CSX Corp (CSX) 2013 Q1 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the CSX Corporation first-quarter 2013 earnings call. As a reminder, today's call is being recorded. During the call, all participants will be in a listen-only mode. For opening remarks and introductions, I would like to turn the call over to Mr. David Baggs, Vice President of Capital Markets and Investor Relations for CSX Corporation.

Thank you, Maryanne, and good morning, everyone. And, again, welcome to CSX Corporation's first-quarter 2013 earnings presentation. The presentation materials that we'll review this morning, along with our quarterly financial report and our safety and service measurements, are available on our website at CSX.com under the Investor section. In addition, following the presentation this morning, a webcast and podcast replay will be available on that same website. Here representing CSX Corporation this morning are Michael Ward, the Company's Chairman, President and Chief Executive Officer; Clarence Gooden, Chief Sales and Marketing Officer; Oscar Munoz, Chief Operating Officer; and Fredrik Eliasson, Chief Financial Officer.

Now, before we begin the formal part of our program, let me remind everyone that the presentation and other statements made by the Company contain forward-looking statements. You are encouraged to review the Company's disclosure and the accompanying presentation on slide 2. This disclosure identifies forward-looking statements, as well as risks and uncertainties that could cause actual performance to differ materially from the results anticipated by those statements.

In addition, let me also remind everyone that at the end of the presentation we will conduct a question-and-answer session with the research analysts. With 30 analysts covering CSX, I would ask, as a courtesy for everyone, to please limit your inquiries to one primary and one follow-up question. With that, let me turn the presentation over to CSX Corporation's Chairman, President and Chief Executive Officer, Michael Ward. Michael?

Thank you, David, and good morning, everyone. Last evening CSX reported record first-quarter earnings per share of $0.45, with another excellent productivity performance by the team and a couple of unique items that helped the quarter. The underlying strength of our business continues, even with the transition that is taking place in the domestic coal market. Looking at the top line, revenue was $3 billion, essentially flat versus last year. With gains in merchandise, intermodal and other revenue offsetting the declines in coal. The operating team is producing industry-leading results in safety. And is driving excellent service and efficiency for our customers and you, our shareholders. Bottom line, we set record first-quarter for operating income at $875 million, and for operating ratio at 70.4%.

We also issued new financial guidance, reflecting our confidence in the future. And rewarded shareholders with another increase in the quarterly dividend and a new share repurchase program. As the team walks you through the results this morning, I think you'll see evidence of a company that is doing very well in the current environment. And is well-positioned to achieve even greater results longer term, as the economy eventually accelerates, the domestic coal market begins to stabilize, and the industry fundamentals continue to evolve.

With that, let me turn the presentation over to Clarence to review what we are seeing in the broader economy, how this relates to our top-line results, and more importantly, what this means for the outlook ahead. Clarence?

Thank you, Michael, and good morning. Looking at the key economic indicators, they continue to point to slow, steady growth in the US economy. Starting on the left side of the chart, the Purchasing Managers Index registered a reading of 51.3% in March, reflecting a modest expansion of US manufacturing. At the same time, the Customers Inventory Index registered a reading of 47.5%, indicating respondents believe their inventories are still slightly below normal levels. Looking at the right side of the chart, both GDP and IDP rates reflected expansion in the quarter. Forward projections show continued slow growth in the near term, with improved growth rates later in the year. Overall, transportation demand in the markets we serve was mixed in the first quarter, consistent with the broader economic environment.

Now, let's look at overall revenue. Total first-quarter revenue of nearly $3 billion was essentially flat compared to the prior year. Starting to the left, the combination of rate and mix was favorable by $28 million in the quarter. Here, core pricing gains and liquidated damages, which increased $32 million year over year, were partially offset by the unfavorable mix impact related to the growth in intermodal versus the decline in coal. Moving to the right, volume had an unfavorable impact of $39 million in the quarter, as volume growth in chemicals and intermodal was more than offset by declines in coal and agricultural products. Finally, fuel recovery increased $3 million in the quarter, as diesel fuel prices were relatively stable, year over year.

Now, let's turn to pricing. Core pricing on a same-store sales basis remained solid across nearly all markets. Recall that same-store sales are defined as shipments with the same customer, commodity and car type, and the same origin and destination. These shipments represented 76% of CSX's traffic base for the quarter. Looking at the chart, overall pricing, shown on the blue bars, increased 0.3% in the first quarter, which reflects the more challenging export coal market. The gold bars, which exclude export coal, showed pricing gains of 4.1% in the quarter, exceeding rail inflation, and consistent with the performance in prior quarters. Looking forward, a strong service product provides a solid foundation for pricing above rail inflation over the long term. Given our confidence in the value of our product offering and the need for the ongoing reinvestment in the business, we remain focused on profitable growth.

Let's turn to the next slide and take a closer look at the volume. Total volume declined 2% in the quarter versus the same period last year, with mixed performance across the diverse markets we serve. Intermodal and the industrial sector delivered solid growth in the quarter. High service levels helped generate growth in the domestic intermodal market, and captured opportunities in domestic manufacturing in the growing oil and gas industry. Growth in these sectors was more than offset by declines in the construction, agricultural and coal sectors, where market fundamentals remain challenged.

Now, let's look at the individual markets in more detail, starting with coal. Coal revenue declined 13% to $726 million. Although the demand for electricity grew, and natural gas prices rose at the end of the quarter, domestic volume declined 14% as inventory levels at the utilities remained high. Export coal volume declined 3% as demand from thermal coal softened, particularly in Europe where broader economic conditions remain weak. Total revenue per unit was down 3%, as lower export pricing more than offset core pricing gains in the domestic markets. Looking ahead, domestic coal headwinds persist, although we expect volume to be relatively stable on a sequential basis. For the full year, we continue to anticipate domestic volume will decline about 5% to 10%. At the same time, our best estimate for 2013 export coal volume remains about 40 million tons. And year-over-year pricing declines should moderate throughout the year.

Next, let's look at Merchandise. Overall, Merchandise revenue increased 2% to over $1.7 billion. Chemicals was the key driver in the industrial sector, growing 11% on strength in energy-related products including crude oil, liquefied petroleum gas and frac sand. In the agricultural sector, feed grain shipments to the Southeast were lower as a result of last year's severe drought in the Midwest. In addition, ethanol shipments declined as a result of lower production, increased competition from imports and lower gasoline demand. Regarding the construction sector, building products and aggregates increased on the strength of a slowly improving housing environment. However, this was partially offset by lower shipments of paper products as the use of electronic media continued to replace paper.

Looking at the second quarter, in the industrial sector, we continued to see growth opportunities in chemicals, particularly in commodities related to the oil and gas drilling. The automotive market will remain strong, although we are now cycling tougher comparables. We expect the agricultural sector to remain soft, with lower grain shipments and continued weakness in ethanol more than offsetting increased fertilizer demand. Finally, we anticipate the slow steady recovery in the construction sector will drive growth in building products and aggregates.

Moving to the next page, let's review Intermodal. Intermodal revenue increased 4% to $404 million. Domestic volume was up 5%, driven by growth with our existing customers in highway-to-rail conversions. International volume was essentially flat as growth with existing customers and from new service offerings was offset by volume loss due to a carrier port shift. Total Intermodal revenue per unit increased 1% due to core pricing gains.

Looking forward, we continue to make strategic investments in our network that drive profitable growth. During the first quarter, we began work on a new terminal in Valleyfield near Montreal. This terminal will expand our network reach and when combined with the capabilities of our Northwest Ohio hub, will allow new service offerings to drive growth. In addition, we began an expansion of our Fairburn terminal in Atlanta to support robust growth in this key market. At the same time, we continue to generate growth opportunities through our highway-to-rail, or H2R, initiative. We are working jointly with our channel partners to market the compelling value of intermodal rail transportation to targeted customers, and further tap into an estimated 9 million truckload opportunities.

Let's turn to the outlook for the second quarter. Looking forward, we expect stable to favorable conditions for 86% of our markets. Although the overall volume outlook for the second quarter is neutral. We expect continued growth in chemicals as we capture opportunities created by the expanding domestic oil and gas industry. Intermodal growth will continue at a similar rate in the second quarter, as our strategic network investments and service reliability continue to support highway-to-rail conversions. In forest products and minerals, we expect to continue recovery in demand for construction and building materials.

Automobile and light truck production will remain strong, but year-over-year comparisons are now more difficult. Although headwinds persist, the outlook for domestic coal volume in the second quarter is neutral, due to easier year-over-year comps. We still expect the full-year volume will be 5% to 10% lower year over year. The overall outlook for agricultural products remains unfavorable, with low corn supply and high prices caused by last year's drought impacting shipments to feed mills, and ethanol shipments impacted by lower demand and production. Finally, export coal volumes will be lower on softer demand for thermal coal.

Now, I'll wrap up on the next slide. Looking at the state of the economy, the indicators we follow point to steady expansion. Overall, the second-quarter volume outlook is stable, while the outlook for 86% of our markets is neutral to favorable. We anticipate total volume will be flat year over year, with declines in unfavorable markets offsetting gains in favorable markets. Domestic and export coal markets still face challenges. High stockpiles will continue to impact domestic shipments. And softening demand for US thermal coal will have an unfavorable impact on the export market. At the same time, we expect our merchandise and intermodal markets to grow at a rate that is above the general economy, as we continue to deliver high levels of service, which creates compelling value for customers and will drive long-term profitable volume and revenue growth for shareholders.

Thank you. And now I'll turn the presentation over to Oscar, to review our operating results.

Thank you, Clarence, and good morning, everyone. I'm pleased to report again that CSX's operating results for the first quarter are very strong. Safety results remain at or near all-time record levels and service continues to improve and set new records. Additionally, resource adjustments and improved asset utilization in the first quarter provided a great start and we are now on a path to exceed $150 million of efficiency gains in 2013. Bottom line, with sustained high levels of operating performance, CSX remains very well positioned to deliver a compelling service product for customers, while ensuring value for shareowners.

Now let's review the operating results for the first quarter. On the safety side, I am happy to report that CSX, once again, produced industry-leading results. Reviewing those measures, on the left, the FRA personal injury rate was at a record first-quarter level of 0.66, representing an 18% improvement year-over-year. The chart on the right shows the FRA train accident rate, which improved 31% to 1.54, and represents a record level. Now, before moving on, I think it's important to note, and to thank our employees in the field at all levels for their truly outstanding and continued commitment to safety, and as evidenced by these great results.

So, let's turn to the next slide and review on-time performance. Here you can see on-time originations on the left and on-time arrivals on the right. Both measures were all-time highs in the first quarter, with on-time originations at 91% and on-time arrivals at 85%. Both on-time measures also represent sequential improvement, which is particularly meaningful given that the first-quarter volume was higher, and weather was more challenging than it was in the fourth quarter. These results represent strong collaboration between our customers, sales and marketing, and the operating team. Setting new records for service demonstrates employee commitment to a shared purpose founded on service excellence.

Turning to system performance on the next slide, as we all know, a capital-intensive industry like ours requires a strong focus on maximizing the productive use of our assets. As a result, this is a top priority as we look to further improve shareowner returns. Looking to the chart on the left, CSX drove an 8% improvement in terminal dwell for the quarter at a record low 22.2 hours. This means cars are spending less time sitting in terminals and thus more time in productive freight service. Velocity also showed improvement, up 5% to 23.4 miles per hour, with improvement across all three networks -- Coal, Merchandise and Intermodal. Record on-time performance, dwell and velocity mean customers are receiving great service. And, as a result, return on asset is improving.

Turning to slide 20, let's turn our attention to operating efficiency, which, as we are proving, is not mutually exclusive with great service. Looking at crew efficiency in the Merchandise and Intermodal markets, overall volume is up 1%, with 3% fewer crew starts. Growth is largely being absorbed onto existing trains, meaning there is no need to add locomotives and crews to handle increasing volume. In Coal, crew start reductions have more than kept up with volume decline. By actively managing the workforce and increasing coal tons per car and cars per train, the Company has been able to continue to drive crew efficiency in the coal market.

Now, let's turn to the next slide and discuss employment levels. The chart on the left represents the total active train and engine workforce, with the blue portion of the bars representing full-time employees, and the gold portion representing employees on furlough retention boards. On a year-over-year basis, active T&E employees is down 4%, with volume down 2%. In addition to lower T&E employment, the Company continued to deliver strong operating efficiency. Here, overtime hours were down 11%, and relief crews were down 9% for the quarter. Across all our operating crafts, employment levels were down 5%, reflecting reductions in mechanical and engineering departments as we drove further efficiencies in these areas, as well. Next, looking at where we stand with furlough and furlough retention boards, at the end of the quarter there were over 600 T&E employees on full furlough, and approximately 150 on furlough retention boards. The furlough retention board count came down over the course of the first quarter as CSX put employees back to work to replace attrition and handle modest sequential business growth.

Let me now turn to locomotives on the next slide. Looking at the chart on the left, you can see that the active locomotive count is down 8% versus the first quarter of 2012, though up modestly on a sequential basis to account for seasonal increases in volume. Locomotive efficiency, as measured by gross ton miles per horsepower hour, improved 8% on a year-over-year basis. The team has been working diligently to minimize the time it takes to put locomotives into or take them out of storage, resulting in the ability to react more dynamically to customer demand, thus driving greater operating efficiency.

Let me quickly wrap up on the next slide. The outstanding first-quarter personal injury and train accident results demonstrate the Company's commitment to keep our employees and the communities we work in safe. This commitment is why CSX is a leader in one of the nation safest industries. The operating team continues to sustain record service in 2013, serving customers efficiently with fewer resources. The sustained service improvement is evidenced by both what we are hearing directly from customers, as well as the record levels of satisfaction reported by our customers in third-party surveys. So, given the strong start to the year, we expect to deliver over $150 million in efficiency savings through improved service, growing with fewer assets, and spinning those assets more quickly to maximize return. In this dynamic environment, CSX remains committed to providing flexible solutions for customers, to enable growth and drive significant long-term value for shareowners.

With that, let me turn the presentation over to Fredrik to review the financials.

Thank you, Oscar, and good morning, everyone. Looking at the top of the chart, revenue was essentially flat for the first quarter, as declines in coal revenue were offset by gains in merchandise, intermodal and other revenue, including the $32 million of liquidated damages year over year that Clarence mentioned earlier. Expenses improved 1%, aided by a $20 million deferred gain, which I will speak to in the coming slides. Excluding this gain, expenses were slightly down versus last year, as CSX was able to more than offset inflation and higher depreciation through improved efficiency. Operating income was $875 million, up 2% versus the prior year.

Looking below the line, interest expense was $147 million, reflecting slightly higher debt levels year over year. Other income was negative $3 million and income taxes were $266 million in the quarter. While the effective tax rate was 36.7%, we continue to expect a 38% tax rate going forward. Overall, net earnings was $459 million, up 2% versus last year. And EPS was $0.45 per share, up 5%, reflecting growth in net earnings and the impact of last year's share repurchase program.

As we turn to the next slide, let's briefly discuss how fuel lag benefited the quarter. On a year-over-year basis, the effect of the lag in our fuel surcharge program was $10 million favorable. This reflects $5 million of negative in-quarter lag during the first quarter of this year, versus $15 million of negative in-quarter lag for the same period last year.

Turning to the next slide, let's review our expenses. Overall expenses were down 1% in the quarter. I will talk about the top three expense items in more detail on the next few slides, but let me briefly speak to the last two on the chart. Depreciation was up 5% to $270 million, due to the increase in the net asset base. Going forward, we continue to expect depreciation to increase sequentially a few million dollars each quarter, reflecting the ongoing investments in our business. Lastly, equipment rent was down 2% to $95 million as a result of improved utilization and fewer leased locomotives.

Now, let's discuss labor and fringe in more detail. Labor and fringe expense was down $3 million versus last year. Looking at the chart on the left, total headcount was down 4% versus last year, and down 1% sequentially, reflecting favorable crew start performance and reductions in mechanical and engineering that Oscar discussed earlier. Moving to the table on the right, efficiency- and volume-related cost savings of $20 million reflects the financial benefit of the year-over-year improvement in crew starts and overtime, as well as lower mechanical, engineering and training expenses. Moving down the table, labor inflation was up $13 million, favorable to our guidance, as lower costs on health and welfare programs partially offset wage inflation that remained above 3%. Rounding out the table, other costs were $4 million higher, primarily driven by higher incentive compensation.

Looking at the second quarter, headcount should remain relatively constant on a sequential basis, although, as we've demonstrated over the past several quarters, to continue driving efficiency, we will adjust quarterly as business conditions warrant. In addition, we expect labor inflation will rise approximately $15 million to $20 million year over year for the remaining quarters. And incentive compensation will become more material headwind with a year over year variance of about $15 million in the second quarter.

Next, we will review MS&O expenses on slide 29. MS&O expenses decreased 6% or $35 million versus last year, with the key drivers shown in the table on the right. Total deferred gains reduced MS&O expenses by $30 million, reflecting two items. The first relates to $20 million deferred gain associated with a prior-year conveyance of a formerly owned company, the details of which can be found in the quarterly financial report. The second relates to the continuing SunRail gain which was $29 million in the period, or $10 million favorable year over year. Looking at the second quarter, we expect to recognize another $14 million of SunRail gain, which will be down from the $20 million we recorded in the second quarter of last year. For the balance of 2013, no further gains are expected to be realized. Turning to the operating activities, efficiency- and volume-related cost savings reduced MS&O expenses by $22 million compared to last year. This was driven by materials and repair cost savings enabled by an 8% reduction in active locomotive count, as well as other initiatives. Moving down the table, inflation increased by $11 million, while other MS&O costs increased by $6 million.

Moving to the next slide, let's discuss the impact of fuel. Total fuel costs remained flat versus last year. Looking at the table to the right, fuel efficiency was favorable by $10 million, reflecting a 2% year-over-year improvement in gallons consumed per gross ton mile. Next, as shown in the chart on the left, CSX average cost per gallon for locomotive fuel increased to $3.26, up 3% versus last year. And driving an increase of $14 million as seen in the chart on the right. Rounding out the table, lower volume drove $4 million decrease in volume and other expenses, with gross ton miles down 1%. That concludes the expense review for the first quarter.

Now, let's turn to slide 31, and review our new financial targets along with our dividend and share repurchase announcements. You may recall that I mentioned last quarter that we would update you on our longer-term financial expectations after we completed a detailed review of our strategic plan with our board. With this review complete, and taking into account the new coal environment, we are updating our financial targets to reflect the expectations for our business. As I've stated before, we expect 2013 to be another transition year for CSX, as utilities work to reduce inventories to adjust to the new environment where natural gas remains cheap and abundant. That said, we continue to expect domestic coal headwinds to subside by the end of 2013, setting the stage for both earnings growth and operating ratio improvement in 2014 and 2015.

Over those two years, we are targeting average annual earnings-per-share growth of 10% to 15% off the 2013 base. Including our first-quarter earnings per share of $0.45, we now expect full-year EPS to be flat to slightly down from 2012, as we continue to face headwinds in coal and cycle one-time favorable items from the prior year. Looking at the Company's operating ratio after this year, we expect to regain the momentum we had prior to the recent transition in coal, driven by our continued focus on pricing above inflation, profitable volume growth and efficiency. As a result, we now expect to achieve high 60%s operating ratio by 2015. And we continue to target the mid-60%s longer-term.

Because of our continued confidence in the Company's core earnings power, we remain committed to deploying cash within the balanced framework that prioritizes investment in the business to drive long-term value creation, along with dividends and share repurchases that also provide value for shareholders. First, our capital investment remains unchanged for 2013, at $2.3 billion. Long-term, we continue to expect to invest 16% to 17% of revenue in our business, plus an overlay for PTC. We view capital investment as a key driver of long-term shareholder value, as infrastructure and rolling stock investments allow CSX to sustain high safety and service levels, enhance efficiency, and capitalize on strategic growth opportunities that produce superior returns.

Second, CSX remains committed to a dividend payout range of 30% to 35% of trailing 12-month earnings. In accordance with this policy, we have announced a 7% increase in the quarterly dividend to $0.15 per share, reflecting a payout at the high end of our targeted range. Third, CSX remains committed to utilizing share buybacks as an important tool to return cash to investors. As such, we announced a new $1 billion buyback program, which is expected to be completed over the next 24 months. This new program is expected to be primarily funded by excess cash and free cash flow. Finally, within the context of these announcements, we continue to target an improving credit profile that balances between financial flexibility and cost of capital through a full business cycle.

In summary, CSX's business remains fundamentally strong. Our recent financial performance and future free flow prospects continue to provide the basis for increased shareholder distributions. Through prudent capital investment, and executing well on the things more in our control, CSX will be able to continue to create long-term value for our shareholders. With that, let me turn the presentation back to Michael for his closing remarks.

Thank you, Fredrik. Over the last several years, CSX has consistently delivered strong results over a wide range of economic conditions. Producing record first-quarter earnings, after experiencing yet another sharp decrease in coal revenue, is emblematic of our ability and our resolve. But we know that our stakeholders are more interested in tomorrow than yesterday. And the guidance and shareholder actions we outlined show our confidence in both the near and long term. Over the next several months, we envision a transition period where coal begins to stabilize at a lower level. And, more importantly, where the 80%-plus of our business that is not related to coal provides opportunities for the team to deliver vibrant results.

Our diverse portfolio, far-reaching network, and dynamic operating platform will allow the Company to optimize its performance. And any momentum that would occur in the economy would increase opportunities further. Put another way, we believe that CSX has emerged from yet another period of multiple challenges, even stronger than before, just as it did after the global recession and in the quarter just completed. These achievements add to our confidence in this team's ability to produce double-digit earnings growth and a high 60%s operating ratio by 2015, and a mid-60%s operating ratio longer-term. CSX stands for how tomorrow moves. And the employees of this Company have once again quietly and diligently backed up that promise with excellent service product and consistently strong financial results.

Thank you for your interest in CSX and we look forward to answering your questions at this time.

(Operator Instructions)

Ken Hoexter of Bank of America Merrill Lynch.

Fredrik, if we could just follow up on that outlook a bit -- or Michael. Looking at that 10% to 15% growth, the midpoint -- it looks like a bit slower if you include the full $0.45, as you mentioned. So, maybe just talk about what are in the assumptions there. Are you looking at coal maybe being worse than targeted? Is the profit loss from that just too great to overcome? Is pricing on export coal getting more aggressive? Maybe if you could just give us some parameters around what's in that 10% to 15% thought process.

Sure, Ken. So, obviously, now, we have a detailed plan after we've reviewed it with our Board, that is behind this guidance. Clearly, as you know, seldom does long-term plan exactly end up the way that you expect them to when you put them in place. So, we are going to have to continue to be flexible and adapt, just like we have over the last couple of years, to produce these sort of results in whatever economic environment that we are seeing.

I would say, overall, underlying those assumptions is essentially a flat coal environment versus what we are seeing -- basically between export and domestic, an overall flat environment. On the overall economy, I would say the same thing. We're going to see, slowly, a recovering economy. Nothing more than what we've seen here over the last year or so. And you couple that with continued inflation plus pricing, and the productivity focus that we've shown here over the last three years, that is really the foundation for our long-term guidance. So, we know that we are going to continue to be flexible and adapt to whatever environment we have. And then continue to push the same levers that we have over the last few years.

Great. I appreciate the insight.

Brandon Oglenski of Barclays Capital.

Fredrik, maybe if I can just follow up on that. So, just to be clear, you guys are assuming that coal demand flattens out in the 2014, 2015 period?

Over this period of time, between, I think, domestic and export -- clearly there could be periods where one is up and one is down. But overall, I would say that our view is that, between the two, it will be flattish during this period of time.

And that's coming off of the negative guidance you have for '13, right?

That's correct.

Okay. And if I can just ask one on the energy markets for Clarence. What are some of the opportunities? Or where do you have facilities on your network today that can accept crude oil? And are you willing to put out some growth targets, potentially, for this segment of business?

Thanks, Brandon. We have about four different facilities right now in the East that we have the capability of serving directly. And we are currently doing that through the average of about seven to nine trains a week. The limiting factor on what the long-term growth of that will be, as you are aware, is the production capabilities, particularly in the Bakken in the Eastern markets. So, for us, it's going to be driven by what the production capabilities are, not by what the demand is.

All right. Thank you.

Chris Wetherbee of Citi Research.

Just a question on coal yields. As I think sequentially in the second quarter through the fourth quarter, Clarence, how should we be thinking about the coal yields? Are you still looking for flattish yields on a full-year basis for 2013? Should they be getting better sequentially?

Chris, we are looking for those coal yields to be flat on a basis going forward. And that's subject to any fluctuation that we could have in the fuel surcharge application that's coming in.

Okay. And then just a quick follow-up to that. When you think about the met coal settlements for the second quarter coming in a little bit higher than where they were in the first quarter, does that give you some support to potentially bring that number up a little bit? Or does it at least provide you some downside support, so there's not further declines? I just want to get a sense of how much flexibility you have within that.

I think it's the latter. It provides us support against any further downward movement. Those prices that have just been announced at Queensland are an effort by the producers to push the rates up. What actually settles in the market traditionally has been a slightly lower number.

Okay. That's helpful. Thank you.

Chris Ceraso of Credit Suisse.

There was a comment on slide number 10 about stronger domestic pricing in coal. Was that just from inflation adjustments on existing contracts? Or were you successful in getting price increases on anything that may have turned over in the quarter?

It's both.

Okay. And then, just as a follow-up, I think you've spoken to this. The guidance for domestic coal for the rest of the year of down 5% to 10% suggests that things are down only small-single digit for the rest of the year. Is that just the effect of comps getting easier? Or are you actually seeing increased demand because of where gas prices are?

The comps in the second quarter are actually better because we had a terrible second quarter last year in domestic coal. The third and the fourth quarters tend to even out a little bit more.

But are you seeing any sort of response -- any kind of demand response to where gas prices are? Or are you still eating into existing inventories?

In the North, we've seen some response to the gas prices, particularly where Powder River Basin and Northern Appalachian coals are being used. In the South, the inventory levels are still at persistently high levels. And so, that's going to be determined mainly by the weather and by the price of natural gas. But we expect those stockpiles to stay fairly high throughout the year.

Okay. Thank you.

Justin Yagerman of Deutsche bank.

It's Rob on for Justin. Clarence, you had sounded a little more cautious on the export thermal coal outlook on the call. Are you implying that the 2013 outlook is now below the 20 million tons that you've been talking to in Q4? Or are you just highlighting that the year-over-year comps are growing more challenging as we move out to the second quarter?

It's the latter -- that the year-over-year comps are growing a little bit more challenging as we go forward. It is a fact that the API 2 index numbers, as you are aware, have come down. But we think they're starting to stabilize. And actually, the forward curve on the API 2 through the second, third, fourth quarters, and through 2014, is actually increasing.

Clarence, while we're talking about the API 2, could you discuss a little bit in more detail about your export thermal coal contracts? How much of that book of business is linked to metrics like the API 2 in terms of the contracts? What percentage of that book, again, is tied to a take-or-pay commitment volume?

Not all, but a preponderance of the thermal exports, particularly into Europe, are tied to the API 2 index. Our rates don't go up as fast, nor do they go down as fast as the API 2 index does. And a large percentage of our contracts would be on a take-or-pay basis, although there is a certain amount of those thermal contracts that are on a spot-market basis.

Appreciate the color.

Thomas Kim of Goldman Sachs.

If I could ask, Clarence, just with regard to the intermodal side. You mentioned that there's a 9-million truckload opportunity. I was wondering if you could, perhaps, give us the path toward that opportunity being realized?

We have a highway initiative called highway-to-rail conversion, in which we go out with a specialized sales force that we have to the beneficial cargo owners, and through our other intermediary channels. And we discuss with them our profits, our opportunities. We have an optimizer that can take their freight and determine what is best suited for you, the long-term, short-term rail. Term being defined as distance. So, we are doing that initiative.

We are opening up new markets. The Montreal market that we discussed on the call will be, we think, a very lucrative market for us on the domestic side, serving over 7 million people. Our expansion at Fairburn has been indicative of what we've seen happening in our domestic growth. We will be opening a new terminal in Winter Haven, Florida, here before long. They will expand further in that central and lower-central Florida market, which is very fast growing. We have got new construction happening now in Baltimore, as we speak. We have the expansions in Columbus that we've just completed. A new terminal in Louisville, Kentucky that we've just completed, which I'm pleased to announce is almost at capacity, and has been wildly successful for us. So, a combination of all those factors leads us to believe that we are going to have good, continued growth in our intermodal market.

Great. And if I can just ask a separate question. Thus far, we've only heard a few companies talk about the sequester impacting transport companies, and they happen to be within the airline space. But I noticed in your outlook that you had commented that the sequester could have some impact. And I was just wondering if you might be able to provide a little bit of color in terms of what the impact might be?

I don't remember having anything about the sequestration. We haven't seen any impact from it, that I'm aware of.

Okay. Sorry. I should clarify. It was on page 13 -- a comment with regard to budget uncertainty impacting military shipments. I apologize with the terminology.

Our military shipments have been down. This is the second, almost third year in a row that our military shipments have been down. They are mainly being impacted on a year-over-year basis by the war material that we were sending overseas. And fortunately, because of the -- I say fortunately -- it depends on your perspective, but from mine as an American, bringing down our troops abroad has been a positive thing for the country. But it's negatively impacted our numbers.

So, it's not so much the sequestration as the war --

As the war effort, yes.

Okay, great. Thank you for clarifying. Thanks a lot.

Tom Wadewitz of JPMorgan.

Clarence, I've got one for you, and then one for Fredrik, as well. You mentioned, I think, four terminals that you now can serve on the East that are online, or coming online, for crude by rail. And you're doing about seven to nine trains a day. What do you think is the most realistic expectation for second half? Would you think that that -- can you get to two trains a day versus roughly one now? Or how do you view the likely ramp in crude by rail in the second half this year?

Tom, first, good morning. It's good to talk with you. Number two is, we are not handling seven to nine a day. It's seven to nine a week.

Yes, sorry about that. Yes.

I'd like to handle seven to nine a day, but --

I misspoke. Right, clearly. So, roughly one train a day. How would that look in second half, do you think?

I think that will increase in the second half. We feel very positive about it with the discussions that we have. But as I pointed out earlier, at the end of the day, the production levels in the Williston Basin, the Bakken, is going to determine what we have. And the joke we have internally -- if everybody got the two trains a day that they want, the numbers would be out the roof. And it's just unrealistic to expect. So, I would think of it more in terms of the Bakken producing to 700,000 barrels a day that they're producing, the 70,000 barrels a day that the train itself can haul, and back into what you think the potential numbers are going to be, given the fact that all of that oil is not going to come east. Does that make sense to you?

Yes, it does. I guess we'll see as it plays out. There will be some meaningful growth, and we will see as it happens how large it is and what production does. So, thank you for that.

Then, for Fredrik, your share buyback, essentially $500 million a year for the next few years. If I look at that in historical context, so if I take out 2009 and look at the prior five years, you did on average $1.5 billion a year of buyback. And I'm just trying to get my arms around why the number you have the next few years is quite a bit smaller than that. Obviously, your coal franchise is very different today than it was. But it also seems like you're seeing some stability in that, and especially when you look beyond 2013. So, is that temporarily conservative, and you improve credit a little bit? Or is it just the capability for share buyback is a lot less than it was in the past? How would you frame that? And why such a conservative approach on buyback?

Tom, as you know, our prioritization is pretty straightforward. First it's about reinvesting in our Business. Second is the dividend. And the third is our share repurchase program. And based on available cash flow that we have -- that we think we are going to have, coupled with some use of our balance sheet within the context of improving credit profile, that's how we determine the amount of share buybacks that we will do.

When we look at the next few years, we see two things that is impacting the sizing of the program, specifically. Which, first of all, is the fact that our PTC spending is ramping up a little bit more. And that is impacting the size of the program. And then, second, we also are seeing the reversal starting to happen because of what we've seen over the last couple of years from bonus depreciation. So, bonus depreciation has been a wonderful tailwind for the last couple of years, in terms of free cash flow. And we are now getting to the point where we are starting to see that minimizing the positive impact of that. And, in fact, as we get into '14 and '15, are going to see the negative impact from that. So, that is considered in that sizing of that program.

Okay. Great. Thanks for the time.

Bill Greene of Morgan Stanley.

I just want to come back to some of the underlying assumptions on the long-term guidance. I want to ask Oscar about the cost side of it. Because you've done a great job in the last few quarters on getting these costs up, particularly on -- looking at the labor numbers, but even MS&O and stuff like this. It's been very impressive. What we've seen at some of the other rails over time is they've come at the costs in a very aggressive way. And they've gotten them out in a way that essentially says -- no matter what the macro hands us, we're going to get these operating ratios lower. So, I was wondering if you can talk about your ability to flex up on that if these macro assumptions that Fredrik outlined don't play out like that. Is a lot of this in your control, even beyond the macro -- that we get these numbers through cost alone if we need to?

Bill, you've said a lot, and I think at the heart of your question is that -- are we going to increase our productivity targets by year?

Yes. And really, I look at this and say -- you've demonstrated an ability to get out a lot when the macro is not helpful. Fredrik outlined a macro that is kind of neutral. But if it's not that good, can you still get at these numbers through productivity anyway?

Absolutely. If you think of the way we've been getting at these numbers, we get them through asset utilization, technology improvements, resource planning. Dynamic communication tools that allow us to use a lot less resources in that critical first and last mile with our customers. We think there's ample opportunity there within our existing structure, regardless of what happens in the macro environment. Our future view on our productivity targets is very solid, and will continue.

All right. And then just one follow-up for Clarence on the competitive dynamic. Can you help us understand how it's playing out right now in the East? It feels a little bit like the growth rates by you and your competitor are a little bit different on volume. Is that because there's a much more aggressive pricing environment in the East than we've seen in recent years? Or do you feel like that's just some of the geographies playing out, and not too much to pay attention to?

First, I think it's great to see that the rail industry, in general, is doing well. That's a positive thing for all of us. If you look in the East, what you'll essentially see between the two carriers is that we have some issues in our coal franchise versus NS. And their intermodal growth rates have been higher than ours. As I outlined to you earlier, we have terminal expansions in place. We will have over 90% of our network double-stack cleared here very soon. So, we feel very positive about what our growth rates are. And I think, with the 9-million truckload opportunity in the East, there's a lot of business out there for everybody.

Okay. Fair enough. Thank you for the time.

Scott Group of Wolfe Trahan.

Just want to clarify just a couple of things on the export side, particularly met. The guidance of 40 million tons, I think, if I remember from last quarter, it was split relatively pretty equally between met and thermal on the export side. We were a good amount above that run rate for met in first quarter. Does that suggest that there's upside to the 40 million tons? Or that 7-million run rate for met in first quarter isn't sustainable?

And then just longer term, the high-60%s OR target for '15, do we need export to stay at or above 40 million tons? Or is there some cushion if that starts dropping below 40? I know there were a couple things there.

Okay, Scott. I will go first, and Fredrik can go second. On the export tons, as we mentioned earlier, we expect it still to be about 40 million. We told you originally that the split would be about 50/50. It came in this quarter about 57/43. As we forecast throughout the year, we expect it to be somewhere in the 50/50 range. If it's anything, it could tend towards being more favorable to the met.

And, Scott, in regards to coal and what the expectations are, I outlined earlier that we think that it's going to be flattish overall, clearly, from where we are here in 2013, and the guidance we provided. But as we also said, seldom do the plans actually work out exactly that you expect. So, we are going to continue to be flexible. And if one of those markets are a little bit weaker, we will have to find other opportunities either on the top line or the cost side to try to offset that.

Okay. That's great. And then just one follow-up on crude by rail. As the Business really starts to ramp up over the next year or so, should we be thinking about a big positive mix impact on yields like we've seen with some of the other rails? I'm just not sure how to think about the pricing, necessarily, in the East, and some of the refineries are a little bit more competitive between the rails. How do we think about that, and just the impact of maybe the Brent and WTI spread tightening a bit on pricing?

I would say, first off, on the Brent, WTI and the Bakken spreads that are all three tightening up, that's a commodity-based number that's going to do what it's going to do on a worldwide global basis. So, it's just very difficult to predict what that's going to be. On the profit margins for the crude, it is very profitable for us. It's probably not what a lot of people think. It's not coal, if that's the question that you are asking. But it is a very profitable part of our business for us.

Okay. All right. Thanks a lot for the time, guys, appreciate it.

Jason Seidl of Cowen Securities.

A couple questions. I'll focus on the pricing side. One, you obviously mentioned a little bit of weakness on the export side. I don't think that's of any surprise. I don't know if you could split out some comments between thermal and met?

And, two, just to clarify one of the questions I think Bill asked about the pricing dynamic in the East. It doesn't seem, at least from your results, that there is any aggressive pricing between you and the NS going on right now. I just wanted to make sure that that is the case.

What do you mean by aggressive pricing between us and the NS?

I'm saying aggressive -- are you guys getting more aggressive with trying to steal freight from one another? I think that was the crux of Bill's question.

Absolutely not. As we've told you earlier, we are going to price to above rail inflation. We're going to price above it because, one, we think we've got a product that offers a significant value. And, secondly, because it's necessary for us to invest in our infrastructure. We've had a solid plan over the last 10 years now, nearly, in which we've wanted to work on our pricing. And that's what we're going to continue to do.

What was the second part of your question? On met versus thermal?

Met versus thermal in terms of export pricing. You talked about pricing in general. I was wondering if you could parse out both of them.

The met obviously goes at a higher rate than the thermal does -- pricing rate, because of the commodity type and what it demands in the marketplace in there. As you know, we've seen downward pressure on both. And I would say that that downward pressure has been equally between the two markets, just at a different level.

Okay. And my follow-up question -- you talked about your new intermodal program. It sounds like that's going more direct to marketing. Is that the case?

No, it's not going more direct to marketing, but it is going more direct to the customers themselves. We do that jointly with our intermediaries. But we want to make sure that the ultimate beneficial cargo owners are very cognizant of what our capabilities are, what values that we can offer to those customers, and how we can best serve them and in what markets.

Okay. I appreciate the clarifications. Thanks for the time, as always, guys.

Ben Hartford of Robert W. Baird.

Fredrik, can you clarify, or remind us, what the incentive-comp headwind by quarter for the next three quarters is going to be?

Here, in the first quarter, incentive-comp headwind was about $7 million year over year. And as I outlined in my comments, we think it's going to be about $15 million in the second quarter, as we reset the targets, and we now have the broader application of the bonuses to include a larger portion of our union employees, as well. As we look at the second half, it will probably be a little bit more than that -- probably closer to the $20 million, on average.

Okay, that's helpful. And then a follow-up, but unrelated. Crew starts were down 16% in coal, but volumes were down 10%. What's driving the longer train length? Is it just mix of a greater percentage of export coal volumes? Or are you seeing more activity from bigger customers at the expense of smaller customers, that that may not be generating at full capacity? Can you talk a little bit about that dynamic?

Yes. This is Oscar, Ben. I think it's a mixture of several things. Our southern utility coal, the [more normal] longer haul is, where our volume declines, whereas you'd think they'd be shrinking. But we've got increases in export coal to Newport News, which is affecting that mix. We've got a higher percentage of stuff coming from the Illinois Basin, which has a little bit longer haul. And then, in the Northeast, where we are growing, we have lesser declines in the Northeast and Mid-Atlantic utilities, which contribute to the longer haul. So, it's a mix of all those factors. It's traffic mix. It's nothing more broader oriented --.

That's helpful. Thanks, Oscar.

David Vernon of Sanford Bernstein.

With the liquidated damages of $32 million in the quarter, is that something we should expect more of going forward? Or is this it, as far as what's on the radar screen right now?

This is Fredrik. I think that we have seen the vast majority of the liquidated damage that we expect for the year in the first quarter. So, I wouldn't expect to -- there's no need to really build in a lot more after this. We will certainly update you and being transparent, as we do get them going forward, just as we have in the past.

And other revenue would then be in that $80-million range -- $70-million, $80-million range, then?

Yes, I think that's the best place. If you look back over the last few years, that seemed to be the place where it normalizes.

Okay, great. And then just one last follow-up for Clarence. Are you guys starting to see any type of pick up in demand for drilling materials into the Marcellus, with gas prices coming back up?

So far we've not seen any additional pick up for the drill counts themselves. We are seeing an increase in the amount of frac sand that we are moving into the Marcellus.

Great. Thank you.

John Larkin of Stifel Nicolaus.

Just on the broader issue of seasonality. For many decades, usually the first quarter is your weakest quarter in transportation across most modes. Your guidance implies that maybe there is less seasonality this year than there might be in a normal year. Or is it just the way that the one-time items flows? Could you, perhaps, illuminate us on that point?

I'm not going to get into quarterly guidance. But based on what we said here earlier, we had about $52 million between the liquidated damages and the conveyance -- the [coach] agreement associated with the conveyance of our formerly owned subsidiary, that impacted us favorably this quarter. So, if you adjust for that, you get to a different run rate.

And then, as you've seen a little bit, in regards to where you are alluding to, the seasonality is perhaps not as strong as it's been in the past. But there's still seasonality, especially in the second quarter and the third quarter. The third quarter with the automotive shutdown, and some of the coal holidays and so forth. So, there is still seasonality there. But I do think you need to change the starting point. And once you do that, I think it makes more sense versus the historical pattern.

Thank you for that. And then maybe as a second question -- one of the other hot topics amongst investors has been activity into and out of Mexico. While you don't touch Mexico directly, with your partner railroads you can do business into and out of that country. Do you see that as a major opportunity that might ultimately be as big as crude by rail?

John, one, we see it as a major opportunity for us. We do a lot of business today in and out of Mexico, both containerizable, as well as boxcar freight, and automotive businesses in and out of Mexico. I haven't really thought about it in terms of comparables as crude by rail. The Mexican market for us is a very large market. And I hope that crude by rail grows as fast as Mexico has.

Thank you.

Jeff Kauffman of Sterne Agee.

I just want to follow up on Tom Wadewitz's question. Because I see the point here -- you paid down about $400 million of debt in the first quarter, no share repurchases. I hear what Fred is saying, is we want to keep our cash level and neutral. And that's what the share repurchase is based on. But it seems like you are delevering here. And I would guess share repurchase would be more accretive to earnings than a debt paydown at these levels of interest rates. Can you guide me through the thinking on that?

Just a very brief answer to that. Our intent is not to delever during this period of time.

Okay. So, in other words, we are open-ended, but we're just being conservative, given the environment and matching our cash flows?

We are going to continue to make sure that we are -- you approach it the same way we have approached it the last couple of years in regards to the balanced approach. We are going to size the share repurchase program based on whatever free cash flow that we have available, including using whatever debt capacity we have. And clearly, as I think you know, we also had, going into the year, a significant amount of pre-funding done on our balance sheet because of taking advantage of some attractive rates last Fall. So, our cash balances are relatively high going into the year.

Okay. And one detail question, Fred. You said bonus depreciation is reversing. Does that mean that your GAAP depreciation expense levels out in 2014, 2015? Or am I thinking about that wrong?

I think you should really just think about it from -- that the relationship between deferred taxes and our GAAP taxes. So, it doesn't really impact whatever you see on the P&L side. It really just impacts the ability to continue to defer some of our taxes.

Okay. Very well. Thank you.

Anthony Gallo of Wells Fargo.

As I understand it, the export coal pricing from you is going to vary with the underlying commodity price change. Are there any other commodities on your network that have a similar dynamic? And more specifically, could you clarify the comment on crude? So, will crude pricing by you vary as the differentials vary?

Anthony, this is Clarence. We don't have any other commodities that we've specifically tied -- any other lines of business that we specifically have tied to commodity prices. And on the crude pricing, it will not follow the spreads.

Very helpful. That's all I had. Thank you.

Peter Nesvold of Jefferies.

Just a follow-up on liquidated damages. Can you just maybe talk a little bit about how the liquidated damages provisions are changing with coal industry, given the underlying changes within the industry itself? Are these becoming harder to implement? Are there different ways that these provisions are being put into contracts, et cetera?

I think that clearly the liquidated damages that we have in contracts today are different than they were a few years ago, where we essentially had both min and max with certain contracts. And that the liquidated damages today are a lot smaller than they used to be. I think that's a trend that we expect to continue going forward, as well.

Okay. Is that a gradual evolution? Or is it -- given the significant downturn that we saw in coal volumes in 2012, are there step changes that are occurring in those provisions, as you implement them now?

This has been occurring over the last couple of years.

Okay. That's very helpful.

And we expect that to continue going forward.

Great, thank you.

Keith Schoonmaker of Morningstar.

I'd like to ask about coal inventory. You indicated utility inventories are high. Can you compare to levels in the past year? And related, could you also comment on what may be a unique attribute of your franchise? Do you consider your ground storage capability more advantageous during periods like the present?

Keith, this is Clarence. The coal inventories, as I mentioned earlier, in the North have pretty much gotten down to what would be considered historically normal levels. And that's been driven by the colder Winter. I think we had like six more weeks of colder weather than we normally had. It's also been driven by natural gas prices slightly going up. A lot of that coal that moves into that area, which is both Powder River Basin and Northern App, has a lower ratio rate between coal and natural gas than it does in the South.

In the South, the utilities have a tendency to burn a lot more gas. Even though electrical consumption is up, they have a lot more gas capacity. And as a result of that, they went into the year, again, with excessively high inventories, and they have stayed fairly high throughout this period. Now, there are isolated cases were some utilities have actually dropped. But there's also isolated cases where the utilities have increased.

What was the second part of your question? Is ground storage related to export?

Yes.

We think it gives CSX a competitive advantage. We have ground storage at all three of our major exporting terminals that allows our customers to blend the coal and to have the coal there available for immediate loading, as well as the asset utilization.

Great. Thank you.

Walter Spracklin of RBC Capital Markets.

My question is on Intermodal. I know, Fredrik, you gave some color on coal assumptions going out there. But on a little bit of a brighter note here, your truck-to-rail conversion is certainly, probably a more systemic and longer-term evolution. I'm just curious as to what level of Intermodal volumes are you assuming above your average levels for the rest of your business for Intermodal going out to your targets?

I think, as you've seen here over the last few years, we continue to have great success in modal conversion in the modal space. And we certainly expect that during this period, as well.

At rates above the average, I guess?

I would say above average, yes.

When you look at the profitability of your Intermodal, I know all the railroads have termed the profitability of intermodal as average with the group. But clearly, as you get growth in that segment, your train links become more optimal. Intuitively, it would lead one to assume that this will be an above-average growth level. Is there a certain level of volumes that you see as being a key volume level, and you can term that with regards to your market share versus the trucks or the 9 million that you are talking about? Or is there a volume level you can point to within your own carload statistics that would say -- okay, at this level, we really start to get some good economies of scale here, and get profitability above the average?

I do think that you're right. I think that as we continue to grow that business, we do see economies of scale. And it's going to be helpful. At the same time, though, Intermodal also is the toughest part of the business to get pricing on. So, you are very much dependent on making sure that you create that leverage as you move forward.

As we've said, Intermodal is a profitable business to us. It's on par with most of our Merchandise market. And we want to grow it as much as we possibly can. So, we are excited about the opportunity. We are excited about the 9 million loads. And we are going to continue to grow that market at a faster rate than overall economy.

That's great. Thank you.

I just have a housekeeping question for Oscar. Your employee base has come down quite a bit -- quite nicely here. How should we look at employee count going forward in terms of a more flattish volume growth after the decline in coal volumes? Is this something that stabilizes or starts ticking back up now as you see that stability in coal, and perhaps some growth in your Merchandise and Intermodal business?

We are going to continue -- this is Fredrik -- we are going to continue to make sure that we are responsive to whatever market conditions we are seeing. So, in a flattish environment, we expect our headcount to remain flattish. We're obviously going to see what we can do on the productivity side. But then, if we see a ramp-up in volume here in the second and third and fourth quarter, we are going to see some adjustment to our headcount. But hopefully, not a 1-for-1 ratio.

Great. Thank you very much.

I will now turn it back to the speakers for closing remarks.

Thank you for your attention. And we look forward to seeing you next quarter.

This concludes today's teleconference. Thank you for your participation in today's call. You may disconnect your lines.