CSX Corporation - 10-Q quarterly report FY

CSX Corporation (“CSX”) together with its subsidiaries (the “Company”), based in Jacksonville, Florida, is one of the nation's leading transportation suppliers.  The Company’s rail and intermodal businesses provide rail-based transportation services including traditional rail service and the transport of intermodal containers and trailers.

CSX’s principal operating company, CSX Transportation, Inc. (“CSXT”), provides a crucial link to the transportation supply chain through its approximately 21,000 route mile rail network, which serves major population centers in 23 states east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec.  CSX Intermodal, Inc. (“Intermodal”), one of the nation’s largest coast-to-coast intermodal transportation providers, is a stand-alone, integrated intermodal company linking customers to railroads via trucks and terminals.

In the opinion of management, the accompanying consolidated financial statements contain all normal, recurring adjustments necessary to fairly present the following:

Pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted from these interim financial statements.  CSX suggests that these financial statements be read in conjunction with the audited financial statements and the notes included in CSX's most recent Annual Report on Form 10-K, its most recent Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

CSX follows a 52/53 week fiscal reporting calendar with the last day of each reporting period ending on a Friday:

In 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 160, Noncontrolling Interests in Consolidated Financial Statements - An amendment of ARB No. 51 (“SFAS 160”). This statement requires that noncontrolling minority interests should be reported as equity instead of a liability on the balance sheet.  Additionally, it requires disclosure of consolidated net income attributable to the parent and to the noncontrolling interest on the face of the income statement.  CSX has noncontrolling minority interests primarily in its investments in Four Rivers Transportation Inc. and The Indiana Railroad Company.  For CSX, SFAS 160 is effective beginning fiscal year 2009 and resulted in a $20 million reclassification of noncontrolling minority interests from other long-term liabilities to shareholders’ equity on the December 2008 consolidated balance sheet.  Income attributable to noncontrolling minority interests is included in other income in the consolidated income statements and is not material to CSX.  Therefore, the Company did not present income attributable to non-controlling interests separately in the consolidated income statements.

Since March 2008, CSX has completed $1.25 billion in share repurchases and has remaining authority of $1.75 billion.  The Company did not repurchase any shares during the first quarter 2009.  Any future repurchases will be dependent upon an improvement in capital market and business conditions.

CSX share-based compensation plans primarily include performance grants, restricted stock awards, stock options and stock plans for directors.  CSX has not granted stock options since 2003.  Awards granted under the various plans are determined and approved by the Compensation Committee of the Board of Directors or, in certain circumstances, by the Chief Executive Officer for awards to management employees other than senior executives.  The Board of Directors approves awards granted to the Company’s non-management Directors upon recommendation of the Governance Committee.

Total pre-tax expense associated with share-based compensation and its related income tax benefit is as follows:

As of December 2008, all outstanding options are vested and therefore there will be no future expense related to these options.  As of March 2009, CSX had approximately 7 million stock options outstanding.  However, the impact to diluted earnings per share is much smaller see Note 2, Earnings Per Share for more information.

Defense and processing costs, which historically have been insignificant and are anticipated to be insignificant in the future, are not included in the recorded liabilities. The Company is presently self-insured up to $25 million per injury for personal injury and occupational-related claims.

CSXT retains an independent actuarial firm to assist management in assessing the value of personal injury claims and cases.  An analysis is performed by the independent actuarial firm semi-annually and is reviewed by management. The methodology used by the actuary includes a development factor to reflect growth or reduction in the value of these personal injury claims. It is based largely on CSXT’s historical claims and settlement experience.  Actual results may vary from estimates due to the type and severity of the injury, costs of medical treatments and uncertainties in litigation.

Occupational claims arise from allegations of exposure to certain materials in the workplace, such as asbestos, solvents (which include soaps and chemicals) and diesel fuels or allegations of chronic physical injuries resulting from work conditions, such as repetitive stress injuries, carpal tunnel syndrome and hearing loss.

An analysis is performed semi-annually by an independent third party and reviewed by management.  The methodology used includes an estimate of future anticipated claims based on the Company’s trends in average historical claim filing rates, future anticipated dismissal rates and settlement rates.

The Company is a party to various proceedings related to environmental issues, including administrative and judicial proceedings, involving private parties and regulatory agencies. The Company has been identified as a potentially responsible party at approximately 252 environmentally impaired sites.  Many of those are, or may be, subject to remedial action under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, or CERCLA, also known as the Superfund Law, or similar state statutes. Most of these proceedings arose from environmental conditions on properties used for ongoing or discontinued railroad operations.  However, a number of these proceedings are based on allegations that the Company, or its predecessors, sent hazardous substances to facilities owned or operated by others for treatment or disposal.  In addition, some of the Company’s land holdings were leased to others for commercial or industrial uses that may have resulted in releases of hazardous substances or other regulated materials onto the property and could give rise to proceedings against the Company.

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

In accordance with Statement of Position 96-1, Environmental Remediation Liabilities, the Company reviews its role with respect to each site identified at least once a quarter.  Based on the review process, the Company has recorded amounts to cover anticipated contingent future environmental remediation costs with respect to each site to the extent such costs are estimable and probable.  The recorded liabilities for estimated future environmental costs are undiscounted and include amounts representing the Company's estimate of unasserted claims, which the Company believes to be immaterial. The liability includes future costs for remediation and restoration of sites as well as any significant ongoing monitoring costs, but excludes any anticipated insurance recoveries.  Payments related to these liabilities are expected to be made over the next several years.

Currently, the Company does not possess sufficient information to reasonably estimate the amounts of additional liabilities, if any, on some sites until completion of future environmental studies.  In addition, conditions that are currently unknown could, at any given location, result in 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 fund 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 financial condition, results of operations or liquidity.

As of first quarter 2009, the Company’s guarantees primarily related to the following:

As of first quarter 2009, the Company has not recognized any liabilities in its financial statements in connection with any guarantee arrangements described above.  The maximum amount of future payments the Company could be required to make under these guarantees is the sum of the guaranteed amounts.

Since 2007, at least 30 putative class action suits have been filed in various federal district courts against CSXT and three other U.S.-based Class I railroads.  The lawsuits contain substantially similar allegations to the effect that the defendants’ fuel surcharge practices relating to contract and unregulated traffic resulted from an illegal conspiracy in violation of antitrust laws.  The suits seek unquantified treble damages (three times the amount of actual damages) allegedly sustained by purported class members, attorneys’ fees and other relief.  All but three of the lawsuits purport to be filed on behalf of a class of shippers that allegedly purchased rail freight transportation services from the defendants through the use of contracts or through other means exempt from rate regulation during defined periods commencing as early as June 2003 and that were assessed fuel surcharges.  Three of the lawsuits purport to be on behalf of indirect purchasers of rail services.  The district court has dismissed all of the indirect purchasers causes of action except for injunctive relief.  The indirect purchasers have appealed that decision and the district court case has been stayed pending the appeal.

The class action suits have been consolidated in federal court in the District of Columbia.  The railroads have asked the Court to first proceed with discovery relating to the appropriateness of class certification, and then permit merit discovery only if a class is certified.

CSXT believes that its fuel surcharge practices are lawful.  Accordingly, CSXT intends to vigorously defend itself against the purported class actions, which it believes are without merit.  CSXT cannot predict the outcome of the private lawsuits, which are in their preliminary stages, or of any government investigations, charges or additional litigation that may be filed in the future.  Penalties for violating antitrust laws can be severe, involving both potential criminal and civil liability.  CSXT is unable to assess at this time the possible financial impact of this litigation.  CSXT has not accrued any liability for an adverse outcome in the litigation.  If a material adverse outcome were to occur and be sustained, it could have a material adverse impact on the Company’s financial condition, results of operations, or liquidity.  For more information, please refer to CSX’s most recent Annual Report on Form 10-K.

During 2008, Seminole Electric Cooperative, Inc. (“Seminole”) filed a complaint before the U.S. Surface Transportation Board (“STB”) against CSXT.   CSXT and Seminole were parties to a railroad transportation contract that expired on December 31, 2008.  Seminole is contesting tariff rates that went into effect on January 1, 2009 for movements of coal to its existing and planned facilities.  Because of the preliminary nature of this case, CSXT is not able to assess at this time the possible financial impact of the STB proceeding.  However, the Company will continue to consider and pursue all available legal defenses in this matter.

Also during 2008, E.I. du Pont de Nemours and Company filed a complaint before the STB against CSXT, contesting tariff rates that went into effect on December 1, 2008 for movements of various commodities from and/or to certain of its existing facilities.    CSXT and DuPont have engaged in mediation sponsored by the STB and have made sufficient progress in their mediation to stay this proceeding while they attempt to reach a final agreement.

The Company sponsors defined benefit pension plans principally for salaried, management personnel.  The plans provide eligible employees with retirement benefits based predominantly on years of service and compensation rates near retirement.  For employees hired after December 31, 2002, benefits are determined based on a cash balance formula, which provides benefits by utilizing interest and pays credits based upon age, service and compensation.

In addition to these plans, CSX sponsors a post-retirement medical plan and a life insurance plan that provide benefits to full-time, salaried, management employees hired on or before December 31, 2002 upon their retirement if certain eligibility requirements are met.  The post-retirement medical plan is contributory (partially funded by retirees), with retiree contributions adjusted annually.  The life insurance plan is non-contributory.

The following table describes the components of expense/(income) related to net periodic benefit cost:

In accordance with the Pension Protection Act of 2006 (the “Act”), companies are required to be 94% funded for their outstanding qualified pension obligations as of January 1, 2009 in order to avoid a scheduled series of required annual contributions to reach 100% funding over seven years.  Due to recent market volatility and overall investment losses of pension assets for 2008, the Company will be required to make additional contributions to maintain at least a 94% funding target.  The contribution is required to be made by September 2009.  For further details, see Note 7, Employee Benefit Plans, in CSX’s most recent annual report on Form 10-K.

Total activity related to long-term debt for first quarter 2009 was as follows:

CSX has a $1.25 billion unsecured revolving credit facility with a diverse syndicate of banks. The facility allows borrowings at floating rates based on the London interbank offered rate ("LIBOR"), plus a spread depending upon ratings assigned by Moody's Investors Service and Standard & Poor's Ratings Group to CSX's senior, unsecured, long-term indebtedness for borrowed money. The facility requires CSX to maintain a ratio of total debt to total capitalization below a prescribed limit.  The facility contains no provisions that would require CSX to post collateral.  As of March 2009, this facility was not drawn on, and CSX was in compliance with all covenant requirements under the facility.  This facility expires in 2012.

On March 19, 2009, Greenbrier Hotel Corporation (“GHC”), owner of The Greenbrier resort and subsidiary of CSX Corporation, filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Eastern District of Virginia. CSX has agreed to extend up to $19 million in bankruptcy financing to GHC.

In conjunction with the bankruptcy, GHC also announced an agreement to sell the resort pursuant to an asset purchase agreement (“Agreement”) with Marriott Hotel Services, Inc. (“Marriott”).  The Agreement remains subject to the approval of the Bankruptcy Court and contemplates that CSX will provide $50 million to be used in the operations of the resort after completion of the sale.  These funds are expected to be paid over a two-year period following the closing of the transaction.  In turn, Marriott would pay GHC between $60 million and $130 million within approximately seven years, with the actual amount depending on the timing of the payment and The Greenbrier’s financial performance.

The sale to Marriott is expected to close later this year, but is contingent on various closing conditions, including the ability of The Greenbrier and its unions to negotiate labor contracts satisfactory to Marriott.  It is also subject to a Bankruptcy Court-supervised auction process in which other qualified purchasers will have an opportunity to bid on the resort.  Currently, the bid and auction process are scheduled in June 2009.

At this time, this transaction does not qualify for discontinued operations under SFAS 144 Accounting for the Impairment or Disposal of Long-lived Assets due to the nature of certain closing conditions under the Agreement.  Once these conditions have been satisfied, it is likely that the resort’s results of operations will be reclassified into discontinued operations.

As of March 2009 and December 2008, the Company had approximately $48 million and $57 million, respectively, of total unrecognized tax benefits.  After consideration of the impact of federal tax benefits, $41 million and $50 million, respectively, could favorably affect the effective income tax rate. The Company estimates that approximately $12 million of the net unrecognized tax benefits as of March 2009 for various state and federal income tax matters will be resolved over the next 12 months.  Approximately $4 million of this total will be recognizable upon the expiration of various statutes of limitation.  The final outcome of the remaining uncertain tax positions, however, is not yet determinable.

As a result of the expiration of statutes of limitation and the resolution of other income tax matters during the first quarter 2009, the Company recorded income tax and interest benefits of $13 million.

The Company files a consolidated federal income tax return, which includes its principal domestic subsidiaries.  CSX and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions.  During 2008, the Internal Revenue Service (“IRS”) completed examinations of tax years 2004 through 2006 as well as for 2007. The Company has appealed a tax adjustment proposed by the IRS with respect to the 2004 through 2006 period and a related amount is included in the uncertain tax positions above.  This appeals process is expected to last more than one year.  Federal examinations of original federal income tax returns for all years through 2007 are otherwise resolved.

CSX’s continuing practice is to recognize net interest and penalties related to income tax matters in income tax expense.  As of March 2009 and December 2008, the Company had a $5 million gross receivable and a $2 million gross payable before the consideration of state tax impacts, respectively, accrued for interest and penalties.  The payable changed to a receivable due to the expiration of statutes of limitation noted above.

Through a limited liability company, CSX and Norfolk Southern Corporation (“NS”) jointly own Conrail Inc., (“Conrail”).  CSX has a 42% economic interest and 50% voting interest in the jointly-owned entity, and NS has the remainder of the economic and voting interests.  Pursuant to APB Opinion 18, The Equity Method of Accounting for Investments in Common Stock, CSX applies the equity method of accounting to its investment in Conrail.

CSX’s income statement is impacted in several ways by the joint ownership of Conrail.  First, Conrail owns and operates rail infrastructure for the joint benefit of CSX and NS.  This is known as the shared asset area.  Conrail charges fees for right-of way usage, equipment rentals and transportation, switching and terminal service charges in the shared asset area.   Next, because of CSX’s equity interest in Conrail, CSX also includes a share of Conrail’s income which is recorded as a contra-expense and reduces the total amount of expense recorded for Conrail.  The purchase price amortization primarily represents the additional after-tax depreciation expense related to the write-up of Conrail’s fixed assets when the original purchase price, from the 1997 acquisition of Conrail, was allocated based on fair value.  Last, interest expense is recorded on long-term payables to Conrail.

Dollar amounts of these items impacting the consolidated income statements were as follows:

Additional information about the investment in Conrail is included in CSX’s most recent Annual Report on Form 10-K.

The Company’s consolidated operating income results are comprised of two business segments: Rail and Intermodal.  The Rail segment provides rail freight transportation over a network of approximately 21,000 route miles in 23 states, the District of Columbia and the Canadian provinces of Ontario and Quebec. The Intermodal segment provides integrated rail and truck transportation services and operates a network of dedicated intermodal facilities across North America.  These segments are strategic business units that offer different services and are managed separately.  Performance of the segment is evaluated and resources are allocated based on several factors, of which the principal financial measures are business segment operating income and operating ratio.  The accounting policies of the segments are the same as those described in Note 1, Nature of Operations and Significant Accounting Policies, in CSX’s most recent Annual Report on Form 10-K.

Business segment information for first quarters 2009 and 2008 is as follows:

In December 2007, CSXT sold secured equipment notes maturing in 2023 and in October 2008, CSXT sold additional secured equipment notes maturing in 2014 in registered public offerings pursuant to an existing shelf registration statement. CSX has fully and unconditionally guaranteed the notes. In connection with the notes, the Company is providing the following condensed consolidating financial information in accordance with SEC disclosure requirements. Each entity in the consolidating financial information follows the same accounting policies as described in the consolidated financial statements, except for the use of the equity method of accounting to reflect ownership interests in subsidiaries which are eliminated upon consolidation and the allocation of certain expenses of CSX incurred for the benefit of its subsidiaries.

Condensed consolidating financial information for the obligor and parent guarantor is as follows:

The Company provides customers with access to an interconnected transportation network that links ports, production facilities and distribution centers to markets in the Northeast, Midwest and southern states.  The Company serves major markets in the eastern United States and has direct access to all significant Atlantic and Gulf Coast ports, as well as the Mississippi River, the Great Lakes and the St. Lawrence Seaway.  The Company also has access to Pacific ports through alliances with western railroads.

The Company transports a broad portfolio of products, such as coal, forest products, ethanol, automobiles, chemicals and consumer electronics. Those goods are transported across the country in a way that, compared to alternative modes of transportation, reduces the impact on the environment, takes traffic off an already congested highway system and reduces fuel consumption and transportation costs.

The global recession that intensified in late 2008 has continued to impact CSX’s business in 2009, and rail volume will be lower for the year. Beginning in late 2008, the Company began taking aggressive actions to manage costs and right-size resources to match demand conditions.  With a mix of pricing, productivity, prudent investment in train network and rail efficiency, the Company believes it is positioned to take advantage of an eventual economic recovery.

CSX financial results reflect the impact of the ongoing recessionary environment. Revenue and volume declined 17% from first quarter 2008 driven by the broad-based weakness across most sectors of the economy. The lines of business tied to the industrial, housing construction and consumer spending markets all experienced significant volume declines, while the energy and agriculture related markets were less severely impacted by the current economic conditions.

Despite a challenging environment, CSX was able to maintain revenue per unit at levels consistent with those in first quarter 2008.  The Company’s ongoing yield management initiatives offset lower fuel recovery associated with the sharp decline in fuel prices.  The Company was able to achieve pricing gains predominantly due to the overall cost advantages that the Company’s rail based solutions provide to customers versus other modes of transportation.

For additional information, refer to Rail and Intermodal Results of Operations discussed on pages 33 through 36.

The Company’s safety and train accident prevention programs rely on broad employee involvement.  The programs utilize operating rules training, compliance measurement, root cause analysis and communication to create a safer environment for employees and the public.  Continued capital investment in Company assets, including track, bridges, signals, equipment and detection technology, also supports safety performance.

In first quarter 2009, the Company continued its focus on safety and operating performance.  Results in both FRA personal injuries and train accidents remained at historically high levels as a result of leadership and high levels of employee commitment to the Company’s safety programs.  The number of FRA reported personal injuries increased slightly to 94, up 4% compared to the same quarter in 2008.  Reported FRA train accidents declined to 71, as the Company reported 9% fewer accidents versus prior year.  However, Train Accident frequency increased, to 3.08 accidents per million train miles as sharply lower business levels drove both employee man hours and train miles lower in the quarter.

Key service metrics improved significantly in the quarter.  On-time train originations and arrivals were 83% and 79%, respectively, during the quarter.  Average dwell rose slightly to 24.1 hours and average cars-on-line declined to 218,863 primarily due to lower demand levels.  Average train velocity improved to 21.6 miles per hour, as the network remained fluid.  The Company aims to maintain key operating measures and service reliability at high-levels, while reducing resource levels in response to current business conditions.

Volume declines were driven by a weaker export market and lower demand from electric utilities.  The demand for electrical generation from coal was down because of low natural gas prices and lower industrial production.  

Revenue and volume were down due to declining new car sales resulting from the weak economic environment and low consumer confidence.

Intermodal operating expense decreased due to lower inland transportation expense as a result of lower volume and lower fuel expense during the first quarter of 2009.

Interest expense increased $22 million to $141 million primarily due to higher debt balances in first quarter 2009.

Income tax expense decreased $85 million to $126 million primarily due to lower earnings in first quarter 2009 and $13 million of certain favorable tax adjustments.

Net Earnings decreased $105 million to $246 million and earnings per diluted share decreased $.23 to $.62 in first quarter 2009 as a result of lower earnings.

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

Long-term debt increased $483 million driven by a $500 million debt issuance during first quarter 2009.  This increase was partially offset by a $21 million reclassification to current maturities of long-term debt.  For additional information, see Note 7, Debt and Credit Agreements of this Quarterly Report on Form 10-Q.

Cash provided by operating activities decreased to $449 million due in part to lower pre-tax earnings.  Also contributing to this decrease were higher incentive compensation payouts compared to last year.  Additionally, cash from investing activities decreased due to a reduction in the purchases and sales of short-term investments partially offset by lower property additions. Furthermore, cash provided by financing activities decreased $447 million as the Company issued less debt, had no share repurchases and paid for seller financed assets that were delivered in the prior year.

For 2009, CSX plans to spend $1.6 billion of capital.  CSX is continually evaluating market and regulatory conditions that could affect the Company’s ability to generate sufficient returns on capital investments.  CSX may revise this estimate as a result of changes in business conditions, tax legislation or the enactment of new laws or regulations.

The Company ended the quarter with over $1.1 billion of cash, cash equivalents and short-term investments.  CSX also has available a $1.25 billion credit facility with a diverse syndicate of banks that was not drawn on. 

Working capital can also be considered a measure of a company’s ability to meet its short-term needs.  CSX had a working capital surplus of $530 million at March 2009 and a working capital deficit of $13 million at December 2008.   The favorable change is due to increased cash balances as a result of new debt issued during the quarter.

The Company’s working capital balance varies due to factors such as the timing of scheduled debt payments and changes in cash and cash equivalent balances as discussed above.  As a result, the working capital balance could return to a deficit in future periods.  A working capital deficit is not unusual for CSX or other companies in the industry and does not indicate a lack of liquidity. The Company continues to maintain adequate current assets to satisfy current liabilities and maturing obligations when they come due.  Furthermore, CSX has sufficient financial capacity, including the credit facility and shelf registration statement, to manage its day-to-day cash requirements and any anticipated obligations.  The Company maintains access to the credit markets for additional liquidity as needed. Due to the current economic and credit market environment, CSX as well as other investment grade debt issuers  may be unable to access capital due to lack of market demand or may experience higher interest costs.

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

For further discussion of the Company’s critical accounting estimates, see the Company’s most recent Annual Report on Form 10-K.

Certain statements in this report and in other materials filed with the SEC, as well as information included in oral statements or other written statements made by the Company, are forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934.  These forward-looking statements include, among others, statements regarding:

Forward-looking statements are subject to a number of risks and uncertainties and actual performance or results could differ materially from those anticipated by these forward-looking statements. The Company undertakes no obligation to update or revise any forward-looking statement. If the Company does update any forward-looking statement, no inference should be drawn that the Company will make additional updates with respect to that statement or any other forward-looking statements.  The following important factors, in addition to those discussed in Part II, Item 1A (Risk Factors) of this quarterly report on Form 10-Q, and elsewhere in this report, may cause actual results to differ materially from those contemplated by these forward-looking statements:

Other important assumptions and factors that could cause actual results to differ materially from those in the forward-looking statements are specified elsewhere in this report and in CSX’s other SEC reports, accessible on the SEC’s website at www.sec.govand the Company’s website at www.csx.com.

There have been no material changes in market risk from the information provided under “Quantitative and Qualitative Disclosures about Market Risk” in Item 7A of CSX’s most recent Annual Report on Form 10-K.

None.

None.