FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarter ended September 26, 2003
OR
For the transition period from to
Commission File Number 1-8022
CSX CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(904) 359-3200
(Registrant’s telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of September 26, 2003: 214,018,692 shares.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 26, 2003
INDEX
Financial Statements
Consolidated Income Statements (Unaudited) - Quarters and Nine Months Ended September 26, 2003 and September 27, 2002
Consolidated Balance Sheets - At September 26, 2003 (Unaudited) and December 27, 2002
Consolidated Cash Flow Statements (Unaudited) - Nine Months Ended September 26, 2003 and September 27, 2002
Notes to Consolidated Financial Statements (Unaudited)
Management’s Discussion and Analysis of Results of Operations and Financial Condition
Quantitative and Qualitative Disclosures About Market Risk
Disclosure Controls and Procedures
Legal Proceedings
Changes in Securities and Use of Proceeds
Exhibits and Reports on Form 8-K
Signature
2
CSX CORPORATION AND SUBSIDIARIES
ITEM I: FINANCIAL STATEMENTS
Consolidated Income Statements
(Dollars in Millions, Except Per Share Amounts)
Operating Revenue
Operating Expense
Operating Income (Loss)
Other Income
Interest Expense
Earnings (Loss) before Income Taxes and Cumulative
Effect of Accounting Change
Income Tax Expense (Benefit)
Earnings (Loss) before Cumulative Effect of Accounting Change
Cumulative Effect of Accounting Change - Net of Tax
Net Earnings (Loss)
Earnings (Loss) Per Share:
Before Cumulative Effect of Accounting Change
Cumulative Effect of Accounting Change
Including Cumulative Effect of Accounting Change
Earnings (Loss) Per Share, Assuming Dilution:
Average Common Shares Outstanding (Thousands)
Average Common Shares Outstanding, Assuming Dilution (Thousands)
Cash Dividends Paid Per Common Share
See accompanying Notes to Consolidated Financial Statements.
3
Consolidated Balance Sheets
(Dollars in Millions)
ASSETS
Current Assets:
Cash, Cash Equivalents and Short-term Investments
Accounts Receivable - Net
Materials and Supplies
Deferred Income Taxes
Other Current Assets
Domestic Container-Shipping Assets Held for Disposition
Total Current Assets
Properties
Accumulated Depreciation
Properties - Net
Investment in Conrail
Affiliates and Other Companies
Other Long-term Assets
Total Assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable
Labor and Fringe Benefits Payable
Casualty, Environmental and Other Reserves
Current Maturities of Long-term Debt
Short-term Debt
Income and Other Taxes Payable
Other Current Liabilities
Domestic Container-Shipping Liabilities Held for Disposition
Total Current Liabilities
Long-term Debt
Other Long-term Liabilities
Total Liabilities
Shareholders’ Equity:
Common Stock, $1 Par Value
Other Capital
Retained Earnings
Accumulated Other Comprehensive Loss
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
4
Consolidated Cash Flow Statements
OPERATING ACTIVITIES
Net Earnings
Adjustments to Reconcile Net Earnings to Net Cash Provided:
Depreciation
Additional Loss on Sale
Provision for Casualty Reserves
Other Operating Activities
Changes in Operating Assets and Liabilities:
Accounts Receivable
Termination of Sale of Receivables
Net Cash Provided by Operating Activities
INVESTING ACTIVITIES
Property Additions
Net Proceeds from Divestitures
Short-term Investments - Net
Other Investing Activities
Net Cash (Used) by Investing Activities
FINANCING ACTIVITIES
Short-term Debt – Net
Long-term Debt Issued
Long-term Debt Repaid
Dividends Paid
Other Financing Activities
Net Cash Provided (Used) by Financing Activities
Net Increase (Decrease) in Cash and Cash Equivalents
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash and Cash Equivalents at Beginning of Period
Cash and Cash Equivalents at End of Period
Short-term Investments at End of Period
Cash, Cash Equivalents and Short-term Investments at End of Period
5
ITEM 1: FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
In the opinion of management, the accompanying consolidated financial statements contain all adjustments necessary to fairly present the financial position of CSX Corporation and subsidiaries (“CSX” or the “Company”) at September 26, 2003 and December 27, 2002, the results of its operations for the quarters and nine months ended September 26, 2003 and September 27, 2002, and its cash flows for the nine months ended September 26, 2003 and September 27, 2002, such adjustments being of a normal recurring nature. Certain prior-year data have been reclassified to conform to the 2003 presentation.
The Company suggests that these financial statements be read in conjunction with the financial statements and the notes included in the Company’s most recent Annual Report and Form 10-K, 2003 Quarterly Reports on Form 10-Q, and any Current Reports on Form 8-K.
CSX follows a 52/53 week fiscal reporting calendar. Fiscal years 2003 and 2002 consist of 52 weeks ending on December 26, 2003 and December 27, 2002, respectively. The financial statements presented are for the 13-week quarters ended September 26, 2003 and September 27, 2002, the 39-week periods ended September 26, 2003 and September 27, 2002, and as of December 27, 2002.
Comprehensive income approximates net earnings for all periods presented in the accompanying consolidated income statements.
NOTE 2. EARNINGS PER SHARE
The following table sets forth the computation of basic earnings (loss) per share and earnings (loss) per share, assuming dilution:
Numerator (Millions):
Net Earnings (Loss) Before Cumulative Effect of Accounting Change
Denominator (Thousands):
Average Common Shares Outstanding
Effect of Potentially Dilutive Common Shares
Average Common Shares Outstanding, Assuming Dilution
Assuming Dilution, Before Cumulative Effect of Accounting Change
6
NOTE 2. EARNINGS PER SHARE, Continued
Earnings per share are based on the weighted-average number of common shares outstanding. Earnings per share, assuming dilution, are based on the weighted-average number of common shares outstanding adjusted for the effect of potentially dilutive common shares, mainly arising from employee stock options. Potentially dilutive common shares at CSX include stock options and awards, and common stock that would be issued relating to convertible long-term debt. As the Company reported a loss from continuing operations for the quarter ended September 26, 2003, 34 million of potential common shares are excluded from the computation of diluted earnings per share as their effect is antidilutive. During the quarter and nine months ended September 26, 2003, 38,912 and 214,557 options, respectively, were exercised. During the third quarter of 2002, no options were exercised, while 1,020,161 options were exercised for the nine month period ended September 27, 2002.
Certain potentially dilutive common shares at September 27, 2002 were not included in the computation of earnings per share, assuming dilution, since their exercise or conversion prices were greater than the average market price of the common shares during the period and, therefore, their effect is antidilutive. These potentially dilutive common shares were as follows:
Number of Shares (Thousands)
Average Exercise / Conversion Price
A substantial increase in the fair market value of the Company’s stock price could negatively impact earnings per share if the shares were to become dilutive.
NOTE 3. DEBT AND CREDIT AGREEMENTS
On August 5, 2003 the Company issued $300 million aggregate principal amount of 5.50% notes due 2013.
As of September 26, 2003, the Company has commercial paper borrowings of $729 million with a weighted average rate of 1.8%.
On October 2, 2003, CSX Corporation issued a press release announcing its intention to satisfy its obligation to purchase its Zero Coupon Convertible Debentures due October 30, 2021 in the event that the holders of the debentures require CSX to purchase them on October 30, 2003. If any such securities are required to be purchased by CSX, they will be purchased for cash, paid promptly following the later of October 30, 2003, or the book-entry transfer of the Debentures to the trustee of the Debentures. The procedures that holders must follow in electing to have CSX purchase their Debentures are set forth in the Debentures and have been provided in a notice delivered to holders through The Depository Trust Company by the trustee. The Debentures have been classified as long-term debt due to the Company’s ability and intent to refinance the Debentures on a long-term basis.
7
NOTE 4. DIVESTITURES
In February 2003, CSX conveyed most of its interest in its domestic container-shipping subsidiary, CSX Lines LLC (“CSX Lines”), to a new venture formed with the Carlyle Group for approximately $300 million (gross cash proceeds of approximately $240 million, $214 million net of transaction costs and $60 million of securities). CSX Lines was subsequently renamed Horizon Lines LLC (“Horizon”). Horizon has subleased vessel and equipment from certain affiliates of CSX covering the primary financial obligations related to $300 million of leases under which CSX or one of its affiliates will remain a lessee / sublessor or guarantor. A deferred pretax gain of approximately $127 million as a result of the transaction will be recognized over the 12-year sub-lease term. Approximately $3 million of this gain was recognized in the third quarter, with $7 million being recognized year to date. The securities have a term of 7 years and a preferred return feature. During the third quarter, CSX received a $15 million payment from Horizon Lines, which included $3 million of interest, in return of a portion of its investment in Horizon and now holds $48 million of securities.
NOTE 5. NEW ACCOUNTING PRONOUNCEMENTS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES
Statement of Financial Accounting Standard (“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. With the adoption of SFAS 143 in fiscal year 2003, CSX recorded pretax income of $93 million, $57 million after tax, or 26 cents per share, as a cumulative effect of an accounting change in the first quarter, 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.
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, CSX 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. (See Note 11, Stock Based Compensation)
8
SFAS 142, “Goodwill and Other Intangible Assets,” was issued in 2001. Under the provisions of SFAS 142, goodwill and other indefinite lived intangible assets are no longer amortized, but are reviewed for impairment on a periodic basis. The Company adopted this standard at the beginning of fiscal year 2002, and incurred a pretax charge of $83 million, $43 million after tax and consideration of minority interest, 20 cents per share, as a cumulative effect of an accounting change, which represents the difference between book value and the fair value of indefinite lived intangible assets. These indefinite lived intangible assets are permits and licenses that the Company holds relating to a proposed pipeline to transfer natural gas from Alaska’s north slope to the port in Valdez, Alaska. The fair value was determined using a discount method of projected future cash flows relating to these assets. The carrying value of these assets is now approximately $3 million. The adoption of SFAS 142 did not have a material effect on prior reporting periods, and it does not have a material effect on future earnings.
NOTE 6. INVESTMENT IN AND INTEGRATED RAIL OPERATIONS WITH CONRAIL
Background
CSX and Norfolk Southern Corporation (“Norfolk Southern”) acquired Conrail Inc. (“Conrail”) in May 1997. Conrail owns the primary freight railroad system serving the Northeastern United States, and its rail network extends throughout several Midwestern states and into Canada. CSX and Norfolk Southern, through a jointly owned acquisition entity, hold economic interests in Conrail of 42% and 58%, respectively, and voting interests of 50% each. CSX and Norfolk Southern operate over allocated portions of the Conrail lines.
The rail subsidiaries of CSX and Norfolk Southern each operate separate portions of the Conrail system pursuant to various operating agreements. Under these agreements, the railroads pay operating fees to Conrail for the use of right-of-way and rent for the use of equipment. Conrail continues to provide rail services in certain shared geographic areas (“Shared Asset Areas”) for the joint benefit of CSX and Norfolk Southern, for which it is compensated on the basis of usage by the respective railroads.
In June 2003, CSX, Norfolk Southern and Conrail jointly filed a petition with the Surface Transportation Board (STB) to establish direct ownership and control by their respective subsidiaries, CSX Transportation Inc. (“CSXT”) and Norfolk Southern Railway of their portions of the Conrail system. Conrail would continue to own, manage and operate the Shared Assets Areas as previously approved by the STB. CSX, Norfolk Southern and Conrail also jointly filed a ruling request with the Internal Revenue Service to qualify the transaction as a non-taxable distribution. The proposed transaction is subject to a number of conditions, including, among others, STB approval and a favorable IRS ruling. If all necessary conditions are satisfied, Conrail intends to restructure its existing $800 million of unsecured public debt and seek consents to restructure its operating leases and approximately $348 million of capitalized lease and equipment obligations. It is currently contemplated that guaranteed debt securities of two newly formed subsidiaries of CSXT and Norfolk Southern Railway would be offered in a 42%/58% ratio in exchange for Conrail’s unsecured debentures. The debt securities would be fully and unconditionally guaranteed by CSXT and Norfolk Southern Railway. Upon completion of the proposed transaction, the new debt securities would become direct unsecured obligations of CSXT and Norfolk Southern Railway. Conrail’s secured debt and lease obligations will remain obligations of Conrail and are expected to be supported by new leases and subleases which, upon completion of the proposed transaction, would be the direct lease and sublease obligations of CSXT or Norfolk Southern Railway. This transaction would significantly impact the balance sheet by increasing debt and fixed assets, while reducing the investment in Conrail. There would not be a material impact on earnings per share.
9
NOTE 6. INVESTMENT IN AND INTEGRATED RAIL OPERATIONS WITH CONRAIL , Continued
Accounting and Financial Reporting Effects
CSX’s rail and intermodal operating revenue includes revenue from traffic moving on Conrail property. Operating expenses include costs incurred to handle such traffic and operate the Conrail lines. Rail operating expense includes an expense category, “Conrail Rents, Fees and Services,” which reflects:
Detail of Conrail Rents, Fees and Services
Rents and Services
Purchase Price Amortization and Other
Equity in Income of Conrail
Total Conrail
Conrail Financial Information
Summary financial information for Conrail for its fiscal periods ended September 30, 2003 and 2002, and at December 31, 2002, is as follows:
Income Statement Information:
Revenues
Expenses
Operating Income
Net Income Before Cumulative Effect of Accounting Change
Net Income
10
NOTE 6. INVESTMENT IN AND INTEGRATED RAIL OPERATIONS WITH CONRAIL, Continued
Balance Sheet Information:
Current Assets
Property and Equipment and Other Assets
Current Liabilities
Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
Transactions with Conrail
As listed below, CSX has amounts payable to Conrail, representing expenses incurred under the operating, equipment and shared asset area agreements. Also, Conrail advances its available cash balances to CSX and Norfolk Southern under variable-rate notes, with CSX’s note maturing on March 28, 2007.
CSX Payable to Conrail
Conrail Advances to CSX
Interest Rates on Conrail Advances to CSX
Interest Expense Related to Conrail Advances
The agreement under which CSX operates its allocated portion of the Conrail route system has an initial term of 25 years and may be renewed at CSX’s option for two five-year terms. Operating fees paid to Conrail under the agreement are subject to adjustment every six years based on the fair value of the underlying system. Lease agreements for the Conrail equipment operated by CSX cover varying terms. CSX is responsible for all costs of operating, maintaining, and improving the routes and equipment under these agreements.
11
NOTE 7. ACCOUNTS RECEIVABLE
Sale of Accounts Receivable
As of June 27, 2003, CSXT discontinued the sale of accounts receivable, which resulted in a $380 million increase in accounts receivable and increased commercial paper borrowings included in short-term debt. Prior to June 27, 2003, CSXT sold, without recourse, a revolving pool of accounts receivable to CSX Trade Receivables Corporation (“CTRC”), a bankruptcy-remote entity wholly-owned by CSX Corporation. CTRC transferred the accounts receivable to a master trust and caused the trust to issue two series of certificates representing undivided interests in the receivables. The certificates issued by the master trust were sold to investors, and the proceeds from those sales were paid to CSXT.
Two series of certificates were outstanding as of December 27, 2002. One series in the amount of $300 million was sold to investors in 1998 and matured in June 2003. A second series was sold to a private entity in 2000 and matured in June 2003 as well. As of December 27, 2002, the amount sold to the private entity was $80 million. Accounts receivable related amounts were as follows:
Amounts sold under:
Public Series of Certificates
Private Series of Certificates
Total
Retained Interest in Master Trust
The fair value of retained interests approximated book value as the receivables were collected in approximately one month.
Net losses associated with the sale of receivables are as follows:
Discounts on Sales of Accounts Receivable
CSXT retained responsibility for servicing accounts receivables held by the master trust. The average servicing period was approximately one month. No servicing asset or liability was recorded since the fees CSXT received approximated its related costs.
12
NOTE 7. ACCOUNTS RECEIVABLE, Continued
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts based on the expected collectibility of all accounts receivable. The allowance for doubtful accounts is included in the balance sheet as follows:
The decrease in the allowance for doubtful accounts was primarily due to the write-off of uncollectible receivables during 2003.
NOTE 8. OPERATING EXPENSE
Operating expense consists of the following:
Labor and Fringe
Materials, Supplies and Other
Conrail Rents, Fees and Services
Building and Equipment Rent
Inland Transportation
Fuel
Additional Loss on Sale (See Note 13)
Provision for Casualty Claims (See Note 12)
Operating expenses include amounts from the Company’s domestic container-shipping subsidiary, CSX Lines for fiscal year 2002 and through February of 2003, when most of CSX’s interest in the entity was conveyed to a new venture. See note 4, “Divestitures.”
13
NOTE 9. OTHER INCOME
Other income consists of the following:
Interest Income
Income from Real Estate and Resort Operations
Minority Interest
Equity Loss of Other Affiliates
Miscellaneous
Gross Revenue from Real Estate and Resort Operations Included in Other Income
NOTE 10. DERIVATIVE FINANCIAL INSTRUMENTS
CSX uses derivative financial instruments to manage its overall exposure to fluctuations in interest rates and fuel costs.
Interest Rate Swaps
CSX has entered into various interest rate swap agreements on the following fixed rate notes:
Maturity Date
December 1, 2003
May 1, 2004
June 22, 2005
August 15, 2006
May 1, 2007
May 1, 2032
Total/Average
Under these agreements, the Company will pay variable interest based on LIBOR in exchange for a fixed rate, effectively transforming the notes to floating rate obligations. The instruments qualify, and are designated, as fair value hedges.
14
NOTE 10. DERIVATIVE FINANCIAL INSTRUMENTS, Continued
The interest rate swap agreements are designated and qualify as fair value hedges and the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the fixed rate note attributable to the hedged risk, are recognized in current earnings during the period of change in fair values. Hedge effectiveness is measured at least quarterly based on the relative change in fair value of the derivative contract in comparison with changes over time in the fair value of the fixed rate notes. Any change in fair value resulting from ineffectiveness, as defined by SFAS 133, “Accounting For Derivative Instruments and Hedging Activities,” is recognized immediately in earnings. The Company’s interest rate swaps qualify as perfectly effective fair value hedges, as defined by SFAS 133. As such, there was no ineffective portion to the hedge recognized in earnings during the current or prior year periods. Long-term debt has been increased by $77 million and $78 million for the fair market value of the interest rate swap agreements at September 26, 2003 and December 27, 2002, respectively.
The differential to be paid or received under these agreements is accrued based on the terms of the agreements and is recognized in interest expense over the term of the related debt. The related amounts payable to, or receivable from, counterparties are included in other current liabilities or assets. Cash flows related to interest rate swap agreements are classified as “Operating Activities” in the Consolidated Cash Flow Statement. For the quarter and nine month periods ended September 26, 2003, the Company reduced interest expense by approximately $11 million and $33 million, respectively, as a result of the interest rate swap agreements that were in place during that period. For the quarter and nine month periods ended September 27, 2002, the Company reduced interest expense by approximately $8 million and $24 million, respectively.
The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. However, the Company does not anticipate nonperformance by the counterparties.
Fuel Hedging
In the third quarter of 2003, CSX began a program to hedge a portion of its 2004 and 2005 locomotive fuel purchases. This program was established to manage exposure to fuel price fluctuations. In order to minimize this risk, CSX has entered into a series of swaps in order to fix the price of a portion of its estimated future fuel purchases.
Following is a summary of fuel swaps executed during the quarter:
Approximate Gallons Hedged (Millions)
Average Price Per Gallon
Swap Maturities
Estimated % of Future Fuel Consumption Hedged at September 26, 2003
15
The program limits fuel hedges to a 24 month duration and a maximum of 80% of CSX’s average monthly fuel purchased for any month within the 24 month period, and places the hedges among selected counterparties. Fuel hedging activity did not have a material affect on fuel expense for the quarter and nine months ended September 26, 2003. Ineffectiveness, or the extent to which changes in the fair values of the fuel swaps did not offset changes in the fair values of the expected fuel purchases, was immaterial.
These instruments qualify, and are designated by management, as cash-flow hedges of variability in expected future cash flows attributable to fluctuations in fuel prices. The fair values of fuel derivative instruments are determined based upon current fair market values as quoted by third party dealers and are recorded on the balance sheet with offsetting adjustments to Accumulated Other Comprehensive Income, a component of Shareholders’ Equity. These amounts are immaterial as of September 26, 2003. Fair value adjustments are noncash transactions, and accordingly, are excluded from the Cash Flow Statement.
The Company is exposed to credit loss in the event of nonperformance by other parties to fuel swap agreements. However, the Company does not anticipate nonperformance by the counterparties.
NOTE 11. STOCK-BASED COMPENSATION
Effective beginning with fiscal year 2003, CSX 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, the Company has adopted the fair value recognition provisions on a prospective basis and accordingly, expense of $2 million and $3 million, respectively, was recognized in the quarter and nine months ended September 26, 2003 for stock options granted in May 2003.
16
NOTE 11. STOCK BASED COMPENSATION, Continued
The following table illustrates the pro forma effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period:
Net Earnings (Loss) - As Reported
Add: Stock Based Employee Compensation Expense Included in Reported Net Income - Net of Related Tax Effects
Deduct: Total Stock Based Employee Compensation Expense Determined Under the Fair Value Based Method For all Awards - Net of Related Tax Effects
Pro Forma Net Earnings
Basic - As Reported
Basic - Pro Forma
Diluted - As Reported
Diluted - Pro Forma
NOTE 12. CASUALTY, ENVIRONMENTAL AND OTHER RESERVES
Casualty, environmental and other reserves are provided for in the balance sheet as follows:
Casualty and Other
Separation
Environmental
17
NOTE 12. CASUALTY, ENVIRONMENTAL AND OTHER RESERVES, Continued
Casualty Reserves
Casualty reserves represent accruals for the uninsured portion of occupational injury and personal injury claims. In the third quarter of 2003, the Company changed its estimate of casualty reserves to include an estimate of incurred but not reported claims for asbestos and other occupational injuries to be received over the next seven years. 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, the Company recorded a charge of $232 million ($145 million after tax, 68 cents per share) in the third quarter of 2003 to increase its provision for these claims. Approximately $141 million relates to asbestos claims.
Asbestos and Other Occupational Injuries
During the third quarter of 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.
The methodology used by the third party to project future occupational injury claims was based largely on CSX’s recent experience, including claim-filing and settlement rates, injury and disease mix, open claims and claim settlement costs. However, projecting future occupational injury claims and settlements costs is subject to numerous variables that are difficult to predict. In addition to the significant uncertainties surrounding the number of claims that might be received, other variables, including the type and severity of the injury or disease alleged by each claimant, the long latency period associated with exposure, dismissal rates, costs of medical treatment, uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case and the impact of changes in legislative or judicial standards, may cause actual results to differ significantly from estimates. Furthermore, predictions with respect to these variables are subject to greater uncertainty as the projection period lengthens. In light of these uncertainties, CSX believes that seven years is the most reasonable period for estimating future claims, and that claims received after that period are not reasonably estimable.
CSX increased its reserve for asbestos and other occupational claims by a net $206 million to cover the estimate of incurred but not reported claims to be filed during the next seven years. Reflecting the additional provisions, CSX’s reserve for asbestos and other occupational claims on an undiscounted basis amounted to $350 million at September 26, 2003, compared to $171 million at December 27, 2002.
18
Casualty Reserves, Continued
A summary of existing claims activity is as follows:
Asserted Claims:
Open Claims - Beginning of Period
New Claims Filed
Claims Settled
Claims Dismissed
Open Claims - End of Period
Approximately 5,500 of the open claims above are asbestos claims against the Company’s previously owned international container-shipping business, Sea-Land. Because the Sea-Land claims are claims against multiple vessel owners, the Company’s reserves reflect its portion of those claims. The remaining open claims have been asserted against CSX Transportation. At September 26, 2003 and December 27, 2002, the Company had approximately $13 million and $10 million reserved for the Sea-Land claims.
Personal Injury
During the third quarter of 2003, CSX retained an independent actuarial firm to assess the value of CSX’s personal injury portfolio. This firm’s methods and procedures yielded a slightly higher valuation for personal injury claims than previously recognized by CSX due to a higher estimated cost for adverse development. Utilizing the analysis provided, CSX increased its reserves for alleged personal injury claims by $26 million.
Environmental Reserves
CSX is a party to various proceedings involving private parties and regulatory agencies related to environmental issues. CSXT has been identified as a potentially responsible party (“PRP”) at approximately 100 environmentally impaired sites that 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. Such proceedings arising under Superfund or similar state statutes can involve numerous other waste generators and disposal companies and seek to allocate or recover costs associated with site investigation and cleanup, which could be substantial.
19
Environmental Reserves, Continued
CSXT is involved in administrative and judicial proceedings, and other clean-up efforts at approximately 224 sites, which include the 100 Superfund sites noted above, where it is participating in the study or clean-up of alleged environmental contamination. At least once each quarter, CSXT reviews its role with respect to each such location, giving consideration to a number of factors, including 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 PRPs 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 September 26, 2003, and December 27, 2002 were $36 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) where such costs 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. The majority of the September 26, 2003 environmental liability is expected to be paid out over the next seven years, funded by cash generated from operations.
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. 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.
NOTE 13. COMMITMENTS AND CONTINGENCIES
Purchase Commitments
The Company has a commitment under a long-term maintenance program for approximately 40% of CSXT’s fleet of locomotives. The agreement expires in 2026 and approximates $3.1 billion. The long-term maintenance program is intended to provide CSX access to efficient, high-quality locomotive maintenance services at fixed price levels through the term of the program. Under the program, CSX paid $32 million and $98 million in the quarter and nine month periods ended September 26, 2003. In the quarter and nine month periods ended September 27, 2002, $31 million and $93 million, respectively was paid.
20
NOTE 13. COMMITMENTS AND CONTINGENCIES, Continued
Purchase Commitments, Continued
The Company has entered into fuel purchase agreements for approximately 14% of its fuel requirements over the next five months. These agreements amount to approximately 88 million gallons in commitments at a weighted average of 75 cents per gallon. These contracts require the Company to take monthly delivery of specified quantities of fuel at a fixed price. These contracts cannot be net settled.
Self-Insurance
The Company obtains substantial amounts of commercial insurance for potential losses for third-party liability and property damages. Specified levels of risk (up to $35 million for property and $25 million for liability per occurrence) are retained on a self-insurance basis. The Company uses a combination of third-party and self-insurance to realize savings on insurance premium costs.
Guarantees
The Company and its subsidiaries are contingently liable individually and jointly with others as guarantors of obligations principally relating to leased equipment, joint ventures and joint facilities used by CSX in its business operations. Utilizing a CSX guarantee for these obligations allows CSX to take advantage of lower interest rates and obtain other favorable terms when negotiating leases or financing debt. Guarantees are contingent commitments issued by the Company that could require CSX or one of its affiliates to make payment or to perform certain actions to the guaranteed party based on another entity’s failure to perform. CSX’s guarantees can be segregated into three main categories:
The maximum amount of future payments the Company could be required to make under these guarantees is the amount of the guarantees themselves.
21
Matters Arising Out of Sale of International Container-Shipping Assets
CSX has entered into two settlement agreements with Maersk which resolve all material disputes pending between the companies arising out of the 1999 sale of the international container-shipping assets. On September 17, 2003, CSX entered into a final settlement agreement with Maersk allocating responsibility between the two companies for third party claims and litigation relating to the assets acquired by Maersk
On October 20, 2003, CSX entered into a conditional settlement agreement with Maersk designed to settle all the remaining material disputes pending between the companies. The agreement settles the two major disputes arising out of the Maersk transaction. The first dispute involves a post-closing working capital adjustment to the sale price for which the Company had recorded a receivable of approximately $70 million. The second dispute involves a claim of 425 million Dutch Guilders plus interest (amounting to approximately $180 million plus interest under then prevailing currency exchange rates) received from Europe Container Terminals bv (“ECT”) alleging certain breaches by the Company at the Rotterdam container terminal facility owned by ECT. The settlement is subject to certain conditions which the Company believes it is probable will be met. Accordingly, the Company has recorded a charge relating to this settlement. The charge set forth below primarily includes the write-off of the receivable recorded for the working capital adjustment as well as a net cash payment. If the conditions are not satisfied, then CSX will not be bound by the settlement agreement and will proceed with litigation of the disputed matters. The effect of the two settlements is to reduce the Company’s earnings by $108 million pretax, $67 million after tax, or 31 cents per share. This charge is reflected in the financial statements as the additional loss on sale of the international container-shipping assets. Neither settlement is expected to have a material impact on future cash flows.
Other Legal Proceedings
A number of other legal actions are pending against CSX and certain subsidiaries in which claims are made in substantial amounts. While the ultimate results of these legal actions cannot be predicted with certainty, management does not currently expect that the resolution of these matters will have a material effect on CSX’s consolidated balance sheet, income statement or cash flows. The Company is also 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.
22
NOTE 14. BUSINESS SEGMENTS
The Company operates in three business segments: rail, intermodal, and international terminals. The rail segment provides rail freight transportation over a network of more than 23,000 route miles in 23 states, the District of Columbia and two Canadian provinces. The intermodal segment provides transcontinental intermodal transportation services and operates a network of dedicated intermodal facilities across North America. The international terminals segment operates container freight terminal facilities and related businesses in Asia, Europe, Australia, Latin America and the United States. The Company’s segments are strategic business units that offer different services and are managed separately based on the differences in these services. Because of their close interrelationship, the rail and intermodal segments are viewed on a combined basis as Surface Transportation operations.
The Company evaluates performance and allocates resources based on several factors, of which the primary financial measure is business segment operating income, defined as income from operations excluding the effects of non-recurring charges and gains. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note 1) in the CSX Annual Report on Form 10-K, except that for segment reporting purposes, CSX includes minority interest expense on the international terminals segment’s joint venture businesses in operating expense. These amounts are reclassified through eliminations in CSX’s consolidated financial statements to other income. Intersegment sales and transfers are generally accounted for as if the sales or transfers were to third parties, at current market prices.
Business segment information for the quarters and nine months ended September 26, 2003 and September 27, 2002 is as follows:
Quarter Ended September 26, 2003
Revenues from external customers
Intersegment revenues
Segment operating income (Loss)
Assets
Quarter Ended September 27,2002
Segment operating income
23
NOTE 14. BUSINESS SEGMENTS, Continued
Nine Months Ended September 26, 2003
Nine Months Ended September 27, 2002
A reconciliation of the totals reported for the business segments to the applicable line items in the consolidated financial statements is as follows:
Revenues:
Total external revenues for business segments
Intersegment revenues for business segments
Elimination of intersegment revenues
Other
Total consolidated revenues
Operating Income (Loss):
Total operating income for business segments
Reclassification of minority interest expense for International Terminals segment
Unallocated corporate expenses
Total consolidated operating income (loss)
Assets:
Assets for Business Segments
Elimination of intersegment receivables
Non-segment assets
Total consolidated assets
24
NOTE 15. SUMMARIZED CONSOLIDATING FINANCIAL DATA
During 1987, the predecessor company to CSX Lines entered into agreements to sell and lease back by charter three new U.S.-built, U.S.-flag, D-7 class container ships. CSX guaranteed the obligations of CSX Lines pursuant to the related charters which, along with the container ships, serve as collateral for debt securities registered with the Securities and Exchange Commission (“SEC”). On February 27, 2003, CSX conveyed most of its interest in CSX Lines to a new venture. A newly formed CSX subsidiary, CSX Vessel Leasing, will retain certain vessel obligations, with CSX remaining as the guarantor. These vessels have been subleased to Horizon. CSX believes that Horizon will fulfill its contractual commitments with respect to such leases and that CSX will have no further liabilities for these obligations. The September 26, 2003 consolidating schedules reflect CSX Vessel Leasing as the obligor, while the September 27, 2002, and December 27, 2002 consolidating schedules reflect CSX Lines as the obligor. In accordance with SEC disclosure requirements, consolidating financial information for the parent and obligor are as follows:
Consolidating Income Statement
CSX
Corporation
CSX Vessel
Leasing
Quarter ended September 26, 2003
Other Income (Expense)
Earnings (Loss) before Income Taxes
Quarter ended September 27, 2002
25
NOTE 15. SUMMARIZED CONSOLIDATING FINANCIAL DATA, Continued
Nine Months ended September 26, 2003
Earnings before Income Taxes and Cumulative Effect of Accounting Change
Earnings Before Cumulative Effect of Accounting Change
Nine Months ended September 27, 2002
Income Tax Expense
26
Consolidating Balance Sheet
September 26, 2003
Investment in Consolidated Subsidiaries
LIABILITIES
Payable to Affiliates
Casualty, Environmental and Other reserves
Long-term Payable to Affiliates
SHAREHOLDER’S EQUITY
Preferred Stock
Common Stock
27
December 27, 2002
Domestic Container-Shipping Assets Held For Disposition
Domestic Container-Shipping Liabilities Held For Disposition
Shareholders’ Equity
28
Consolidating Cash Flow Statements
Operating Activities
Net Cash Provided (Used) by Operating Activities
Investing Activities
Short-term Investments
Net Cash Provided (Used) by Investing Activities
Financing Activities
Short-term Debt-Net
Cash Dividends Paid
Short-term Investments-net
Short-term Debt - Net
29
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
CSX follows a 52/53-week fiscal reporting calendar. Fiscal years 2003 and 2002 consist of 52 weeks ending on December 26, 2003 and December 27, 2002, respectively. The financial statements presented are for the 13-week quarters and nine months ended September 26, 2003 and September 27, 2002, and as of December 27, 2002.
Quarter ended September 26, 2003 Compared to September 27, 2002
Consolidated Results
Operating revenue decreased $173 million to $1,882 million in the quarter ended September 26, 2003, as compared to the 2002 quarter. Surface Transportation revenue increased $37 million quarter-over-quarter, but was offset by the elimination of $215 million in revenue from the domestic container-shipping business as a majority of CSX’s interest in CSX Lines was conveyed during the first quarter of 2003 (See Note 4, Divestitures).
Operating income for the quarter ended September 26, 2003 was down $374 million to a loss of $98 million, compared to income of $276 million in the 2002 quarter.
The decline is primarily the result of the Company recording a charge in conjunction with changing its estimate of casualty reserves to include an estimate of incurred but not reported claims for asbestos and other occupational injuries to be received over the next seven years. The Company recorded a charge of $232 million in the third quarter of 2003 to increase its provision for casualty reserves. (See Note 12, Casualty, Environmental, and Other Reserves).
Additionally, in the third quarter of 2003, CSX entered into one final settlement agreement and another conditional settlement agreement, which together resolve all material outstanding disputes with Maersk. This decreased operating income by $108 million, and is reflected in operating expense as the additional loss on sale of international container-shipping assets (See Note 13, Commitments and Contingencies).
The remaining decline in operating income is due to a $22 million decrease in operating income from the sale of a majority of CSX’s interest in CSX Lines during the first quarter of 2003 as previously discussed, and increased operating expenses at the Surface Transportation Segment, primarily due to increased materials, supplies and other costs and labor and fringe benefit expense.
30
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS
Consolidated Results, Continued
Other income decreased $7 million in the third quarter of 2003, as compared to the same period of the prior year. The decrease is primarily the result of decreased income from real estate and resort operations, offset by the elimination of costs resulting from the discontinuance of the sale of accounts receivable program.
Interest expense decreased $5 million in the quarter ended September 26, 2003, as compared to the prior year quarter. Lower interest rates on floating rate debt and the favorable impact of interest rate swaps (see Note 10, Derivative Financial Instruments) continue to benefit the Company.
CSX’s net loss was $103 million, or 48 cents per share, in the quarter ended September 26, 2003, compared to earnings of $127 million or 60 cents per share for the same period of the prior year. The decrease is a result of the previously mentioned items.
31
Segment Results
The following tables provide a detail of operating revenue and expense by segment:
(Dollars in Millions) (Unaudited) (1)
Quarters Ended September 26, 2003 and September 27, 2002
Conrail Rents, Fees & Services
Provision for Casualty Claims (3)
Additional Loss on Sale (4)
Total Operating Expense
Operating Ratio
Nine Months Ended September 26, 2003 and September 27, 2002
32
Surface Transportation Results
The following tables provide Surface Transportation carload and revenue data by service group and commodity:
Quarters ended September 26, 2003 and September 27, 2002
Carloads
(Thousands)
Revenue
Merchandise
Phosphates and Fertilizer
Metals
Forest and Industrial Products
Agricultural and Food
Chemicals
Emerging Markets
Total Merchandise
Automotive
Coal, Coke & Iron Ore
Coal
Coke and Iron Ore
Total Coal, Coke & Iron Ore
Total Rail
Intermodal
Domestic
International
Total Intermodal
Total Surface Transportation
33
Nine Months ended September 26, 2003 and September 27, 2002
34
Rail
Rail revenue increased $37 million, or 3% in the quarter ended September 26, 2003, as compared to the quarter ended September 27, 2002.
Merchandise showed strong growth in the third quarter with revenues up 5% on 3% volume growth. All markets showed year-over-year improvements in revenue and volume.
Volume decline was directly attributed to flat sales and a 200,000 unit year-over-year decline in North American light vehicle production. Field inventories were five days higher year-over-year. Haul extensions and price increases partially mitigated sales and production impact on revenue and improved yield.
Coal, Coke and Iron Ore
Reduced production levels drove year-over-year weakness in steel related traffic. Strength in export moves resulted due to high European steam coal demand for electricity generation to cooling systems. Utility revenue was favorable year-over-year due to pricing initiatives and strong long haul mix.
35
Rail, Continued
Operating income decreased $233 million to a loss of $45 million in the third quarter of 2003, compared to income of $188 million in 2002 due to the $229 million provision for casualty claims and other expenses previously discussed. Excluding the provision for casualty claims, operating income would have been $184 million.
36
Intermodal, Continued
Intermodal operating expense increased $10 million, or 4% compared to the prior year quarter. The increase is due primarily to traffic mix and inflationary factors.
Operating income decreased to $29 million in the third quarter of 2003, compared to $39 million in the prior year quarter.
International Terminals Results
Revenue decreased $5 million, or 8% to $59 million for the 2003 quarter, compared to $64 million in the prior year quarter, primarily due to weakness in the Hong Kong market.
Expense decreased $7 million to $39 million for the third quarter, compared to $46 million for the 2002 quarter, partially attributed to reduced labor and fringe costs due to reduced volume at its Hong Kong operations and a $3 million gain related to the divestiture of a portion of the Caucedo terminal ownership interest, which offset other miscellaneous expenses.
Operating income increased $2 million for the 2003 quarter, as compared to the 2002 quarter, due to a gain on the sale of a portion of the Caucedo terminal ownership interest and aggressive cost focus to offset the revenue decline in Hong Kong.
Nine Months ended September 26, 2003 Compared to September 27, 2002
Operating revenue decreased $252 million for the nine months ended September 26, 2003, as compared to the nine months ended 2002. A $416 million decline resulted from a reduction of revenue in the domestic container-shipping segment as a majority of CSX’s interest in CSX Lines was conveyed during the first quarter of 2003 (See Note 4, Divestitures), which was offset by an increase in Surface Transportation revenue of $175 million.
37
Operating income for the nine months ended September 26, 2003 was down $445 million to $364 million, compared to $809 million for the same period of the prior year.
The decline is primarily the result of the Company recording a $232 million charge in conjunction with the change in estimate for casualty reserves (See Note 12, Casualty, Environmental and Other Reserves).
Additionally, in the third quarter of 2003, CSX entered into one final settlement agreement and another conditional settlement agreement, which together resolve all material outstanding disputes with Maersk. This decreased the Company’s operating income by $108 million. This is reflected in operating expense as the additional loss on sale of international container-shipping assets (See Note 13, Commitments and Contingencies).
Other factors contributing to the decline are increased fuel prices and abnormally harsh winter weather during the first quarter which impacted Surface Transportation operating income.
Other income decreased $11 million to $30 million for the nine months ended September 26, 2003, compared to $41 million for the same period of the prior year. The decline primarily results from real estate gains in the 2002 nine-month period being larger than those during the 2003 period.
Interest expense decreased $27 million for the nine months ended September 26, 2003, as compared to the prior year period. Lower interest rates on floating rate debt and the favorable impact of interest rate swaps (see Note 10, Derivative Financial Instruments) continue to benefit the Company.
Net earnings were $123 million, or 57 cents per share, for the nine months ended September 26, 2003, compared to $287 million, or $1.35 per share for the same period of the prior year.
The nine months ended September 26, 2003 included a cumulative effect of accounting change after tax benefit of $57 million, or 26 cents per share, offset by a $145 million after tax, or 68 cents per share, charge to increase the Company’s provision for casualty reserves and a $67 million after tax, 31 cents per share, charge to record the loss on sale of international container-shipping assets.
The nine months ended September 27, 2002 included a cumulative effect of accounting change charge of $43 million, or 20 cents per share.
Earnings before the cumulative effect of accounting changes were $66 million and $330 million for the nine months ended September 26, 2003 and September 27, 2002, respectively.
The effective tax rate for the nine month period is lower than the Company’s historical effective tax rate due to a change in the mix of earnings to lower tax rate jurisdictions and a favorable adjustment to deferred state tax liabilities.
38
Divestitures
In February 2003, CSX conveyed most of its interest in its domestic container-shipping subsidiary, CSX Lines LLC (“CSX Lines”), to a new venture formed with the Carlyle Group for approximately $300 million (gross cash proceeds of approximately $240 million, $214 million net of transaction costs and $60 million of securities). CSX Lines was subsequently renamed Horizon Lines LLC (“Horizon”). Horizon has subleased vessels and equipment from certain affiliates of CSX covering the primary financial obligations related to $300 million of leases under which CSX or one of its affiliates will remain a lessee or guarantor. A deferred pretax gain of approximately $127 million as a result of the transaction will be recognized over the 12-year sub-lease term. Approximately $3 million of this gain was recognized in the third quarter, with $7 million being recognized year to date. The securities have a term of 7 years and a preferred return feature. During the third quarter, CSX received a $15 million payment from Horizon Lines, which included $3 million of interest, in return of a portion of its investment in Horizon and now holds $48 million of securities.
New Accounting Pronouncements and Cumulative Effect of Accounting Change
39
New Accounting Pronouncements and Cumulative Effect of Accounting Change, Continued
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short term investments increased $472 million to $736 million, from $264 million at December 27, 2002. Primary sources of cash and cash equivalents during the nine months ended September 26, 2003 include normal transportation operations, $214 million of net proceeds from the divestiture of CSX Lines LLC (see Note 4, Divestitures), and the issuance of $300 million of long-term notes.
Additionally, short-term commercial paper borrowings have netted proceeds of $586 million for the nine month period. The majority of the proceeds of these borrowings are being held to fund the potential purchase of the Company’s zero coupon convertible debentures which may be put to CSX on October 30, 2003. The aggregate value of these debentures is approximately $470 million. Should the Company not be required to purchase the convertible debentures on October 30, 2003, the Company expects to use its excess cash reserve to reduce its commercial paper balance. In the event the Company is required to purchase the convertible debentures, the Company has the ability and intent to refinance the debt on a long-term basis.
The Company has a $1 billion five-year revolving credit facility and a $345 million 364-day revolving credit facility. A portion of these credit facilities may be used to support the Company’s commercial paper. The facilities may also be used for working capital and other general corporate purposes. Under the 364-day facility, the Company pays an annual fee to the participating banks of .125% of total commitment. Under the five-year facility, the Company pays annual fees to the participating banks that may range from 0.08% to 0.23% of total commitment, depending on the Company’s credit rating. As of September 26, 2003, the Company had no borrowings outstanding under these facilities.
40
LIQUIDITY AND CAPITAL RESOURCES, Continued
Primary uses of cash include $757 million in property additions, approximately $292 million in scheduled repayments of long-term debt, and $65 million in dividend payments.
CSX’s working capital deficit at September 26, 2003 was $644 million, up from $630 million at December 27, 2002. A working capital deficit is not unusual for the Company 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 and has sufficient financial capacity to manage its day-to-day cash requirements and any obligations arising from legal, tax and other regulatory rulings.
FINANCIAL DATA
Cash, Cash Equivalents and Short-Term Investments
Working Capital (Deficit)
Current Ratio
Debt Ratio
Ratio of Earnings to Fixed Charges
41
FACTORS EXPECTED TO INFLUENCE 2003
Fuel expenses fluctuate and are a significant cost of CSX Surface Transportation operations. Fuel prices can vary significantly from period to period and impact future results. Although the Company is in the implementation stage of a fuel price hedging program, it will remain subject to fuel price fluctuation over the remainder of 2003. Economic factors also influence results and it is still uncertain whether significant improvements in the industrial sector will come in the last part of 2003.
INVESTMENT IN AND INTEGRATED RAIL OPERATIONS WITH CONRAIL
See background, accounting and financial reporting effects and summary financial information in Note 5, Investment In and Integrated Rail Operations with Conrail.
Conrail’s Results of Operations
Conrail reported net income of $42 million in the third quarter of 2003, compared to $44 million in the prior year quarter. Operating revenues increased $7 million to $228 million for the 2003 quarter, while operating expenses increased $10 million for the same period.
In June 2003, CSX, Norfolk Southern and Conrail jointly filed a petition with the Surface Transportation Board (STB) to establish direct ownership and control by CSXT and Norfolk Southern Railway of their portions of the Conrail system. CSX, Norfolk Southern and Conrail also jointly filed a ruling request with the Internal Revenue Service to qualify the transaction as a non-taxable distribution. See Note 6, “Investment and Integrated Rail Operations With Conrail.”
OTHER MATTERS
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. For information regarding CSX’s significant estimates using management judgment, see management’s discussion and analysis of financial condition and results of operations on page 26 of the 2002 Annual Report.
In the third quarter of 2003, the Company evaluated and changed its estimate for casualty reserves to include an estimate of incurred but not reported claims for asbestos and other occupational injuries to be received over the next seven years. (See Note 12, Casualty, Environmental and Other Reserves). As of September 26, 2003, there have been no other material changes to significant estimates as stated in the 2002 Annual Report.
42
OTHER MATTERS, Continued
Matters Arising From Sale of International Container-Shipping Assets
CSX has entered into two settlement agreements with Maersk which resolve all material disputes pending between the companies arising out of the 1999 sale of the international container-shipping assets. On September 17, 2003, CSX entered into a final settlement agreement with Maersk allocating responsibility between the two companies for third party claims and litigation relating to the assets acquired by Maersk.
On October 20, 2003, CSX entered into a conditional settlement agreement with Maersk designed to settle all the remaining material disputes pending between the companies. The agreement settles the two major disputes arising out of the Maersk transaction. The first dispute involves a post-closing working capital adjustment to the sale price for which the Company had recorded a receivable of approximately $70 million. The second dispute involves a claim received from Europe Container Terminals bv (“ECT”) alleging certain breaches by the Company at the Rotterdam container terminal facility owned by ECT. The settlement is subject to certain conditions which the Company believes it is probable will be met. Accordingly, the Company has recorded a charge relating to this settlement. The charge set forth below primarily includes the write-off of the receivable recorded for the working capital adjustment as well as a net cash payment. If the condition is not satisfied, then CSX will not be bound by the settlement agreement and will proceed with litigation of the disputed matters. The effect of the two settlements is to reduce the Company’s earnings by $108 million pretax, $67 million after tax, or 31 cents per share. This charge is reflected in the financial statements as the additional loss on sale of the international container-shipping assets. Neither settlement is expected to have a material impact on future cash flows.
43
FORWARD LOOKING STATEMENTS
This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act with respect to, among other items: projections and estimates of earnings, revenues, cost-savings, expenses, or other financial items; statements of management’s plans, strategies and objectives for future operations, and management’s expectations as to future performance and operations and the time by which objectives will be achieved; statements concerning proposed new products and services; and statements regarding future economic, industry or market conditions or performance. Forward-looking statements are typically identified by words or phrases such as “believe”, “expect”, “anticipate”, “project”, and similar expressions. Forward-looking statements speak only as of the date they are made, and 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.
Forward-looking statements are subject to a number of risks and uncertainties, and actual performance or results could differ materially from that anticipated by these forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by these forward-looking statements include, among others: (i) the Company’s success in implementing its financial and operational initiatives, (ii) changes in domestic or international economic or business conditions, including those affecting the rail industry (such as the impact of industry competition, conditions, performance and consolidation); (iii) legislative or regulatory changes; and (iv) the outcome of claims and litigation involving or affecting the Company. 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 the Company’s other SEC reports, accessible on the SEC’s website at www.sec.gov and at the Company’s website at www.csx.com.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CSX addresses market risk exposure to fluctuations in interest rates and 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 addresses its exposure to interest rate market risk through a controlled program of risk management that includes the use of interest rate swap agreements. In the event of a 1% increase or decrease in the LIBOR interest rate, the interest expense related to these agreements would increase or decrease approximately $14 million on an annual basis.
During the third quarter of 2003, the Company began a program to hedge its exposure to fuel price volatility through swap transactions. As of September 26, 2003, CSX has hedged approximately 11% and 9% of expected requirements for 2004 and 2005, respectively. At September 26, 2003, a 1% change in fuel prices would result in a $1 million increase or decrease in the liability related to the swaps.
The Company is exposed to loss in the event of non-performance by any counter-party to the interest rate swap or fuel hedging agreements. The Company does not anticipate non-performance by such counter-parties, and no material loss would be expected from non-performance.
Exclusive of derivative contracts that swap fixed rate notes to floating, at September 26, 2003 and December 27, 2002, CSX had approximately $1.4 billion and $709 million, respectively, of floating rate debt outstanding. A 1% variance in interest rates would on average effect annual interest expense by approximately $14 million.
While the Company’s international terminals segment does business in several foreign countries, a substantial portion of its revenue and expenses are transacted in U.S. dollars, or currencies with little fluctuation against the U.S. dollar. For this reason, CSX does not believe its foreign currency market risk is significant.
A substantial increase in the fair market value of the Company’s stock price could negatively impact earnings per share due to the dilutive effect of stock options and convertible debt.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
As of September 26, 2003, under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of September 26, 2003. There were no changes in the Company’s internal controls over financial reporting during the fiscal quarter covered by this quarterly report that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
45
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
For information relating to CSX’s settlements with Maersk and other legal proceedings, see Note 13.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
On October 8, 2003, the CSX of Board of Directors, approved Amendment No. 2 to the Rights Agreement, dated as of May 29, 1998, as amended by Amendment No. 1 thereto, dated as of June 27, 2000 (as amended, the “Rights Agreement”), between the Company and Harris Trust and Savings Bank, as Rights Agent, to change the final expiration date of the Rights Agreement from June 8, 2008 to October 10, 2003. As a result of this action, the preferred stock purchase rights granted under the Rights Agreement expired at 5:00 p.m., New York City time, on October 10, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K, Continued
(b) Reports on Form 8-K
47
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
By:
/s/ CAROLYN T. SIZEMORE
Vice President and Controller
(Principal Accounting Officer)
Dated: October 24, 2003
48