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CSX CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

July 15, 2014

SECOND QUARTER 2014 HIGHLIGHTS

Revenue of $3.2 billion grew $198 million or 7% year over year driven by

overall volume growth.



Expenses of $2.2 billion increased $141 million or 7% year over year

primarily due to higher volume, increase in costs related to network performance and inflation.



Operating income of $997 million rose $57 million or 6%.

Operating ratio of 69.3% remained relatively flat compared to the prior year. Second Quarters Six Months 2014 2013 Change % Change 2014 2013 Change % Change Volume (in thousands) 1,781 1,656 125 8% 3,401



3,234 167 5%

(in millions) Revenue $ 3,244$ 3,046$ 198 7% $ 6,256$ 6,009$ 247 4% Expense 2,247 2,106 (141 ) (7)% 4,520



4,189 (331 ) (8)% Operating Income $ 997$ 940$ 57 6% $ 1,736$ 1,820$ (84 ) (5)%

Operating Ratio 69.3 % 69.1 % (20 ) bps 72.3 % 69.7 % (260 ) bps Earnings Per Diluted Share $ 0.53$ 0.51$ 0.02 4% $ 0.92$ 0.96$ (0.04 ) (4)%



For additional information, refer to Results of Operations discussed on pages 27 through 30.

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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Volume and Revenue (Unaudited) Volume (Thousands of units); Revenue (Dollars in



millions); Revenue Per Unit (Dollars)

Second Quarters (a) Volume Revenue Revenue Per Unit 2014 2013 % Change 2014 2013 % Change 2014 2013 % Change Agricultural Agricultural Products 105 95 11 % $ 285$ 248 15 % $ 2,714$ 2,611 4 % Phosphates and Fertilizers 86 86 - 143 135 6 1,663 1,570 6 Food and Consumer 25 25 - 70 69 1 2,800 2,760 1 Industrial Chemicals 157 133 18 556 476 17 3,541 3,579 (1 ) Automotive 114 113 1 321 318 1 2,816 2,814 - Metals 74 66 12 184 163 13 2,486 2,470 1 Housing and Construction Forest Products 79 74 7 210 195 8 2,658 2,635 1 Minerals 80 75 7 123 115 7 1,538 1,533 - Waste and Equipment 40 35 14 79 63 25 1,975 1,800 10 Total Merchandise 760 702 8 1,971 1,782 11 2,593 2,538 2 Coal 330 310 6 744 770 (3 ) 2,255 2,484 (9 ) Intermodal 691 644 7 449 425 6 650 660 (2 ) Other - - - 80 69 16 - - - Total 1,781 1,656 8 % $ 3,244$ 3,046 7 % $ 1,821$ 1,839 (1 )% Six Months(a) Volume Revenue Revenue Per Unit 2014 2013 % Change 2014 2013 % Change 2014 2013 % Change Agricultural Agricultural Products 211 190 11 % $ 569$ 489 16 % $ 2,697$ 2,574 5 % Phosphates and Fertilizers 169 170 (1 ) 277 279 (1 ) 1,639 1,641 - Food and Consumer 48 49 (2 ) 135 137 (1 ) 2,813 2,796 1 Industrial Chemicals 303 263 15 1,072 944 14 3,538 3,589 (1 ) Automotive 212 218 (3 ) 596 611 (2 ) 2,811 2,803 - Metals 139 132 5 349 324 8 2,511 2,455 2 Housing and Construction Forest Products 153 147 4 404 384 5 2,641 2,612 1 Minerals 134 132 2 218 211 3 1,627 1,598 2 Waste and Equipment 71 67 6 138 120 15 1,944 1,791 9 Total Merchandise 1,440 1,368 5 3,758 3,499 7 2,610 2,558 2 Coal 623 607 3 1,406 1,496 (6 ) 2,257 2,465 (8 ) Intermodal 1,338 1,259 6 870 829 5 650 658 (1 ) Other - - - 222 185 20 - - - Total 3,401 3,234 5 % $ 6,256$ 6,009 4 % $ 1,839$ 1,858 (1 )% (a) Previously reported 2013 other revenue, total revenue and total revenue per unit have been revised as disclosed in CSX's most recent annual report on Form 10-K. 27



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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Second Quarter 2014 Revenue Volume increased 8% year over year with growth across most markets. Revenue increased by 7% year over year driven by this broad-based volume growth.



Merchandise

Agricultural Sector Agricultural Products - Volume growth was driven by increased shipments of export grain and ethanol. A combined record corn and soybean crop has reduced U.S. grain prices resulting in higher export grain shipments and has increased ethanol production. Phosphates and Fertilizers - Volume was flat year over year as growth in finished fertilizer products was offset by lower phosphate rock shipments. Growth in fertilizers was driven by the recovery from the severe winter weather that delayed the planting season and fertilizer application, while phosphate rock declined due to maintenance at a customer's facility. Food and Consumer - Volume was flat as growth in alcoholic beverage shipments was offset by lower rice shipments. Beverage shipments increased due to a customer's gain in market share as well as inventory accumulation for the summer season. Rice declined as customers substituted lower-priced corn. Industrial Sector Chemicals - Volume growth was driven by an increase in energy-related shipments that included crude oil, liquefied petroleum gas (LPG) and frac sand. The rise in crude oil shipments to east coast refineries was due to increased supply of low cost crude from shale drilling activity.



Automotive - Automotive volume increased as North American light vehicle production grew, but rail equipment shortages due to network performance tempered this growth.

Metals - Volume growth was driven by an increase in sheet steel shipments due to growth in automotive production and competitive gains.

Housing and Construction Sector Forest Products - Volume growth was led by an increase in building products and pulp board shipments. Building products increased year over year due to the continued recovery in the residential housing market as well as the recovery from shipping delays earlier this year. Pulp board shipments also rebounded from earlier delays and increased due to modal conversions. Minerals - Volume increased year over year due to growth in aggregates (which include crushed stone, sand and gravel) and salt. Growth in aggregates was driven by the continued recovery in construction activity and shipping delays earlier this year caused by network performance. Strength in salt shipments was driven by inventory replenishment as a result of the increased application during the severe winter weather.



Waste and Equipment - Volume increased year over year due to growth in municipal solid waste shipments from a new service offering to a customer location.

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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Coal

Coal volume increased due to higher shipments of domestic coal attributable to marketplace gains and utilities replenishing stockpiles. This growth was partially offset by a decrease in export coal as a result of softening global market conditions.



Intermodal

Domestic volume growth was driven by continued success with highway-to-rail conversions and strong demand. International volume also increased due to growth with customers in global container shipments moving to inland destinations.

Expenses

Expenses in the second quarter 2014 increased $141 million from the prior year's second quarter. Significant variances are described below.

Labor and Fringe expense increased $32 million due to the following: Volume-related costs were $25 million higher.

Labor costs were $14 million higher due to overtime and relief crews associated with network performance.



Inflation was $14 million higher.

Other costs were $21 million lower primarily due to reduced pension costs

and incentive compensation costs that reflect lower expected award payments.



Materials, Supplies and Other expense increased $61 million due to the following: No real estate gains were recognized in the current year, whereas, in the

prior year, the Company realized gains of $36 million.

Volume-related costs rose $19 million primarily due to higher volume and

resource levels.

Inflation was $10 million higher.

Costs for locomotives from other railroads were $9 million higher due to

efforts to improve network performance.

Various other costs decreased $13 million during the quarter.

Fuel expense was $19 million higher as increased volume was partially offset by lower price and improved efficiency. Depreciation expense increased $11 million due to a larger asset base. Equipment and Other Rents expense was $18 million higher due to increased car hire costs of $9 million related to network performance and $3 million due to greater volume as well as $6 million from inflation. Interest expense decreased $5 million to $135 million due to lower average interest rates as well as lower average debt balances. Other (expense) income - net decreased $21 million to an expense of $12 million primarily due to an increase in estimated environmental cleanup costs related to non-operating activities. Income tax expense increased $33 million to $321 million primarily due to higher earnings as well as the prior year impacts of a deferred tax adjustment, resolution of certain tax matters and a change in state tax legislation that did not repeat in the current year. 29



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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Six Months Results of Operations Revenue increased $247 million to $6,256 million as a result of volume growth in most of the markets CSX serves along with higher yields resulting from pricing gains across many markets. Other revenue also increased primarily due to higher revenue from customers who did not meet minimum contractual volumes. Operating income decreased $84 million to $1,736 million primarily due to higher costs related to network performance and volume, prior year gains on operating properties that did not repeat in the current year and inflation. These declines were partially offset by higher revenue. Interest expense decreased $12 million to $275 million primarily due to lower average interest rates as well as lower average debt balances. Other (expense) income-net decreased $11 million to an expense of $5 million primarily due to an increase in estimated environmental cleanup costs related to non-operating activities. Income tax expense decreased $27 million to $529 million primarily due to lower earnings as well as a current year benefit which resulted from a change in state tax legislation.



Operating Statistics (Estimated)

Second Quarters Six Months Improvement / Improvement / 2014 2013 (Deterioration) 2014 2013 (Deterioration) Safety and Service Measurements FRA Personal Injury Frequency Index 0.90 1.00 10 % 0.93 0.90 (3 )% FRA Train Accident Rate 2.07 2.18 5 %



2.26 1.98 (14 )%

On-Time Originations 56 % 91 % (38 )% 59 % 91 % (35 )% On-Time Arrivals 42 % 82 % (49 )% 46 % 84 % (45 )% Train Velocity 19.3 23.0 (16 )% 19.9 23.3 (15 )% Dwell 25.9 21.9 (18 )% 26.3 22.1 (19 )% Cars-On-Line (a) 207,141 181,929 (14 )% 202,005 182,572 (11 )% Increase / Resources (Decrease) Route Miles 20,771 20,864 - % Locomotives (owned and long-term leased) 4,259 4,212 1 % Freight Cars (owned and long-term leased) 67,381 68,983 (2 )% Containers 18,249 17,965 2 % (a) Cars-on-line increased approximately 14,000 or 7.5% in 2014 due to a calculation error correction made by the American Association of Railroads in February 2014. This error impacted the industry cars-on-line since 2011. Previously reported amounts have not been adjusted to reflect this correction. 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 Originations - Percent of scheduled road trains that depart the origin yard on-time or ahead of schedule. On-Time Arrivals - Percent of scheduled road trains that arrive at the destination yard on-time to two hours late (30 minutes for intermodal trains). Train Velocity - Average train speed between terminals in miles per hour (does not include locals, yard jobs, work trains or passenger 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. Cars-On-Line - An average count of all cars on the network (does not include locomotives, cabooses, trailers, containers or maintenance equipment). 30



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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company measures and reports safety and service performance. The Company strives for continuous improvement in these measures through training, innovation and investment. For example, the Company's safety and train accident prevention programs rely on the latest tools, programs and employee participation that strengthen the safety culture in a supportive environment that allows each employee to be successful at CSX. Continued capital investment in the Company's assets, including track, bridges, signals, equipment and detection technology also supports safety performance. CSX safety programs are designed to prevent incidents that can impact employees, customers and the communities we serve. The Company routinely collaborates with the Federal Railroad Administration ("FRA") and industry organizations as well as federal, state and local governments on the development and implementation of safety programs and initiatives. For example, earlier this year, CSX and other major freight railroads have met with the U.S. Department of Transportation ("DOT") and other key stakeholders to discuss potential safety enhancements to our nation's freight railroad network. CSX and other railroads voluntarily committed to take certain actions to make railroads even safer. Among other things, CSX agreed to reduce the speed of certain trains to 40 miles per hour through high threat urban areas, increase the frequency of track inspections, and work collaboratively and proactively with local communities to address area-specific concerns. Furthermore, CSX, Operation Lifesaver, Inc., the DOT and other major railroads from across the country have partnered in the Common Sense campaign to reduce the number of injuries and deaths around tracks and trains. Also, CSXT has an ongoing public safety program to clear-cut trees and vegetation at public passive highway-rail intersections (crossings with no flashing lights or gates) to improve the public's ability to discern rail hazards. CSX remains an industry leader in employee safety. The FRA reportable personal injury frequency index improved 10 percent year over year to 0.90, and the reported FRA train accident frequency rate improved 5 percent year over year to 2.07. CSX's service performance remained challenged in the quarter as significant volume growth immediately followed a difficult winter, which negatively impacted the fluidity of the network, and drove shortages in locomotives and crews. On-time performance was down significantly, with on-time originations at 56 percent and on-time arrivals at 42 percent. Average train velocity declined 16 percent to 19.3 miles per hour, and dwell worsened 18 percent to 25.9 hours. In response, the Company is adding more locomotives and train crews to support a gradual recovery in key service measures. LIQUIDITY AND CAPITAL RESOURCES



The following are material changes in the consolidated balance sheets and sources of liquidity and capital, which provide an update to the discussion included in CSX's most recent annual report on Form 10-K.

Material Changes in Consolidated Balance Sheets and Significant Cash Flows Consolidated Balance Sheets Total assets as well as total liabilities and shareholders' equity increased $193 million from year end. Total assets increased primarily due to the increase in net properties of $394 million resulting from capital investments partially offset by the decline in cash of $290million (including short-term investment activity). Total liabilities and shareholders' equity increased primarily driven by net earnings of $927 million partially offset by dividends paid of $311 million, share repurchases of $257 million and payout of incentive compensation of $175 million. 31



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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Significant Cash Flows Cash and cash equivalents decreased in both years. However, the decrease in the current year was $151 million less than in prior year primarily due to the following:



Lower debt repayments of $211 million

Lower property additions of $129 million

Partially offset by higher share repurchases of $162 million

In July 2014, CSX announced an increase in 2014 capital investments from $2.3 billion to $2.4 billion to support long-term growth through investment in infrastructure and freight cars. Planned capital investments include expected 2014 spending of approximately $300 million for Positive Train Control ("PTC"). It excludes investments related to partially or wholly reimbursable public-private partnerships where reimbursements may not be fully received in a given year.



Over half of the 2014 investment will be used for core infrastructure. The remaining amounts will be allocated to locomotives, freight cars, and high return projects that support long-term profitable growth and productivity initiatives that improve the returns of the business, such as intermodal terminal capacity projects. CSX intends to fund capital investments through cash generated from operations.

Over the long term, the Company expects to incur significant capital costs in connection with the implementation of PTC. CSX estimates that the total multi-year cost of PTC implementation will be at least $1.7 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 June 2014 was $1 billion. Liquidity and Working Capital As of the end of second quarter 2014, CSX had $789 million 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 September 2016 and as of the date of this filing, the Company has no outstanding balances under this facility. CSX uses current cash balances for general corporate purposes, which may include reduction or refinancing of outstanding indebtedness, capital expenditures, working capital requirements, contributions to the Company's qualified pension plan, redemptions and repurchases of CSX common stock and dividends to shareholders. See Note 7, Debt and Credit Agreements. The Company's $250 million receivables securitization facility has a three-year term expiring in June 2017. The purpose of this facility is to provide an alternative to commercial paper and a low cost source of short-term liquidity. As of the date of this filing, the Company has no outstanding balances under this facility. CSX had a working capital deficit of $425 million and a surplus of $178 million as of June 2014 and December 2013, respectively. While working capital can also be considered a measure of a company's ability to meet its short-term needs, the second quarter 2014 deficit is not unusual to CSX or other companies in the industry and does not indicate a lack of liquidity. This decline since year end is primarily due to long-term debt that will mature within one year as well as cash used for dividends paid, share repurchases and incentive compensation payouts. 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. The Company continues to maintain adequate liquidity 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. 32



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Table of Contents CSX CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 areas below. For further discussion of CSX's critical accounting estimates, see the Company's most recent annual report on Form 10-K.



casualty, environmental and legal reserves;

pension and post-retirement medical plan accounting;

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

income taxes. 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;


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