CSX Corporation — Q2 2017 Form 10-Q
Business context and reporting period. CSX provides rail and intermodal transportation, primarily across the eastern United States. This unaudited filing covers the 13 weeks ended June 30, 2017, compared with the 13 weeks ended June 24, 2016; six-month comparisons are also included.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $2.933 billion | $2.704 billion | $5.802 billion | $5.322 billion |
| Operating income | $958 million | $840 million | $1.670 billion | $1.544 billion |
| Operating ratio | 67.4% | 68.9% | 71.2% | 71.0% |
| Net earnings | $510 million | $445 million | $872 million | $801 million |
| Diluted EPS | $0.55 | $0.47 | $0.94 | $0.84 |
| Operating cash flow | Not presented for the quarter | $1.566 billion | $1.592 billion |
Q2 revenue rose 8%, operating income 14%, and diluted EPS 17% year over year. The operating ratio improved 150 basis points in Q2, but deteriorated 20 basis points for the six-month period. Management reported six-month free cash flow before dividends of $652 million, or adjusted free cash flow of $737 million after adding back after-tax restructuring cash payments; these are non-GAAP measures.
Balance sheet and liquidity
- At June 30, 2017, cash and cash equivalents were $620 million and short-term investments were $477 million. Management reported $1.1 billion in combined cash, cash equivalents and short-term investments.
- Long-term debt, including current maturities, was $11.825 billion, up from $11.293 billion at year-end 2016. CSX issued $850 million of 3.25% notes due 2027 and repaid $313 million of debt during the first half.
- Working capital was $958 million, versus $447 million at year-end. The $1 billion revolving credit facility and receivables facility were undrawn as of the filing date. CSX said it remained in compliance with credit-facility covenants and was committed to an investment-grade credit profile.
- Six-month capital additions were $955 million; dividends paid were $350 million and share repurchases were $757 million.
Material changes and operating trends
- Management attributed Q2 revenue growth mainly to coal-related gains, core pricing and volume across other markets, and higher fuel recovery. Coal revenue increased 27% and intermodal revenue increased 7%; total volume increased 2%.
- Q2 expenses rose 6%. Drivers included $122 million of restructuring charges, inflation and higher fuel costs; efficiency savings and a $55 million favorable judgment related to a previously condemned property partly offset the increases.
- For the first half, revenue increased 9% and operating income increased 8%. Expenses rose $354 million, primarily reflecting $295 million of restructuring charges, inflation and fuel costs, partly offset by reported efficiency savings of $213 million.
- CSX continued implementing Precision Scheduled Railroading. Q2 on-time arrivals improved to 79% from 69%, while the FRA personal injury frequency index worsened 19% year over year. The train accident rate improved 1%.
Outlook, unusual items and risks
- Management estimated approximately $200 million in annual pretax savings to future earnings and cash flows from management workforce reductions. The workforce program reduced management headcount by 951 and was completed in April 2017.
- Projected 2017 capital investment was $2.1 billion, including approximately $270 million for Positive Train Control (PTC). Estimated total PTC implementation cost was approximately $2.4 billion, with $1.9 billion spent through June 2017.
- The $295 million year-to-date restructuring charge included workforce reductions, leadership-transition advisory costs, equity-award modifications, and $84 million for CEO reimbursement arrangements. Under the arrangements, CSX paid Mantle Ridge $55 million and assumed a $29 million payment obligation to CEO E. Hunter Harrison, as well as tax-indemnification obligations. The filing notes that Mantle Ridge is controlled by the company’s board vice-chair; shareholders approved the arrangements on an advisory basis.
- Q2 revenue included a $58 million settlement from a customer that did not meet historical volume commitments. The favorable $55 million property judgment reduced reported expenses.
- Management estimated reasonably possible legal losses above reserves at an aggregate $3 million to $128 million. The filing also discusses fuel-surcharge antitrust litigation, environmental matters, and other claims; management cautioned that an unexpected adverse resolution could materially affect results or liquidity in a particular period.
- Effective with fiscal Q3 2017, CSX changed to a calendar-year reporting schedule. Management did not expect the change to materially affect 2016–2017 comparability; 2017 will contain 366 days, five fewer than fiscal 2016.
Important facts for investors to verify
- Whether Precision Scheduled Railroading sustains service improvements and delivers the expected cost savings without further safety deterioration.
- How much of reported revenue and earnings growth is recurring, given the customer settlement, property judgment, restructuring costs and other adjustments.
- The final cost and schedule for PTC implementation, and whether planned capital investment can be funded while supporting dividends, repurchases and debt levels.
- The eventual cash and tax-indemnification costs of the CEO reimbursement arrangements, and the governance implications of the disclosed Mantle Ridge relationship.
- Developments in the fuel-surcharge litigation and environmental and other contingencies, including changes to the estimated possible legal-loss range.
- Share repurchase pace and funding: the board increased authorization to $1.5 billion after quarter-end, and the filing says future repurchases may use cash, operating cash flow or debt issuance.