every six years. The Company believes the frequency currently required by the STB provides adequate review of asset service lives and that a more frequent review would not result in a material change due to the long-lived nature of most of the assets. In 2016, the Company completed a depreciation study for its equipment assets. In 2014, the Company completed a depreciation study for its road and track assets. The Company plans to complete the next depreciation study for road and track assets in 2020 and for equipment assets in 2019.

Changes in asset service lives due to the results of the depreciation studies are applied on a prospective basis and could significantly impact future periods’ depreciation expense, and thus, the Company's results of operations.

CSX 2016 Form 10-K p. 52

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

There are several factors taken into account during the depreciation study and they include:


•	statistical analysis of historical life and salvage data for each group of property;


•	statistical analysis of historical retirements for each group of property;


•	evaluation of current operations;


•	evaluation of technological advances and maintenance schedules;


•	previous assessment of the condition of the assets;


•	management's outlook on the future use of certain asset groups;


•	expected net salvage to be received upon retirement; and


•	comparison of assets to the same asset groups with other companies.

Recent experience with depreciation studies has resulted in depreciation rate changes that did not materially affect the Company’s annual depreciation expense of $1.3 billion, $1.2 billion and $1.2 billion for 2016, 2015 and 2014 respectively. A 1% change in the average life of all group-life assets would result in an approximate $12 million change to the Company’s annual depreciation expense.

For retirements or disposals of depreciable rail assets that occur in the ordinary course of business, the asset cost (net of salvage value or sales proceeds) is charged to accumulated depreciation and no gain or loss is recognized. As individual assets within a specific group are retired, resulting gains and losses are recorded in accumulated depreciation. This practice is consistent with accounting treatment normally prescribed under the group-life method. As part of the depreciation study, an assessment of the recorded amount of accumulated depreciation is made to determine if it is deficient (or in excess) of the appropriate amount indicated by the study. Any such deficiency (or excess), including any deferred gains or losses, is amortized as a component of depreciation expense over the remaining service life of the asset group until the next required depreciation study. Since the overall assumption with group-life is that the assets within the group on average have the same service life and characteristics, it is therefore concluded that the deferred gains and losses offset over time.

In the event that large groups of assets are removed from service as a result of unusual acts or sales, resulting gains and losses are recognized immediately. These acts are not considered to be in the normal course of business and are therefore recognized when incurred. Examples of such acts would be the major destruction of assets due to significant storm damage (e.g., major hurricanes), the sale of a rail line segment to another railroad or the disposal of an entire class of assets (e.g., disposal of all refrigerated freight cars).

Income Taxes

CSX accounts for income taxes in accordance with the Income Taxes Topic in the ASC that addresses how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this topic, the Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The amount recognized in the financial statements from such a position is measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate resolution.

CSX 2016 Form 10-K p. 53

CSX CORPORATION

PART II

Critical Accounting Estimates, continued

CSX files a consolidated federal income tax return, which includes its principal domestic subsidiaries. Examinations of the federal income tax returns of CSX have been completed through 2015. During 2016, the Company participated in a contemporaneous Internal Revenue Service (“IRS”) audit of tax year 2016. Management believes an adequate provision has been made for any adjustments that might be assessed. While the final outcome of these matters cannot be predicted with certainty, it is the opinion of CSX management that none of these items will have a material adverse effect on the financial condition, results of operations or liquidity of CSX. An unexpected adverse resolution of one or more of these items, however, could have a material adverse effect on the results of operations in a particular fiscal quarter or fiscal year. As of December 2016, the Company’s uncertain tax positions were $25 million.

New Accounting Pronouncements and Changes in Accounting Policy

See Note 1, Nature of Operations and Significant Accounting Policies under the caption, “New Accounting Pronouncements and Changes in Accounting Policy.”

FORWARD-LOOKING STATEMENTS

Certain statements in this report and in other materials filed with the SEC, as well as information included in oral statements or other written statements made by the Company, are forward-looking statements. The Company intends for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements within the meaning of the Private Securities Litigation Reform Act may contain, among others, statements regarding:


•	projections and estimates of earnings, revenues, margins, volumes, rates, cost-savings, expenses, taxes or other financial items;


•	expectations as to results of operations and operational initiatives;


•	expectations as to the effect of claims, lawsuits, environmental costs, commitments, contingent liabilities, labor negotiations or agreements on the Company's financial condition, results of operations or liquidity;


•	management's plans, strategies and objectives for future operations, capital expenditures, dividends, share repurchases, safety and service performance, proposed new services and other matters that are not historical facts, and management's expectations as to future performance and operations and the time by which objectives will be achieved; and


•	future economic, industry or market conditions or performance and their effect on the Company's financial condition, results of operations or liquidity.

Forward-looking statements are typically identified by words or phrases such as "will," "should," “believe,” “expect,” “anticipate,” “project,” “estimate,” “preliminary” and similar expressions. The Company cautions against placing undue reliance on forward-looking statements, which reflect its good faith beliefs with respect to future events and are based on information currently available to it as of the date the forward-looking statement is made. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the timing when, or by which, such performance or results will be achieved.

CSX 2016 Form 10-K p. 54

CSX CORPORATION

PART II

Forward-looking statements are subject to a number of risks and uncertainties and actual performance or results could differ materially from those anticipated by any forward-looking statements. The Company undertakes no obligation to update or revise any forward-looking statement. If the Company does update any forward-looking statement, no inference should be drawn that the Company will make additional updates with respect to that statement or any other forward-looking statements. The following important factors, in addition to those discussed in Part II, Item 1A (Risk Factors) and elsewhere in this report, may cause actual results to differ materially from those contemplated by any forward-looking statements:


•	legislative, regulatory or legal developments involving transportation, including rail or intermodal transportation, the environment, hazardous materials, taxation, international trade and initiatives to further regulate the rail industry;


•	the outcome of litigation, claims and other contingent liabilities, including, but not limited to, those related to fuel surcharge, environmental matters, taxes, shipper and rate claims subject to adjudication, personal injuries and occupational illnesses;


•	changes in domestic or international economic, political or business conditions, including those affecting the transportation industry (such as the impact of industry competition, conditions, performance and consolidation) and the level of demand for products carried by CSXT;


•	natural events such as severe weather conditions, including floods, fire, hurricanes and earthquakes, a pandemic crisis affecting the health of the Company's employees, its shippers or the consumers of goods, or other unforeseen disruptions of the Company's operations, systems, property or equipment;


•	competition from other modes of freight transportation, such as trucking and competition and consolidation or financial distress within the transportation industry generally;


•	the cost of compliance with laws and regulations that differ from expectations (including those associated with PTC implementation) as well as costs, penalties and operational and liquidity impacts associated with noncompliance with applicable laws or regulations;


•	the impact of increased passenger activities in capacity-constrained areas, including potential effects of high speed rail initiatives, or regulatory changes affecting when CSXT can transport freight or service routes;


•	unanticipated conditions in the financial markets that may affect timely access to capital markets and the cost of capital, as well as management's decisions regarding share repurchases;


•	changes in fuel prices, surcharges for fuel and the availability of fuel;


•	the impact of natural gas prices on coal-fired electricity generation;


•	availability of insurance coverage at commercially reasonable rates or insufficient insurance coverage to cover claims or damages;


•	the inherent business risks associated with safety and security, including the transportation of hazardous materials or a cybersecurity attack which would threaten the availability and vulnerability of information technology;


•	adverse economic or operational effects from actual or threatened war or terrorist activities and any governmental response;

CSX 2016 Form 10-K p. 55

CSX CORPORATION

PART II


•	labor and benefit costs and labor difficulties, including stoppages affecting either the Company's operations or customers' ability to deliver goods to the Company for shipment;


•	the Company's success in implementing its strategic, financial and operational initiatives;


•	changes in operating conditions and costs or commodity concentrations; and


•	the inherent uncertainty associated with projecting economic and business conditions.

Other important assumptions and factors that could cause actual results to differ materially from those in the forward-looking statements are specified elsewhere in this report and in CSX's other SEC reports, which are accessible on the SEC's website at www.sec.gov and the Company's website at www.csx.com. The information on the CSX website is not part of this annual report on Form 10-K.

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