FORM 10-K

SECURITIES AND EXCHANGE COMMISSION

OR

Commission file number 1-3359

CSX TRANSPORTATION INC.

Registrant’s telephone number, including area code: (904) 359-3100

Securities registered pursuant to Section 12(b) of the Act:

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K

REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I (1) (a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.

Securities Registered Pursuant to Section 12(g) of the Act: None.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( )

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes (X) No ( )

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 126-2). Yes ( ) No (X)

State the aggregate market value of the voting stock held by non-affiliates of the registrant. The aggregate market value of the voting stock at January 23, 2004, was $-0-, excluding the voting stock held by the parent of the registrant.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. The registrant has 9,061,038 shares of common stock, par value $20.00, outstanding at January 23, 2004.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K

Table of Contents

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II

ITEMS 1. & 2. BUSINESS AND PROPERTIES

General

     CSX Transportation Inc. (“CSXT” or “Company”) is the largest rail network in the Eastern United States, providing rail freight transportation over a network of more than 23,000 route miles in 23 states, the District of Columbia, and two Canadian provinces. Headquartered in Jacksonville, Florida, CSXT conducts railroad operations in its own name and through railroad subsidiaries.

     CSXT employed an average of 32,892 employees during 2003. The Company considers employee relations to be good. Most of CSXT’s employees are represented by labor unions and are covered by collective bargaining agreements. Some of these agreements are scheduled to expire in 2004. CSXT is in the process of renegotiating most of these agreements, but the outcome of these negotiations is uncertain at this time. These negotiations have generally taken place over a number of years and have previously not resulted in any extended work stoppages. The existing agreements have remained in effect and will continue to remain in effect until new agreements are reached or the Railway Labor Act’s procedures (which include mediation, cooling-off periods, and the possibility of Presidential intervention) are exhausted.

     CSXT is a wholly-owned subsidiary of CSX Corporation (“CSX”), with headquarters at 500 Water Street, 15th Floor, Jacksonville, Florida 32202. The Company makes available free of charge through its website at www.csx.com, its annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, as soon as reasonably practicable after such reports are filed with or furnished to the Securities and Exchange Commission.

     For additional information concerning business conducted by CSXT during 2003, see “Management’s Narrative Analysis of the Results of Operations” on pages 7-21.

Rail Lines

     On December 26, 2003, CSXT’s consolidated railroad system consisted of 39,826 miles of track consisting of the following:

     Included in the above are the following arrangements for use of track not owned by CSXT:

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II

ITEMS 1. & 2.  BUSINESS AND PROPERTIES, Continued

Equipment

     On December 26, 2003, CSXT and subsidiaries owned or leased the following:

     Included in leased equipment are 502 locomotives and 15,676 freight cars leased from Conrail.

ITEM 3. LEGAL PROCEEDINGS

     CSXT is involved in routine litigation incidental to its business and is a party to a number of legal actions and claims, various governmental proceedings and private civil lawsuits, including those related to environmental matters, Federal Employers’ Liability Act claims by employees, other personal injury claims, and disputes and complaints involving certain transportation rates and charges. Some of the legal proceedings include claims for punitive as well as compensatory damages, and others purport to be class actions. While the final outcome of these matters cannot be predicted with certainty, considering among other things the meritorious legal defenses available and liabilities that have been recorded along with applicable insurance, it is the opinion of CSXT management that none of these items will have a material adverse effect on the results of operations, financial position or liquidity of CSXT. However, an unexpected adverse resolution of one or more of these items could have a material adverse effect on the results of operations in a particular quarter or fiscal year. The Company is also a party to a number of actions, the resolution of which could result in gain realization in amounts that could be material to results of operations in the quarter received.

     In further response to this Item, see the information set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this document under the caption “Casualty, Legal and Environmental Reserves” and under the caption “Commitments and Contingencies.”

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Information omitted in accordance with General Instruction I(2)(c).

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

     CSXT is a wholly-owned subsidiary of CSX, and accordingly, there is no market for its common stock. During the years 2003, 2002 and 2001, CSXT paid dividends to CSX on its common stock of $230 million, $200 million and $212 million, respectively.

ITEM 6. SELECTED FINANCIAL DATA

     Information omitted in accordance with General Instruction I(2)(a)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS

     Information omitted in accordance with General Instruction I(2)(a). However, in compliance with said Instruction, see “Management’s Narrative Analysis of the Results of Operations” on pages 7-21.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

Overview

General

     CSX Transportation (“CSXT” or the “Company”) operates one of the largest rail networks in the United States. The Company generated revenue of $6.2 billion in 2003 compared to $6.0 billion in 2002. Operating income was $289 million in 2003 compared to $577 million in 2002. In 2003, CSXT revenue and volume grew in response to strategies to persuade new customers to ship via a combination of rail and truck, the introduction of new customer services, and the economic recovery. However, as discussed below increased costs and operating inefficiency in the network decreased overall profitability.

     CSXT’s rail system is a network, defined by its more than 23,000 route miles, through which goods and services flow. The inefficiency of any one element in that network can have an effect on other components, and ultimately affect the operating efficiency of the entire network. The decline in operating efficiency, coupled with the increased price of fuel and other higher costs, reduced CSXT’s profit in 2003.

     In addition to reviewing various financial measures, CSXT management uses non-financial indicators to monitor performance and operating efficiency of its network. Those include:

     The decline in these non-financial performance measures contributed to higher operating expenses and resulted in a higher operating ratio, which increased to 91.2% in 2003 from 86.1% in 2002. The number of injuries per 100 employees increased by 11%, while the number of FRA-reportable train accidents per million train miles showed a 31% increase from 2002 to 2003. Average train velocity, which is a measure of efficiency, decreased 6% from 22.5 miles per hour in 2002 to 21.1 miles per hour in 2003. The average system dwell time, which measures the amount of time between car arrival and departure from yards, increased 9% from 2002 to 2003. The percent of scheduled trains departing the origin station at or prior to the scheduled departure time and the percent of scheduled trains arriving at the destination station within two hours of the scheduled arrival time both showed year-over-year declines. The number of relief crews called per day on average, which is an indicator of efficiency in the use of crews, showed the largest percent decline, increasing from 26 to 50.

     CSXT management is taking steps to identify the source of operating inefficiencies and reduce operating expenses. Management also is evaluating ways to restore the network operating efficiency, while maintaining volume. This includes reducing both gross ton-miles and the number of times a railcar is handled, or switched, en route to its final destination. Because American industry has changed significantly in recent years, management believes there are portions of CSXT’s non-core network that could be more efficiently used by third parties. The Company is currently evaluating the lease or sale of up to 3,000 miles of its non-core network. This will allow CSXT to return approximately 50 locomotives to the core network, reduce capital outlays and decrease operating expenses.

     These changes will allow for and require organizational improvements. CSXT is undertaking a major management restructuring that began in November 2003 and is expected to conclude near the end of the first quarter of 2004.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Results of Operations

     CSXT follows a 52/53-week fiscal reporting calendar. Fiscal years 2003 and 2002 consisted of 52 weeks ending on December 26, 2003 and December 27, 2002, respectively.

2003 vs. 2002

Operating Revenue

     Overall revenues were up $179 million to $6.2 billion in 2003 from $6.0 billion in 2002.

Merchandise Revenue

     Merchandise showed strength during 2003 with revenue up 5% on 4% volume growth. All markets showed year-over-year revenue improvement, and all except phosphates and fertilizers experienced increased volumes. Emerging markets realized the most improvement, with 18% revenue growth on 12% volume growth. Aggregates and cement traffic grew faster than average industry growth rates due to new industrial development and increased conversions of truck traffic to rail traffic. Ammunition volumes increased throughout the year and strength continued in waste markets. The metals sector also showed strength in 2003. Revenue improved 8% on 9% volume growth, driven by strong global steel demand, particularly for scrap and sheet steel. Other factors contributing to improvement include strength in semi-finish metals and continued increases in modal conversions. Demand for building products, lumber and paper products resulted in an increase in forest and industrial revenue of 5% on 2% volume growth. The agricultural and food and chemical sectors also realized revenue increases, while volumes remained consistent with 2002. Phosphates and fertilizers revenues increased slightly year-over-year despite decreased volume, due to domestic phosphates and ammonia strength.

Automotive Revenue

     Volume declined largely due to a 200,000 unit year-over-year decrease in North American light vehicle production. Haul extensions and price increases drove improvements in revenue per car.

Coal, Coke and Iron Ore Revenue

     Coal, coke and iron ore volumes and revenue remained consistent with results in the prior year. Export moves were strong due to high European steam coal demand for electricity generation. Steel related traffic was weak throughout the year, but showed renewed strength during the fourth quarter due to consolidation in the steel industry and shifts in scrap metal demands that resulted in increased traffic and revenue for CSX. Utility revenue was favorable due to pricing initiatives and higher average length of haul. Improvements in these areas were offset by abnormally harsh winter weather during the first quarter which adversely affected lake loadings, as lakes were frozen.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

RESULTS OF OPERATIONS, Continued

     Carload and revenue data by service group and commodity is as follows:

Fiscal Years Ended December 26, 2003, December 27, 2002 and December 26, 2001

Operating Expense

     Total operating expenses increased to $5.9 billion, or 9% in 2003 as compared to 2002. The primary component of the expense increase was a charge of $229 million recorded in conjunction with the Company’s change in estimate for its casualty reserves to include an estimate of incurred but not reported claims for asbestos and other occupational injuries that may be received over the next seven years. This charge is reflected as “Provision for Casualty Claims” in the financial statements. (See Note 10, Casualty, Environmental and Other Reserves.)

     Labor and fringe expense increased slightly year-over-year. The cost of labor inflation was offset by December-over-December reductions in staff of approximately 1,000 and the favorable impact of the absence of a management bonus in 2003, as approximately $33 million of such expense was recorded in 2002.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

RESULTS OF OPERATIONS, Continued

     Materials, supplies and other expenses increased $89 million, or 8%, year-over-year. One of the primary drivers was approximately $80 million of increased cost for personal injury and related safety issues. An additional $20 million of the expense deterioration is due to increased cost of derailments. Additionally, due to the adoption of Statement of Financial Accounting Standard (“SFAS”) 143, “Accounting for Asset Retirement Obligations,” as discussed below, depreciation expense has been decreased and materials, supplies and other increased to account for the discontinuation of the accrual of cross-tie removal costs as a component of depreciation expense.

     Conrail rents, fees & services expense increased $11 million in 2003, as compared to the prior year, as a result of increased usage of Shared Asset Areas, a contractual increase in the rental fee for Shared Area facilities, and a favorable tax adjustment in the prior year.

     Related party service fees decreased slightly year-over-year as a result of paying its management service fee at a lower rate. The percentage of revenue on which the fee is charged was lowered in mid-2002, resulting in only a portion of 2002 benefiting from the lower rate, while the lower rate was in effect for the entire year of 2003.

     Building and equipment rent decreased $2 million in 2003 compared to the prior year principally as a result of reduced car rentals from other railroads.

     Depreciation remained consistent year-over-year. The Company had capital additions of $940 million, but the additional depreciation was offset by the reduction in depreciation associated with the adoption of SFAS 143, “Accounting for Asset Retirement Obligations.” In conjunction with the group-life method of accounting for asset costs, the Company historically accrued crosstie removal costs as a component of depreciation, which is not permitted under SFAS 143. The effect is to decrease depreciation expense and increase material, supplies and other expense.

     Fuel expense increased $117 million in 2003, as compared to the prior year. The expense increase is primarily due to $102 million in fuel price increases, while increased volumes were also a factor. The average price per gallon of fuel was 96 cents per gallon for 2003 compared to 78 cents per gallon for 2002. In order to minimize future exposure to fuel price fluctuation risk, during 2003 the Company entered into a series of swaps in order to fix the price of a portion of its estimated future fuel purchases. As of December 26, 2003, 18% and 21% of 2004 and 2005, respectively, estimated fuel purchases were hedged. Fuel swaps did not have an effect on fuel expense for the year ended December 26, 2003.

     The net $13 million restructuring charge in 2003 represents the cost of CSXT’s reorganization charges offset by reductions in 1991/1992 separation reserves. (See Note 3, Restructuring.)

Operating Income

     Operating income decreased $288 million to $289 million in 2003, compared to $577 million in 2002 primarily due to the $229 million provision for casualty claims, the $13 million net restructuring charge and other expense increases as previously discussed.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

RESULTS OF OPERATIONS, Continued

Other Income

     Other income increased $13 million in 2003 as compared to 2002, due mainly to a decrease in discounts on sales of accounts receivable due to the discontinuance of the sale of accounts receivable program mid year.

Interest Expense

     Interest expense was reduced by $11 million in 2003 as compared to 2002, due to lower interest rates on floating rate debt.

Net Earnings

     The Company reported net earnings for 2003 of $196 million compared to $296 million in 2002. The year ended December 26, 2003 included an after-tax cumulative effect of accounting change benefit of $57 million related to the adoption of Statement of Financial Accounting Standard (“SFAS”) 143, “Accounting for Asset Retirement Obligations.” Earnings before the cumulative effect of accounting change were $139 million in 2003. The $100 million year-over-year decrease in net earnings primarily results from a $143 million after-tax charge to increase the Company’s provision for casualty reserves and a $9 million net after-tax charge to record amounts associated with the management restructuring and the change in estimate related to certain separation liabilities, offset by $57 million related to the cumulative effect of an accounting change.

     The remaining decrease results from the decline in operating income as discussed above, somewhat offset by the favorable impact of decreased interest expenses and income taxes.

Liquidity and Capital Resources

Operating Activities

     Cash provided by operations for 2003 was $258 million, compared to $932 million for 2002, and $847 million in 2001. The $674 million decrease in 2003, as compared to the prior year, reflects the $869 million termination of the accounts receivable facility. (See Note 8, Accounts Receivable). Excluding that, cash provided by operating activities was higher than 2002, at $1.2 billion.

     In 2002 cash provided from operations was $932 million, an $85 million increase over 2001. Higher operating income, lower interest expense and significant cash flow relating to real estate activities contributed to the increase, while there was a $85 million negative effect attributable to the New Orleans tank car fire settlement payment.

Investing Activities

     Property additions totaled $940 million in 2003, $981 million in 2002 and $848 million in 2001. Of the $940 million in 2003 capital expenditures, substantially all related to replacing track, locomotives and other costs necessary to maintain the Company’s rail system. Capital expenditures for 2004 are expected to be approximately $900 million.

Financing Activities

     Financing activities provided cash of $680 million during 2003 and $224 million in 2001, compared to a $195 million use of cash during 2002.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

Schedule of Contractual Obligations and Commercial Commitments

(Dollars in Millions)

The following table sets forth maturities of the Company’s contractual obligations:

MARKET RISK

     CSXT addresses market risk exposure to the risk of volatility in its fuel costs through the use of derivative financial instruments. The Company does not hold or issue derivative financial instruments for trading purposes.

     The Company is subject to risk relating to changes in the price of diesel fuel. During 2003, the Company began a program to hedge its exposure to fuel price volatility through swap transactions. As of December 26, 2003, CSXT has hedged approximately 18% and 21% of expected requirements for 2004 and 2005, respectively. The Company expects that by the end of 2004 the programs will result in an increase in the amount of fuel hedged to approximately 80% of 2005 annual purchases. At December 26, 2003, a 1% change in fuel prices would result in an increase or decrease in the asset related to the swaps of approximately $1 million. At the end of 2003, the Company had not entered into any long-term commitments for forward fuel purchases. The Company’s rail unit average annual fuel consumption is approximately 570 million gallons. A one-cent change in the price per gallon of fuel would impact fuel expense by approximately $6 million.

     The Company is exposed to loss in the event of non-performance by any counter-party to the fuel hedging agreements. The Company does not anticipate non-performance by such counter-parties, and no material loss would be expected from non-performance.

     At December 26, 2003 and December 27, 2002, CSXT had approximately $66 million and $101 million, respectively, of floating rate debt outstanding. A 1% variance on interest rates would on average affect annual interest expense by approximately $1 million.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

INTEGRATED RAIL OPERATIONS WITH CONRAIL

     See background and accounting and financial reporting effects in Note 2, Integrated Rail Operations with Conrail.

RESTRUCTURING

     In November 2003, the CSX Corporation (“CSX”), the Company’s sole shareholder, announced a management restructuring plan to streamline the structure at a number of its companies, eliminate organizational layers and realign certain functions. The initiative will reduce the non-union workforce by 600 to 750 positions over the last quarter of 2003 and the first half of 2004. As of December 26, 2003, 16 employees have been terminated under this program. The Company recorded an initial charge related to this reduction of $25 million in 2003, to record the lowest amount of expense to be incurred under this program. The total estimated cost of the program is expected to be in the range of $45 million to $60 million. The majority of separation benefits will be paid from CSX Corporation’s qualified pension plans, with the remainder being paid from general corporate funds.

     Also in 2003, CSX recorded a $10 million restructuring charge related to other workforce reduction programs. Substantially all of this amount had been paid out at December 27, 2003.

     In 2003, CSX recorded a $22 million pretax credit related to a favorable change in estimate related to the 1991 and 1992 separation plans. These plans provided for workforce reductions, improvements in productivity and other cost reductions. The reduction in estimate for these plans results from lower railroad retirement taxes and other benefits than had been included in the initial $1.3 billion charge.

     A net $13 million restructuring charge was recorded representing the cost of the restructuring initiatives offset by reductions in 1991/1992 separation reserves. The associated expense is included in operating expense on the Income Statement as “Restructuring Charge — Net.”

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 the reported amount of certain revenues and expenses during the reporting period. Actual results may differ from those estimates. Significant estimates using management judgment are made for the following areas:

     1. Casualty, legal and environmental reserves

     2. Pension and postretirement medical plan accounting

     3. Depreciation polices for its assets under the group-life method

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

CRITICAL ACCOUNTING ESTIMATES, Continued

1. Casualty, Legal and Environmental Reserves

Casualty Reserve Management

     Casualty reserves represent accruals for the uninsured portion of occupational injury and personal injury claims. These reserves are recorded upon the first reporting of a claim, and estimates are updated as information develops. The amount of liability accrued is based on the type and severity of the claim, and an estimate of future claims development based on current trends and historical data. The Company believes it has recorded liabilities in sufficient amounts to cover all identified claims and estimates of incurred but not reported personal injury claims. During 2003, the Company retained third party professionals to work with it to project the number of asbestos and other occupational injury claims to be received over the next seven years and the related costs. Based on this analysis the Company established reserves for the probable and reasonably estimable asbestos and other occupational injury liabilities. Other occupational claims include allegations of exposure to certain materials in the work place, such as solvents and diesel fuel, or alleged physical injuries, such as carpal tunnel syndrome or hearing loss. In conjunction with the change in estimate, in 2003 the Company recorded a charge of $203 million to increase its provision for these claims. Approximately $138 million of this amount relates to asbestos claims. Additionally, the provision for personal injury claims was increased by $26 million as a result of a change in estimate.

     Estimates for all of these claims are subject to significant uncertainty relating to the outcomes of negotiated settlements and other developments. As facts and circumstances change, the Company may have to change its estimates, and changes could have a material impact on the Company’s financial results. Such events as adverse verdicts, catastrophic accidents and legal settlements will cause the Company to revise its estimated liabilities, which the Company reviews and appropriately adjusts quarterly. Personal and occupational injury liabilities amount to $645 million and $395 million at December 26, 2003 and December 27, 2002, respectively. See additional information in Note 10, Casualty, Environmental and Other Reserves.

Legal Reserves

     In accordance with SFAS 5, “Accounting for Contingencies,” an accrual for a loss contingency is established if information available prior to issuance of the financial statements indicates that it is (1) probable that an asset has been impaired or a liability has been incurred at the date of the financial statements, and (2) the amount of loss can be reasonably estimated. If no accrual is made for a loss contingency because one or both of these conditions is 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 on an ongoing basis and records reserves when appropriate under the guidance noted above.

     In 2001 Duke Energy Corporation (“Duke”) filed a complaint before the U.S. Surface Transportation Board alleging that certain CSXT common carrier coal rates are unreasonably high. In February 2004, the STB issued a decision finding that the CSXT common carrier rates were reasonable. While approving the rate levels, the STB also invited Duke to request a phase-in of rate increases over some time period. The nature and amount of any such phase-in is uncertain, and would only apply to billings subsequent to December 2001. CSXT will continue to consider and pursue all available legal defenses in this matter. Administrative and legal appeals are possible, and could take several years to resolve. An unfavorable outcome to this complaint would not have a material effect on the Company.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

CRITICAL ACCOUNTING ESTIMATES, Continued

Environmental Management

     CSXT is a party to various proceedings, including administrative and judicial proceedings, involving private parties and regulatory agencies related to environmental issues. CSXT has been identified as a potentially responsible party (“PRP”) at approximately 260 environmentally impaired sites, many of which are, or may be, subject to remedial action under the Federal Superfund statute (“Superfund”) or similar state statutes. A number of these proceedings are based on allegations that CSXT, or its railroad predecessors, sent hazardous substances to the facilities in question for disposal. Some of the proceedings involve property formerly or currently owned by CSXT or its railroad predecessors. Proceedings arising under Superfund or similar state statutes can involve numerous other companies who generated the waste or owned or operated the property and involve the allocation of liability for costs associated with site investigation and cleanup, which could be substantial.

     At least once each quarter, CSXT reviews its role with respect to each such location, giving consideration to a number of factors, including:

     • the type of cleanup required,

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

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

     • the accuracy and strength of evidence connecting CSXT to the location,

     • and the number, connection, and financial viability of other named and unnamed PRP’s at the location.

     Based on the review process, CSXT has recorded reserves to cover estimated contingent future environmental costs with respect to such sites. The recorded liabilities for estimated future environmental costs at December 26, 2003, and December 27, 2002 were $45 million and $35 million, respectively. These liabilities, which are undiscounted, include amounts representing CSXT’s estimate of unasserted claims, which CSXT believes to be immaterial. The liability includes future costs for all sites where the Company’s obligation is (1) deemed probable and (2) the amount can be reasonably estimated. 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. During 2003, the Company increased its estimate for environmental liabilities by a net $10 million due to continuing evaluation of the adequacy of the reserve. The majority of the December 26, 2003 environmental liability is expected to be paid out over the next seven years.

     The Company does not currently possess sufficient information to reasonably estimate the amounts of additional liabilities, if any, on some sites until completion of future environmental studies. Also, changes in federal and state laws and regulations may impact, favorably or unfavorably, the effort required to remediate sites. In addition, latent conditions at any given location could result in exposure, the amount and materiality of which cannot presently be reliably estimated. Based upon information currently available, however, the Company believes its environmental reserves are adequate to accomplish remedial actions to comply with present laws and regulations, and that the ultimate liability for these matters, if any, will not materially affect its overall results of operations and financial condition.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

CRITICAL ACCOUNTING ESTIMATES, Continued

2. Pension and Postretirement Medical Plan Accounting

     CSXT is allocated expense relating to pension and postretirement medical plans sponsored by its parent, CSX Corporation. The accounting for these plans at the CSX Corporation level is subject to the guidance provided in SFAS No. 87, “Employers Accounting for Pensions,” and SFAS No. 106, “Employers Accounting for Postretirement Benefits Other than Pensions.” Both of these statements require CSX to make certain assumptions relating to the following:

     • Long-term rate of return of plan assets

     • Discount rates used to measure future obligations and interest expense

     • Salary scale inflation

     • Health care cost trend rates and other assumptions

     All of these assumptions and estimates can have a significant impact on CSX’s accounting for these plans and the amount of expense recorded in a reporting period.

     In December 2003, the President of the United States signed into law the “Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“the Act”), which introduces a prescription drug benefit under Medicare Part D as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is actuarially equivalent to Medicare Part D. SFAS 106 requires that changes in the law that take effect in the future and affect future benefit coverage shall be considered in current-period benefit measurements. However, as significant uncertainties exist for how to account for the subsidy a plan sponsor may not have sufficient information available to measure effects of the Act, prepare related actuarial valuations, and ensure proper accounting. Therefore, FASB has issued staff position No. FAS 106-1 which allows a plan sponsor to elect to defer recognizing the effects of the Act until authoritative guidance on the accounting for the federal subsidy is issued, or until certain other events occur. When guidance is issued, it may cause CSX to revise previously reported information. CSX is currently evaluating how the legislation may impact its postretirement benefit plans. (See Note 14, “Employee Benefit Plans.”)

     For further discussion of CSX’s pension and postretirement assumptions, see CSX Corporation’s Form 10-K for the year ended December 26, 2003.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

CRITICAL ACCOUNTING ESTIMATES, Continued

3. Depreciation Policies Under the Group-Life Method

     The Company accounts for its rail assets, including main-line track, locomotives and freight cars, using the group-life method. This method pools similar assets by road and equipment type and then depreciates each group as a whole. These assets represent 94% of the Company’s total fixed assets and amounted to $12.9 billion on a net basis at December 26, 2003. Under the group-life method, the useful lives of rail assets are determined by the performance of a life-study, which includes:

•		statistical analysis of historical retirements for each group of property
•		evaluation of the current operations
•		previous assessment of the condition of the assets and outlook for their continued use
•		comparison of assets to the same asset groups with other companies.

     The results of the life study process determine the service lives for each asset group. These studies are conducted by a third party expert and analyzed by the Company’s management. Changes in asset lives due to the results of the life studies could significantly impact future periods depreciation expense and thus the Company’s results of operations. Events that could cause the Company to change its estimates relating to the lives of its asset groups could be changes in historical results, technological improvements and changes in specific assets. In 2003, the Company completed life studies for all of its rail assets. The effect of theses studies was to increase the average useful lives on its equipment and track assets, while decreasing the average useful lives on many of the roadway assets. These changes in average useful lives of the assets will have minimal net reduction on depreciation expense in the future. As a result, the net increase in depreciation expense was $1 million in 2003, while the impact will be a decrease of approximately $13 million in 2004 and thereafter.

     Additionally, with the adoption of Statement of Financial Accounting Standard (“SFAS”) 143, “Accounting for Asset Retirement Obligations” in 2003, CSX recorded pretax income of $93 million, $57 million after tax as a cumulative effect of an accounting change, representing the reversal of the accrued liability for crosstie removal costs. On an ongoing basis, depreciation expense will be reduced, while labor and fringe and materials, supplies and other expense will be increased by approximately $12 million annually.

     In 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants voted to approve the Statement of Position (SOP) Accounting for Certain Costs and Activities related to Property, Plant and Equipment and presented it to the Financial Accounting Standards Board (FASB) for approval. If the FASB causes the SOP to be applicable, certain costs and activities that are currently capitalized may require immediate recognition and alternatively, some costs and activities that are currently expensed may require capitalization. In addition, the SOP will require additional refinement in asset componentization. potentially altering the amount of depreciation expense recognized. While the Company is evaluating the proposal, it has not yet determined what effect it may have if passed by the FASB. However, the effect could be material.

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

New Accounting Pronouncements and Change In Accounting Policy

     SFAS 143, “Accounting for Asset Retirement Obligations” was issued in 2001. This statement addresses financial accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. In conjunction with the group-life method of accounting for asset costs, the Company historically accrued crosstie removal costs as a component of depreciation, which is not permitted under SFAS 143. As noted above, with the adoption of SFAS 143 in fiscal year 2003, CSX recorded pretax income of $93 million, $57 million after tax as a cumulative effect of an accounting change, representing the reversal of the accrued liability for crosstie removal costs. The adoption of SFAS 143 did not have a material effect on prior reporting periods, and the Company does not believe it will have a material effect on future earnings. On an ongoing basis, depreciation expense will be reduced, while labor and fringe and materials, supplies and other expense will be increased by approximately $12 million annually.

     SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” was issued in December 2002. SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition to Statement 123’s fair value method of accounting for stock-based employee compensation and require disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation. Effective beginning with fiscal year 2003, CSXT has voluntarily adopted the fair value recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation,” and adopted the disclosure requirements of SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of SFAS 123.” In accordance with the prospective method of adoption permitted under SFAS 148, stock-based awards issued subsequent to fiscal year 2002 are accounted for under the fair value recognition provisions of SFAS 123 utilizing the Black-Scholes valuation method and, accordingly, are expensed.

     In 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” which requires a variable interest entity (“VIE”) to be consolidated by a company that is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns, or both. Interpretation No. 46 also requires disclosures about VIEs that the company is not required to consolidate but in which it has a significant variable interest. Also in 2003, Interpretation 46 (“46R”), a revision to FASB Interpretation No. 46 was issued, to clarify some of the provisions of, and to exempt certain entities from Interpretation 46 requirements. Under the new guidance, CSX will consolidate Four Rivers Transportation, Inc. (“FRT”), a short line railroad, into its financial statements beginning December 27, 2003. Presently, FRT is accounted for under the equity method of accounting. The adoption of Interpretation No. 46 will not have a material impact on results of operations in future reporting periods.

     In 2002, the FASB issued Financial Accounting Standard Interpretation (“FASI”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This statement requires that certain guarantees be recorded at fair value on the statement of financial position and additional disclosures be made about guarantees. CSX did not realize a financial statement impact with the adoption of the accounting provisions of this statement in fiscal year 2003 and does not anticipate a future impact. (See Note 15, Commitments and Contingencies.)

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CSX TRANSPORTATION INC. AND SUBSIDIARIES
2003 FORM 10-K, PART II, ITEM 7
MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

Regulation and Legislation

     Rail operations are subject to the regulatory jurisdiction of the Surface Transportation Board (“STB”) of the United States Department of Transportation (“DOT”), the Federal Railroad Administration of DOT and other state and regulatory agencies. The regulation and legislation passed by these organizations can significantly affect the costs and profitability of the Company’s business.

     In response to the heightened threat of terrorism in the wake of the September 2001 attacks on the World Trade Center, Pentagon and airline infrastructure, federal, state and local regulatory agencies are evaluating various proposals with respect to the transportation industry. Some of these proposals relate to the transport of hazardous material. Certain metropolitan areas considered at high risk for a terrorist attack may be the subjects of future regulation. The ultimate legislation passed by federal, state and local regulators related to issues of security has the potential to severely affect CSX’