CSX Corp (CSX) 2013 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation second-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 introduction, I would like to turn the call over to Mr. David Baggs, Vice President of Capital Markets and Investor Relations for CSX Corporation. Sir, you may begin.

Thank you, Gwen, and good morning, everyone, and welcome again to CSX Corporation's second-quarter 2013 earnings presentation. The presentation material 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, 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 in 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 these 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 now 31 analysts covering CSX, I would ask, as a courtesy to everyone, to please limit your inquiries to one primary and one follow-up question.

And with that, let me turn the presentation over to CSX Corporation's Chairman, President and Chief Executive Officer, Michael Ward. Michael?

Well, thank you, David, and good morning, everyone. Last evening, CSX reported second-quarter earnings per share of $0.52, a 6% increase from the same period last year. The financials benefited from overall revenue growth, excellent operating results, and a few items that Fredrik will outline later in the presentation. On the revenue side, we were encouraged by the solid growth across many of our markets, offsetting the ongoing challenges in Coal. Overall revenue was up slightly on 1% volume growth, combined with the team's ability to drive solid core pricing for the service value CSX is providing.

At the same time, we continued to deliver consistently high performances in safety, service and efficiency in the face of a broad range of economic and market conditions that continue to be dynamic. Those results helped increase the operating income to a record $963 million for the quarter, and improved the operating ratio to a record 68.6%. As you view the presentation today, you'll see a company that is capable of consistently delivering value by leveraging the diversity and value of its product offering, and maintaining a relentless focus on running an excellent railroad.

Now I'll turn my presentation over to Clarence Gooden, who will provide a more in-depth analysis of the top line results and a forward outlook. 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. In June, the purchasing managers index registered a reading of 50.9, reflecting a modest expansion of US manufacturing. At the same time, the customers' inventory index registered a reading of 45, indicating respondents believe their inventories are still below normal levels. Looking at the right side of the chart, both GDP and IDP rates reflected modest expansion in the quarter. Although second-quarter growth estimates were below April expectations, forward projections still show slow, steady growth for the second half. Overall, demand across the diverse markets we serve was generally positive for the quarter, consistent with a broader economy.

Now let's take a look at the overall revenue. Total revenue increased $57 million year over year, approaching $3.1 billion in the quarter. Starting to the left, the combination of rate and mix was favorable by $32 million in the quarter. Here, core pricing gains and liquidated damages were partially offset by the unfavorable mix impact related to growth in Intermodal, and the decline in Coal. Moving to the right, volume had a favorable impact of $26 million in the quarter, as volume declines in Coal were more than offset by growth in the Merchandise and Intermodal markets. Finally, fuel recovery declined $1 million in the quarter.

Now let's turn to pricing. Core pricing on a same-store sales basis remains solid across nearly all markets. Recall that same-store sales are identified as shipments with the same customer, commodity and car type, and the same origin and destination. These shipments represented nearly 80% of CSX's traffic base for the quarter.

Looking at the chart, overall pricing, shown as the blue bars, improved 2.3% in the quarter, reflecting less difficult comparisons in the export Coal market as we began to cycle rate reductions put in place during 2012. The gold bars, which exclude export Coal, show pricing gains of 4.1% in the quarter, consistent with the performance in prior periods. On either basis, pricing exceeded rail inflation, which was low this quarter. A strong service product provides a solid foundation for pricing above rail inflation, which supports reinvestment over the long term. We are confident in the value of our service product, and remain focused on driving profitable growth.

Let's turn to the next slide, and take a closer look at the volume. Total volume was up 1% in the quarter versus the same period last year, with increases across most of the broad sectors we serve. The Intermodal, Industrial and Construction sectors delivered solid growth in the quarter. High service levels helped drive growth in the domestic Intermodal market, and capture opportunities in both the growing domestic, and oil and gas industry, and the recovering construction markets. The Agricultural sector was flat, with growth in phosphates and fertilizer offset by the ongoing challenges in feed grain, soybeans and ethanol. The Coal story was mixed. Domestic volume was up 5% against a very weak second quarter last year, while export volume was down sharply.

Now let's look at the individual markets in more detail, and starting with Coal. Coal revenue declined 6% to $770 million. Domestic coal shipments benefited from higher natural gas prices on a year-over-year basis. Although domestic coal demand has stabilized, inventory levels at Southern utilities still remain high. Export coal volume declined 23% on soft demand for US thermal coal, particularly in Europe, where broader economic conditions remain weak. Total revenue per unit was flat, with strong domestic pricing gains offsetting lower export pricing.

Domestic pricing continues to benefit from the ongoing implementation of a utility contract structure that splits the conventional rate into two components -- a fixed quarterly charge that does not vary with volume, and a variable charge for each ton moved during the quarter. As a result, revenue per unit will vary more under this structure. During periods of low volume, the revenue per unit will be higher, as the fixed component will be spread across fewer units. Conversely, revenue per unit will decline during periods of high volume. That said, these contracts continue to reinforce our overall philosophy of securing inflation plus pricing, which supports reinvestment, and reflects the value of the service we are providing to our customers. Looking ahead, we expect third-quarter domestic volume to be relatively stable on a sequential basis, although down 5% to 10% for the quarter and the full year. At the same time, our best estimate for 2013 export coal volume remains about 40 million tons, with a more unfavorable demand environment in the second half of the year.

Next, let's look at Merchandise. Overall, Merchandise revenue increased 4% to nearly $1.8 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 frack sand. The agricultural sector was flat, as increased phosphate and fertilizer shipments offset the continued weakness in the feed grain, soybean and ethanol shipments. Regarding the Construction sector, building products and aggregates increased due to higher construction activity, and the continued recovery in the residential housing market. This was partially offset by lower military and machinery shipments.

Looking at the third quarter, growth is expected in the industrial sector, driven by ongoing opportunities in chemicals, particularly in commodities related to oil and gas drilling. The automotive market will also remain strong, although we continue cycling tough comparables. We expect the agricultural sector to recover, with the anticipated improvement in crop yields supporting growth in grain shipments, primarily for animal feed. Finally, we anticipate the 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 $425 million. Record domestic volume was up 4%, driven by growth with our existing customers and highway-to-rail conversions. International volume grew less than 1%, as growth with existing customers and from new service offerings was partially offset by volume lost to a carrier port shift. Total Intermodal revenue per unit increased 2% on core pricing gains.

Looking forward, we continue to make strategic investments in our Intermodal network to drive profitable growth. Over 90% of CSX's Intermodal volume currently operates in double-stacked lanes. That number will grow into the mid-90%s by the end of 2015, further improving efficiency and expanding capacity. New terminal construction is progressing as planned in Winter Haven, Florida and Montreal.

In addition, expansions are under way in Atlanta and Louisville, and an expansion of our Northwest Ohio hub is already in the planning stages. These investments will expand our network reach, increase capacity, and will allow the introduction of new service offerings that support profitable growth. 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 opportunity, which aligns very well with our network.

Let's turn to the outlook for the third quarter. For the third quarter, we expect stable to favorable conditions for 83% of our markets, and the overall volume is neutral to slightly positive. The outlook for agricultural products is favorable, with the anticipated improvement in crop yield supporting growth in grain shipments. Automobile and light-truck production will remain strong, with annual production estimates now exceeding 16 million vehicles. We expect growth in chemicals, as we continue to capture opportunities created by the expanding domestic oil and gas industry. Intermodal growth will continue as our strategic network investments and service reliability support the highway-to-rail conversions. Domestic coal volumes is expected to be stable sequentially, but down 5% to 10% for the third quarter and the full year. Finally, export coal volume will again be lower on softer demand for US thermal coals.

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

Thank you, Clarence, and good morning, everybody. As is customary, I discuss safety results at the beginning of each of these operations review to make it clear that safety is our first and foremost priority. Unfortunately, I need to make everyone aware of the tragic loss of two CSX employees this past week in separate incidents. The overriding focus of our safety program is to avoid such catastrophic events, and we are rapidly completing our investigation of how these events unfolded, and the lessons learned will promptly be applied to our operation. We want the colleagues, friends, family of these two gentlemen who might be listening to this call this morning to know that our hearts go out to them. At CSX, we are all passionate about sending each person home safely every day, and we must never, ever lose sight of this goal.

Now, if you'll allow me, let me review the Company's overall safety results on this slide 15. The chart on the left shows FRA personal injury rate, which was 0.93 for the quarter. This rate is higher than the prior period, and underscores our need to remain focused on safety each and every day. The chart on the right shows the FRA train accident rate, which improved by 7% to 1.81, and reflects our continued commitment to accident reduction. We will remain diligent in our efforts to keeping our employees and the communities where we work in safe.

Now, let's turn to the next slide, and review the operating results for the quarter. Here on slide 16, you can see that on-time originations on the left, and on-time arrivals on the right. Both measures improved in the second quarter, with on-time originations at 91%, and on-time arrivals at 82%. Both measures are at record levels. I'm very pleased with these results that represent the culmination of hard work and dedication by all of CSX's 31,000 employees during a quite challenging second quarter. Furthermore, these results demonstrate our commitment to a shared purpose founded on Customer Service.

Let's look at the system performance on the next slide. Terminal dwell and velocity provide a picture of how efficiently cars and locomotives are moving across the network. CSX's continued momentum in these two measures illustrates the Company's ongoing commitment to improved asset utilization. When you look at the chart on the left, we drove a 6% improvement in terminal dwell for the quarter, to a record low 21.9 hours. This means cars are spending less time sitting in terminals, and thus more time in productive freight service. Velocity also showed improvement once again, up 3% to 23 miles per hour, with improvement across all three networks -- Coal, Merchandise and Intermodal. Strong on-time performance, dwell and velocity are a win-win, as our customers receive great service, and you, our investors, get an ever-improving ROA.

Now let me review with you the Company's improvement in operating efficiency on slide 18, which complements better service we are providing to our customers. Carloads were up 1% in the second quarter, and gross ton miles, the best measure of our true workload, was up nearly 2%. CSX absorbed this additional workload in the quarter with fewer resources on a year-over-year basis. Moving down the chart, you can see road-crew starts were nearly 3% lower than last year, as volume growth was largely incorporated into existing trains, and we improved our train crew productivity. In fact, both active locomotive count and total operations employment were lower by over 4% in the quarter, reflecting our improved operating environment.

Now let me wrap up on the next slide. Safety remains a primary focus for us, and we urge our employees every day to look out for and support one another in this endeavor. Service and customer satisfaction remain at high levels, and we delivered these great operating results by simultaneously improving our resource utilization. As such, we remain on track to deliver over $150 million in efficiency savings this year. CSX remains committed to providing flexible solutions for customers to enable sustainable growth, driving significant long-term value for our shareholders.

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

Thank you, Oscar, and good morning, everyone. Looking at the top line, revenue increased 2% in the second quarter. Gains in Merchandise and Intermodal offset the declines in Coal. At the same time, other revenue, which included a $16 million increase in liquidated damages, also contributed to the year-over-year improvement. Expenses also increased 2%, as wage and material inflation, higher depreciation and volume-related costs more than offset savings from improved efficiency. Operating income was a record $963 million, up 2% versus the prior year.

Looking below the line, interest expense was $140 million, other income was $9 million, and income taxes were $297 million, reflecting $17 million or $0.02 per share of tax benefits in the quarter. While this resulted in an effective tax rate of 35.7% for the quarter, we continue to expect a tax rate of approximately 38% going forward. Overall, net earnings were $535 million, up 4% versus last year, and EPS was $0.52 per share, up 16%(sic-see presentation slides "6%") versus last year, reflecting growth in net earnings, and the impact of share repurchases.

As we turn to the next slide, let's briefly discuss how fuel lag impacted the quarter. On a year-over-year basis, the effect of the lag in our fuel surcharge program was $4 million unfavorable. This reflects $13 million of positive in-quarter lag during the second quarter of 2013, versus $17 million of positive in-quarter lag for the same period last year. Based on the current forward curve, the fuel lag impact will be slightly favorable next quarter, primarily driven by the cycling of $16 million of unfavorable in-quarter lag in the third quarter of last year.

Turning to the next slide, let's review our expenses. Overall expenses increased 2% in the quarter. I will talk about the top three expense items in more detail over the next few slides, but let me briefly speak to the bottom two on this chart. Depreciation was up 5% to $276 million due to the increase in the net asset base. Going forward, we continue to expect depreciation to increase sequentially by a few million dollars each quarter, reflecting the ongoing investment in our Business. Lastly, equipment rent was down 6% to $96 million, driven by a reduction in locomotive leases and car hire expense.

Now let's discuss labor and fringe in more detail. Labor and fringe expense increased 4%, or $33 million versus last year. Looking at the chart on the left, total headcount was down 3% versus last year, and up 1% sequentially, to support a seasonal increase in demand and hiring ahead of attrition. Moving to the table on the right, improved efficiencies more than offset higher workload in the quarter to drive $19 million in net efficiencies and volume cost savings. Moving down the table, incentive compensation expense was up $24 million versus last year, and labor inflation was up $18 million, with core wage inflation remaining below 4%. Rounding out the table, other costs were $10 million higher for items that are not expected to re-occur.

Looking at the second half, headcount should be roughly flat on a sequential basis, although as we demonstrated over the past several quarters, we will continue to adjust our resources to reflect the current volume levels and drive efficiency. In addition, we expect labor inflation to continue to increase by $15 million to $20 million year over year for the remaining quarters, and the quarterly incentive compensation headwind to be similar to what we experienced in the second quarter.

Next, let's review MS&O expenses on slide 25. MS&O expense increased 2%, or $10 million versus last year, with the key drivers shown in the table on the right. Total real estate gains reduced MS&O expenses by $16 million, reflecting two items. The first one relates to a $22-million gain on rail assets and easements. The second one relates to SunRail gain, which was $14 million in the period, or $6 million unfavorable year over year. As a reminder, there will be no further material gains related to the SunRail transaction going forward. Moving down the table, inflation increased by $10 million, and train accidents and other increased by $16 million, primarily driven by costs related to a few derailments, including the accident in Rosedale, Maryland.

Moving to the next slide, let's discuss the impact of fuel. Total fuel costs decreased 3% or $13 million versus last year. Looking at the table to the right, fuel efficiency was favorable by $10 million, reflecting a 3% 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 decreased $3 and -- decreased to $3.08, down 2% versus last year, driving a decrease of $7 million, as seen in the chart on the right. Rounding out the table, higher volume drove the $4 million increase in volume and other expenses, with gross ton miles up 2%.

Now let me wrap up on the next slide. Through the first half, CSX has displayed the benefits of its diversified portfolio business by overcoming over $155 million of coal headwinds to achieve record financial results. This was achieved by ongoing strength in our Merchandise and Intermodal businesses, and helped by $46 million in year-over-year gains from real estate transactions, and nearly $50 million of year-over-year favorability related to liquidated damages.

Looking to the second half, coal will continue to be a challenge, driven by depressed global coal environment and high domestic inventories. In addition, the year-over-year impact from real estate transactions, which was positive in the first half, will be negative by greater amount in the second half. At the same time, liquidated damages, which was positive in the first half, are expected to be flat to slightly down on a year-over-year basis in the second half. Taken all together, we're modifying our full-year earnings-per-share guidance slightly to now be roughly flat with 2012. Looking longer term, CSX will continue to focus on the same core elements that have driven the Company to record financial results. By focusing on safety, service, pricing above inflation, and profitable volume growth, CSX will emerge from this two-year transition to a new coal environment as an even stronger Company, and remains on track to sustain a high-60s operating ratio by 2015, and a mid-60s operating ratio longer term.

With that, let me turn the presentation back to Michael for his closing remarks.

Thank you, Fredrik. It's been a pleasure to represent the great efforts of our 31,000 employees this morning. In addition to their positive results this past quarter, this team has delivered earnings growth in five of the past six years, and improved the operating ratio in each of the past six years. This in spite of the fact that CSX has lost over 50% of its domestic coal business over this period, and its Merchandise business is still down from pre-recession levels. As I alluded to in my opening remarks, this team is all about consistency and execution, making the right adjustments at the right time, and focusing on the areas where we know we can make a difference. When we do these things well, the Company stands the best chance of making the most of its opportunities, and meeting its challenges.

At the same time, we are able to return substantial value to our shareholders through dividends and share repurchases, while also investing in our network, which holds great opportunity for well-documented reasons, including population growth, highway and trucking challenges, and the value of sustainability needs of our customers and the nation. In short, we like what we see. Relentless, consistent performance, and a promising future. Your Company is well-positioned to drive strong earnings growth and margin expansion long term, as the economy continues its slow recovery, and the energy environment evolves.

With that, we'll be glad to take your questions.

(Operator Instructions)

Ken Hoexter, Merrill Lynch.

Just let me stick on Clarence with the export coal here. What gives you the confidence in the 40 million tons, just given that API2 is now at just over $86, Aussie coal in the low $100s. Just sounded you were a bit more negative on thermal coal. I thought you were always more positive with that, given contracts. And just surprised not a little bit more negative on met coal, given that's more than 50% of the export side. So if you could just run up on that.

Ken, most of the thermal coal that we'll have for the second half of the year was put under contract in prior periods. So it was either done earlier in this year, before the API2 index dropped so dramatically, or was done last year. So we feel pretty confident about being able to achieve those thermal numbers. And our met numbers, as you can already see, they've been declining on a sequential basis here from the first quarter to second quarter, and we expect that they are pretty much going to stabilize at the level that they are now for the rest of the year. There's a lot of the steel companies, particularly in Europe, can't afford to buy some of the high vol A. They're buying a lot of the high vol B coals, which CSX has been blessed with abundance of, and that gives us some confidence in that market.

No, makes sense. I just thought you said in your presentation that you were more negative on thermal exports.

And going forward into 2014 time frame, we would be.

Okay.

Brandon Oglenski, Barclays.

I wanted to address an issue that we've been hearing a little bit more about and seeing in results here between you and your peer. It seems that some of the pricing discipline that's created so much value for this industry might be -- I don't want to say slipping a little bit, but looks like your competitor might be trading a little bit more volume for price. Can you talk about how that's impacting outcomes for CSX, and what your view is going forward?

Well, where we've lost business, Brandon, we're confident that it wasn't because of our service issues. And consistent with our long-term strategy, we've rank -- we have remained committed here to pricing above rail inflation, which is imperative for us if we're to continue to invest in the business.

Right. But I guess it seems, especially in the Intermodal business, that there might be a little bit more aggressive behavior from the competitor. Is that creating problems for CSX, and do you view this as a longer-term issues that shareholders should be looking at?

I certainly can't address what other competitors are doing. I would tell you that most of our conversions are highway-to-rail. We have a very positive program in our highway-to-rail program. We've added sales personnel in order to do that, with the beneficial cargo honors. We have a proprietary business model that we can use that will take the customer's book of business into consideration. Where that makes strategic fits for CSX, we think we offer a good product, and where it doesn't, we are very upfront with the customer in that regard.

The domestic grew 4% this year to record levels.

Is that where it is?

So we're continuing to see the growth, Brandon, in Intermodal.

All right.

Chris Wetherbee, Citi.

This is a question back on the thermal export coal side. Clarence, just kind of curious about the pricing dynamic. Sounds like most of the business is under contract, so is it fair to assume that the pricing on that specific piece of the exports is going to remain relatively stable sequentially?

I think, yes. I think you'll see it relatively stable sequentially.

Okay. That's helpful. And then maybe just a follow-up on the utility side. You mentioned that the Southern utility stockpiles were still above average. When you think about the overall utility complex that you serve in the US, how do you think about stockpiles in general?

Stockpiles in the north are pretty much at normal levels. Stockpiles in the south are about where they were, and continued along that line. That's based on both the rate of burn, as well as the rate of resupply that the utilities are taking on an ongoing basis.

Okay. That's helpful.

Allison Landry, Credit Suisse.

I was wondering if you could help us bridge the roughly flat earnings in 2013 with the 10% to 15% growth in 2014? And from a high level, are there specific business segments that you see getting materially better next year? And I guess, what's the risk to this guidance, based on the very weak fundamentals that's we're now seeing in the export coal markets?

I think what we've said is, the underlying -- the guidance are two basic macro assumptions, that coal overall will be flat as we get through 2013, both between domestic and export, we think it's going to be flat. And we've also said that underlying that guidance of 10% to 15% CAGR in earnings is going to be an economy that is going to grow, but albeit at the continuous modest pace. Clearly, export coal has gotten weaker, but inherent in the inventory overhang that we're dealing with on the domestic side, there's an opportunity perhaps for a pick-up as we get into 2014 as well. So I think overall, that's the macro assumptions that we have talked about, and I think as we stand here today, a quarter into the new guidance that we have talked about, we still feel very comfortable with that guidance for 2014 and 2015.

Okay. And just as a follow-up, switching gears to crude by rail. Just given the recent narrowing in spreads, have your discussions with customers -- do you get the sense that the Eastern refineries have or will possibly switch back to coastal imports if the economics from the Bakken by rail don't necessarily work? Or is there generally a bias or a commitment to source domestically?

Allison, this is Clarence Gooden. When we talk to our customers as recently as this week about that, what we're -- they're telling us is, they don't see any significant need to change. Number one, they have commitments to the Bakken. Number two, a lot of the East Coast refineries get their oil off of the West African coast, and that is what's really the driving factor for these guys. So we don't see any change right now in their behaviors as a result of the narrowing of the spread.

Fantastic.

Justin Yagerman, Deutsche Bank.

Couple questions on coal, shockingly enough. Where does Illinois basin go, over time, as a percentage of utility coal for you guys, from a sourcing standpoint? Where is it now? And how much of a positive RPU impact did that have in the quarter? Because when I look at RPU versus revenue per gross ton mile, it looks like maybe some of that longer haul had an influence on the RPU side for domestic utility.

Justin, Clarence again. About two years ago, three years ago, 2010, about 12% of our coal originations on CSX were coming out of the Illinois basin, and this most recent quarter, about 28%. Then most of the -- that coal has displaced central Appalachian coal, which is down fairly significantly. So we see the Illinois basin continuing to grow over time, number one. Number two, for our Southern utilities, Illinois basin is a longer length to haul. Therefore, it will tend to carry a higher RPU.

Got it. That makes sense. So positive mix shift. Where do you see that going over time, Clarence? Do you have an idea of 28%? Is that what you think the max would be? Or can it go higher than that?

It's going to go a lot higher than that.

And then, as I think about the domestic coal franchise, you guys in the past have talked about the fact that you had a lot of contracts in Q4. I think 20% to 25% of the book was expiring. As that gets closer, I'm curious, because it sounds like you've had some of these conversations already, and maybe the contracts are already built in. How much of that's already been addressed? And how much of your book is left to re-price, and how is that conversation going in terms of putting in the more variable cost structure and pricing structure that you guys have been talking to for a while now?

I think the same amount of contracts still have to be finalized, because you're correct in your assumption that we're in pretty serious negotiations with people. But we've had a lot of receptivity from a lot of the utilities for the fixed variable pricing. So it's a learning experience for some that haven't used it as much as anything.

So would that mean less liquidated damages on a go-forward basis, and probably just more variability in terms of your overall pricing schematic?

It's obvious that the fixed variable would obviate some of the need for liquidated damages.

All right. Thanks for the color.

Thomas Kim, Goldman Sachs.

Want to just ask you with regard to the longer term outlook and how you're growing the various markets or verticals strategically. Where do you think coal sits in terms of the overall contribution to the mix? Let's say in 2015, as the OR basically stabilizes, as you say, in the similar set of range of 69% or so, or high 68% range.

At 2015, which I guess is two years from now, I think coal now, as we said earlier, has -- is stabilized on a sequential basis. I think as those utility stockpiles draw down in the South, you could see some growth occurring over that period of time. And I think it's just too soon to assess what any further EPA regulations will be, because they'll certainly have court considerations in those.

In the meantime, we'll be growing our other businesses. So as a percentage, coal will probably be a somewhat smaller percentage, because we'll continuing to grow the Intermodal, the crude by rail, the other markets where we have initiatives to grow the revenues, that's correct.

You're right. I think -- and the reason why I ask is because I'm -- clearly, part of the valuation differential between your good sales and some of your peers has, to a good extent, related to the coal side. And so -- and I'm curious as to what some of your targets or internal goals would be to try to mitigate and -- or I should say narrow that differential by addressing some of the market concerns around the coal as you think about the business? Much more strategically and longer term.

But -- and I think just [go] clarifying the -- my answer to the guidance before, overall, as we work off the 2013 base for the '14 and '15 years, we expect our coal business to be flat between domestic and export. And I think that gives you a sense of what the coal picture would look like. And then you add on to Michael's comment around the fact that we do see good growth prospects in many of our other markets, so that's the underlying assumption of our guidance.

Tom Wadewitz, JPMC.

A question on export coal on the thermal side, Clarence. What level of API2 pricing, European thermal pricing, do you think is necessary for your customers to really make money and be sustainably in business? And if you stay at current pricing, which is pretty depressed, do you think it's reasonable to imply that you'd have a pretty significant step-down in your thermal exports in 2014?

Let me give you two answers to that, Tom. The first answer is, the number, as a rule of thumb that we use, with what is necessary just to participate in the market, is going to be in the mid-$80s, somewhere in that number. But to make it sustainable over a long period of time, some of our customers, it probably needs to be in the mid to upper $80s.

Okay. So then if you -- I guess we can just assume what we want on pricing, and then if you're not at that level, then you'd have some impact from the customers in your tonnage.

Right. That's correct.

Okay. One more question for you, the follow-up question, I guess, on the crude by rail. I know you were asked this once. But wanted to see if you could talk about -- I think you've got a couple facilities, maybe two facilities that are scheduled to come online in second half of the year in the receiving side. And I'm wondering if those facilities have been -- are still on track to start up for receiving crude by rail trains, or whether there's been a delay in those facilities and in your volume expectation related to this spread compression that's been pretty significant.

No, Tom, both facilities are still scheduled to come online here in the third quarter.

Okay. Great.

William Greene, Morgan Stanley.

Michael or even Oscar, I'm just wondering if I can ask you a little bit about productivity and cost. So if we look at the second half outlook, obviously still a bit challenged, the longer term outlook on coal questionable. So does it make sense to become now more aggressive on cost? Do almost an inflation plus productivity gain, in addition to the inflation plus pricing? Because it would seem to me that that's the way to almost ensure, outside the macro, that you continue to see these goals on the longer term basis that you're targeting.

Bill, it's Oscar. I couldn't agree with you more, and I think that's the path and initiative you've seen us take over many years.

We started the year thinking we'd get 130 of productivity. We're now saying in excess of 150. So we're constantly striving to find ways to drive down the cost, and I think the most interesting thing we're seeing, as we provide this better service to the customers, it also has very favorable impacts on our cost structure. So we're going to continue refining those resources and pulling them when they're not required and adding when they are required. But I think Oscar and his team are very focused on the productivity side.

Yes, I guess what I was getting at is, is there a world where you could say, cost cutting could become a much bigger part, an element to growing the actual earnings of the Company, as opposed to just waiting for coal and macro to come back?

I think I'd reiterate what Michael said. I think there's a delicate balance between the service we're providing to our customers, clearly the safety of our employees, and the valuation impact that you discussed. And I think we balance all of those very well. And I think there is, on a good news front, there's a lot of efficiency to be gained in our industry, and certainly in our business, and we will pursue that.

Yes. Is there any element on CapEx that could come down, then, given what the outlook on coal is?

I think that the -- our CapEx guidance has an inherent ability to flex, depending on what we think that the gross ton miles is going to be within our coal business. So we have a revenue target out there, as a percentage of revenue in terms of what our CapEx is. And depending on what we see with coal, that CapEx as we get into '14 and '15, is going to flex, whatever we think the underlying workload will be.

And Bill, it's Oscar again. I can't underscore the amount of effort and work inside the Company with regards to asset utilization -- we term it enterprise asset management -- about ensuring that the efficiency of our operating network creates such a more fluid environment, where it does obviate the need for additional CapEx.

Okay. Great.

Scott Group, Wolfe Research.

So wanted to ask one on, first, on export met. How much of the business right now is getting repriced on a quarterly basis? And so we saw that the benchmark wins and rates dropped 16% and 17% sequentially from second to third. Does your pricing go down that much? I think historically, it goes down a little bit less. I just wanted to get some color there. And maybe at a high level, if you think you can sustain flattish year over year overall coal yields in the back half of the year, given the renewed pressure on met rates?

The answer to both questions is yes. Our coal, as we've said before, met coal and export coal does move with the market, but it doesn't move as much in either the upward direction or in the lower direction, as the coal pricing itself does.

Okay. And that was a yes, also, to you think coal yields can be flattish in the back half of the year?

Yes.

Okay, great. And then just one on crude by rail. I understand the -- your commentary that you're not seeing any signs of changes in the demand environment. Are you seeing any changes in the pricing environment from you or the rail industry overall, where you need to give up a little bit of price, given the lower spreads? Or can you envision a scenario where pricing starts to become a little bit more flexible, or get adjusted based on that spread, on a quarterly or some period basis?

I cannot see such a scenario as that happening. We think we've got our product fairly priced. We think that the -- particularly with the tightness that's in the tank car fleets, that the things Oscar mentioned about the asset turns, become a selling point and become very important and critical to keep the overall cost structure to the end user down.

Okay. Great.

Jason Seidl, Cowen.

I guess I'll shift gears and talk a little bit about the Intermodal business. The hours of service, obviously changes are just upon the truck load industry. I think all people agree it's going to have some level of degradation of utilization, therefore impacting capacity. In terms of domestic Intermodal, what is CSX seeing going forward? And what do you expect in terms of a potential volume pickup because of HOS?

Jason, I met with two truckers last week, and they're not seeing as much impact as some of the people have forecasted. So they're looking at some numbers around 5%. As I'm sure you know, a 5% loss of productivity is -- I'm sure you know, there's been a lot of projections around much larger impacts on productivity than those numbers. I think it's too early to tell, until people settle down in some type of working pattern, of exactly what the impact is going to be. I think the more important thing in Intermodal is the value that's being offered to the customers, both in terms of service and in terms of price that's available to them now. And a better awareness of the beneficial cargoes of what those values are.

And in terms of the pricing, are you guys going to take a balanced approach to this going forward, if there is some impact and some spillover in between price and volume?

I don't understand what you're asking. Ask me again.

If you have the opportunity to gain more market share, especially in some of the lanes that you can increase your (technical difficulty), is this going to be a situation where you're going to go for more volume initially? Or is this going to be more of a balanced approach in making sure you get properly compensated?

It's going to be a more balanced approach, as the big thing, I hope, if we've made any one point here, is we're about profitable growth.

Okay. My follow-up question, just so I can understand the longer term guidance. When you said that you're expecting flattish coal, so we should assume that the export coal assumptions in the out years are for 40 million tons?

No, I said overall, between domestic and export, and obviously as we're looking at the market right now, there's more downward pressure on export and perhaps more upward opportunities on domestic. But we got 2.5 years until that end point. So a lot of things will change. There's one thing you know when you put guidance together, and the underlying assumptions, most likely you're going to get there a different way than you originally assumed. So we're going to continue to do what we do best, which is a focus on things that we control, safety, service, efficiency and inflation plus pricing, and we feel very comfortable with the guidance that we have put in place.

And Fred, when you talk about an upward bias to domestic coal, when you look at the Southern utility stockpiles, how long do you think it's going to take for them to get where the Southern utility starts seeing a decent amount of growth in domestic coal?

As we said, on the Northern part, we feel that we're where we need to be in terms of stockpiles. In the Southern end, we think by the end of the year, thereabouts, we think we should be at a more normalized level.

And we would just like the mid-Atlantic to send their heat down south. So that will help.

(laughter) I'll gladly send it, guys. It's going to be a brutal one here in New York.

Ben Hartford, Baird.

Fredrik, if I could just build on that point. Can you remind us what you had assumed in terms of met and thermal, within that 40 million tons target at the beginning of the year, and where you sit today? And then maybe if you could provide some context as well. A lot of discussion about the weakness in both thermal and met coal prices in the export market year-to-date. Can you give us any order of magnitude of where that 40 million tons run rate might be presently, if it weren't for the contracts that were struck late last year or early this year?

I'm going to leave the second part of the question to Clarence, but this is Fredrik. And I would say, in terms of the mix between met and steam in our long-term guidance, we have not given any sort of indication where we think that is. Because here's one thing we do know, that it's very difficult to forecast exactly where export coal is going to be, and even more difficult is to forecast what the split is going to be between the two.

And in the current quarter, that was -- and in the first of half, it's been 57/43 has been the split. 57 met. And I think our coal team, and the export team, did nothing short of a brilliant job in getting a lot of these thermal contracts particularly in place before this API index has collapsed so much. The met was much more difficult to predict. The Australian dollar against the US dollar dropped 9% in the second quarter, and that severely impacted the met imports, along with the fact that the growth in China and the recessionary tendencies you've had in Europe have impacted those steel-making industries. So it's a little hard for us to tell you what it's going to be doing here in the second half, other than what we were confident that we've got committed now.

Yes, is there any context, I guess, in terms of the order of magnitude of where -- how much lower that export coal number would be in total at present prices? Is it -- would it be a 10% reduction? A 50% reduction? Anything within that context might be helpful.

I don't have -- I just don't know. The Australians, they're going to control what happens to that met market in any event, and they're probably about as low as they want to go.

Okay. That's good.

Cherilyn Radbourne, TD Securities.

I was just wondering if you could give us a bit more color on the impact of mix in an overall sense in the quarter? Clearly, it was still negative, but it did seem maybe it was a little bit less negative than it had been, because you did have some decent growth in some of your higher-yielding Merchandise segments.

As we outlined in our presentation, the RPU was up about 1%. Our overall pricing, when you include everything, was a little bit above 2% on a same store sale basis. That would indicate about 1% or so of negative mix, and that is to be expected as our coal business continues to decline as a percentage of our portfolio, and Intermodal, which is significantly lower RPU, is continuing to grow. So the overall pricing, as you saw if you take out export coal, because that continues to be a drag, of course, on our pricing overall, is very solid, right around 4%. So mix is going to be something that we're going to be dealing with for a long period of time -- negative mix, as Intermodal business continues to become a bigger and bigger percentage of our portfolio.

Okay. And Clarence, just wondering if you could offer some thoughts on the peak season? And just whether you're seeing the housing recovery translate into any kind of a ripple effect into things like furniture?

Actually, what we've seen in the housing impacts has not been an impact on furniture. We -- there was a lot of inventory, for example, for appliances, couple of the major manufacturers, and we've seen that inventory actually drop as the housing starts have increased. What was your first part of your question? The phone went out.

Peak season.

Peak season? I'm not sure I know if we're going to have a good peak season or just an average peak season. And average being defined as what peak has been over the last few years. We'll certainly start to get an indication of that toward the end of this month, July, because a lot of the shipments that will be in the back-to-school area, that will be getting ready for the holiday seasons, will all start here in early August. So we'll be able to tell by the lift in the vessels coming out of Asia what that peak is going to look like.

Okay. That's it from me.

David Vernon, Bernstein.

Could we talk a little about the strength in domestic coal pricing? How much of that is due to the move to fixed and variable pricing with utility customers right now?

I would say that, not a lot. It's been mostly impacted by the overall pricing philosophy that we had. About 20% of our volume right now is covered -- or revenue, not volume. Revenue is covered by the fixed variable. So most of it has come off of either the escalators or renegotiated contracts.

So there's in that 20% of the revenue is moving on the fixed variable, is that -- would that be including a bunch of fixed charge? Or was that at an average rate? I'm just trying to get a sense for how the RPU should move as volume flexes.

This quarter there's been no real material impact.

Okay. And then just one last question, Clarence. The IP numbers you guys put out on the macro side look like they're down a little bit, about 60 BPS. And the general balance of the commodity outlook swings a little bit more favorable. Is that just ag? Or are you hearing some more on the industrial side that would lead you to believe the cut in forward IP numbers is probably unwarranted?

Are you saying -- ask me that again. I didn't understand that.

Sorry. I looked at the industrial production growth rates that you guys had in the first quarter, the second quarter, and they look like they're down about 60 BPS.

Industrial products.

Industrial production.

(multiple speakers) IDP.

(multiple speakers) The macro outlook. Right.

Those numbers are coming out of global insights, and it's interesting, as I do all the time, about the IDP and the GDP numbers. Whatever some of these agencies predict they're going to be, I know they're not going to be that. (laughter) I think the industrial growth has been a little bit stronger than what some of these numbers have indicated here for our business. It's certainly showing up in some of the construction materials that we had, as opposed to the paper side of the business. It's strong in our automotive business. It's not as strong in our steel business as we think it should be. But I -- it looks to me like we're going to continue to have growth in the IDP numbers as we move forward.

I guess, Clarence, what housing starts last year were about 780,000, and we're thinking they may be in the 900,000 to 950,000 range.

That's right.

So it is growing, but from a very low base, because a normalized rate is more than 1.5 million. At the peak, it was 2.5. So we're seeing some growth there, but from a real small base. I guess secondly, at least at this point, there's a good planting of crop. So we're hopeful that, toward the end of the third quarter, we're going to see some very good growth in our ag shipments, which have been down for the first half.

All right. Great. That's what I was trying to get at.

John Larkin, Stifel Nicolaus.

By the way, there was some disappointing housing numbers out this morning, you may want to check on that, down 9.9% in June. Just as information. That was a surprise to many people, I think. First question, the incentive comp. I think, Fredrik, you said was up $24 million year over year. How do you reconcile that with the outlook for a flattish year in terms of EPS year over year?

I think, really, you got to go back to last year, when we set our plan for 2012, it was really done in December. We had obviously anticipated a 2012 that turned out to be very different than -- anticipated 2012 that was very different coal environment. And as we moved through 2012, we took down our incentive compensation quite significantly. And we also now have a much larger part of our unions participating in that incentive comp plan. So as you get into 2013 and you reset the targets to properly motivate and incentivize your employees, that headwind becomes a lot more significant and that's what you're seeing this year.

Roughly how much of that incentive is related to the unionized labor force?

It is a relatively large percentage, but I don't have that here.

Okay.

But this has been something that's been going on over the last couple of years.

And then just on the large accident that unfortunately happened up in Quebec involving a crude by rail train, often regulators will, if nothing else, in a knee jerk reaction, put in place some pretty onerous regulations. We saw that with the PTC mandate. Did you see anything like that coming out of that accident across North America? And will that make it more expensive to move crude by rail and therefore less attractive vis-a-vis, say, pipeline?

Tom, this is Michael. First off, we wish to want to express our condolences to the people there in Quebec. It was a terrible accident, and the first responders did a great job of responding to that horrible accident. As you know, they're still investigating what the cause of it is, and I think until the cause is known, it's a little hard to speculate whether there would be additional regulations or not. As you're well aware, we move these because we're a common carrier, and we have a very good record of safety in handling these products. So I'm hopeful that, as they determine the cause of this, if there's something to be learned to make us safer, we want to learn from that, because our ultimate goal was zero. We have a great record now. We want it to be better. So I think until there's a causation here, it's going to be a little difficult to see whether there will be a push for further regulation or not.

Matt Troy, Susquehanna International.

I think this is a question on coal economics. Obviously, exports have been the perceptual albatross, if you will, for your story. And after about two years, they've been poised to drop. Now that we're seeing that, I was just wondering, you implied flat guidance next year in terms of volumes, but there's negative mix. What's the profitability relationship between exports and domestic? Some folks will say it's 2 times, 3 times is profitable. But in export move versus domestic, I think that's crazy. But if you could help us in terms of what that negative mix shift might mean for profitability of coal as a whole, that might help alleviate some concerns in the market about the decline in export tonnage.

Yes, I would say that in the past, prior to us taking -- this is Fredrik, by the way. Prior to us taking some of these rate reductions in our export portfolio, we would have said, if you combine the met and the steam together on the export side, and you compared with domestic, they're relatively similar. Now, with some of the reductions that's we've had to make on export side, I would say that perhaps the domestic portfolio is slightly more profitable. So that from that perspective, at this point, it's not a bad thing. Overall, obviously, coal is a profitable business for us, because it's a very efficient way of moving things, unit train, that's a conveyor belt. So it is not as big of a deal as perhaps some people might think.

I agree, and good to hear. The second question I had simply relates to Intermodal capacity. You talked about the percentage of your traffic that's flowing into double stack lanes moving up into 2015. In terms of train length and some of the yard and asset productivity initiatives, what's the capacity to grow just average train length, where we know those incremental margins for the last cars you're adding are pretty significant?

This is Clarence. Matt, I think it's fairly significant. We still have plenty of capacity as we lengthen the trains and to fill them up in the air. So it's a positive thing for us.

All right. More to come.

Jeff Kauffman, Buckingham Research.

Congratulations. Thank you for taking my question. I'll keep it short. Given the weaker global outlook on API2, and you had mentioned the Australian exchange, these aren't things likely to turn on a dime. Yet you maintain the 2013 to 2015 guidance. So something else, I'm assuming, got a little bit better to offset this. What would that have been?

Jeff, this is Fredrik. Overall, I would say that the reason why we took the guidance up for 2013 was really what happened here in the second quarter. We have several one-time events that got a little bit better than we expected. And that's the foundation, obviously, then also for our long-term guidance. So clearly, the export coal market has gotten a little bit weaker, but we continue to execute very well on the things that we do control, which is what we're focusing on once again, safety, service, efficiency and inflation plus pricing. And that's what gives us confidence to take up guidance slightly. And really is a reflection of what happened more of what happened here in the second quarter than anything that's going to happen in the second half. The second half is still going to be very challenging, consistent with the points that I had in my prepared remarks.

Okay. I'm sorry, Fredrik. What I meant was not 2013, but the 2014, 2015 view. If we're thinking the export markets could be weaker in 2014, what else got better to keep the consistent 10% to 15% to 2015 view?

So two things. First of all, what we have said here is that overall coal we expect to be flat.

Okay.

And so I'm not sure that domestic coal necessarily has gotten stronger during this last quarter, since we issued the guidance originally. But what we are comfortable with is the fact that we are continuing to execute well. And then second, in our guidance is a range of 10% to 15%, so within that range we definitely feel comfortable that we would be able to deliver our earnings growth according to that guidance.

Jeff, this is Michael. The only thing I'd add to that is we have, especially in the last couple of years, seen there's a lot of volatility in the marketplace out there, both with the economy, the energy environment, and it starts to feel like 2.5 years is a long time and many things happen. So what we're trying to position ourselves for, whenever there's opportunities we're making sure we're flexible around. If you think back three years ago, who would have even been talking about crude by rail? So there's a lot of things that can move around in a 2.5 year period.

Michael, Fredrik, thank you and congratulations.

Justin Long, Stephens.

Quick question. Outside of export coal, would you say that core pricing gains right now are pretty consistent among your different end markets? Or are you seeing any particular areas of strength or weakness? And you touched on Intermodal a little bit earlier. But right now, what would you say the pricing dynamics are in that market, given some of the capacity expansions we have going on in the east?

Justin, this is Clarence Gooden. The -- our pricing has been pretty consistent across all of our lines of businesses. There's been a couple that obviously have one point or so better than others. Our Intermodal pricing is always under a lot of intense pressure, not only from other rail competition, but the real competitor is the highway and is the trucker. And there's still a lot of trucking capacity out there. There's still a lot of unused trucking capacity that we see. So the pricing pressures that remain in Intermodal remain from the highway, and it is probably one of our most difficult markets in which to price in. But the others are pretty consistent across the board. We feel very confident that we can get inflation plus pricing.

Okay. Great. As a quick follow-up, on your guidance for 2013 EPS to be roughly flat year over year, there have been some gains and one-time items over the last year. So I was wondering if you could clarify what you're using as both a base EPS number for 2012, as well as what you're using for the first two quarters of this year?

So the base that we have is $1.79, is what we had in 2012. So that's really what we're saying roughly flat, that's what we're expecting again. You're right, we've had -- we had the fortune for -- of several one-time items on our expense side. And also, of course, had the liquidated damages on the top line that has helped us in the first half, which is why the second half is going to be more difficult than the first half. But the base is $1.79.

And for the first half of 2013, what EPS numbers are you using? Are you using the GAAP numbers?

Using the reported numbers.

Okay. Great.

Keith Schoonmaker, Morningstar.

You mentioned the proportion of domestic coal originating in Illinois basin, I think, has doubled from 2010 levels. Other than a longer length of haul, are there aspects of this business that either benefit or constrain productivity or price? For example, train length, car type, lower grade, et cetera?

Keith, this is Clarence Gooden. No, there are no other constraints.

It's a good move for us.

It's a good move for us.

And are there more fixed variable contract structures in this region, or is there no structural pricing difference?

The fixed variable is with the end receiver.

Yes.

So depends entirely on where they receive their coal from.

Great.

(multiple speakers) Illinois basin or Central App, either one.

Yes.

Walter Spracklin, RBC Capital.

Just a quick question on Intermodal. I know that's been a big part of your underlying growth driver. And I think it, perhaps, is getting a little dropped off in terms of context, given coal. So you've invested a lot in your Intermodal network. You've talked about that 9 million loads that are available in truck. When you look at your 4% domestic growth this year, is there any way to disaggregate where you're getting that growth, in terms of success of converting? And then the follow-up to that is, let's just say it starts coming online a lot quicker than you expect. Where is the next bottleneck? I know you've done a great job double stacking. You've got plenty of capacity on your -- on an average train length basis. If it really starts coming online, where will we see the next pinch point?

Walter, I would say that the biggest growth has come vis-a-vis our channel partners from the beneficial cargo owners themselves, and being able to say what the value of Intermodal is. And we have a pretty good handle around who those customers are and what some of their needs and all are. I think our -- we've looked at, in terms of where we could have potential capacity problems in the future going forward, so you heard us mention in the prepared remarks. Number one, we've already got in the planning to expand our Northwest Ohio hub. We're looking at where we could have potential bottlenecks in the Southeast, because there's a lot of growth, both in terms of population as well as in terms of highway conversions in the Southeast.

We are expanding Atlanta now, right?

We're expanding Atlanta as we speak. We -- as you know, we built our Louisville terminal. That -- we went way over capacity -- over the capacity of that terminal in Louisville fairly quickly. And so we had to get in and expand that pretty quick. As the Florida market has continued to grow, we had the foresight to get into the Winter Haven market on an early basis. So we feel like we're pretty well-positioned in terms of capacity for Intermodal growth.

And segregating that 4% growth, how much would you attribute to that -- to conversion or your customers winning market share? And how much is it just simple growth or gaining market share against your rail competitor?

It would be difficult for me to segregate that, to be honest with you.

Okay. That's it.

Thank you all for your attendance today. See you next quarter.

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