CSX Corp (CSX) 2014 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation's second-quarter 2014 earnings call. As a reminder, today's call is being recorded.

(Operator Instructions)

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.

Thank you. And good morning, everyone. And, again, welcome to CSX Corporation's second-quarter 2014 earnings presentation. The presentation material that we will 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 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 the uncertainties and risks, that could cause performance to materially differ 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. That said, with nearly 30 analysts covering CSX, I would ask as a courtesy to 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 second-quarter earnings per share of $0.53, up from $0.51 in the same period last year. CSX also generated record revenues of $3.2 billion for the quarter, up 7% on an 8% volume increase. These results are evidence of both broad-based economic momentum across most markets, and a transition in the energy markets that is largely behind us.

We handled buying levels this quarter that exceeded our expectations, while maintaining stable operations. And we are taking additional steps to return service to the high levels that our customers have come to expect from CSX over the last few years.

We are excited about the growth we're seeing and what it means for the future of this Company and our shareholders. That's why we've added people and capacity, including locomotives, freight cars and infrastructure. Oscar will discuss these initiatives in more detail later in the presentation.

Thanks to the efforts of CSX's 31,000 employees, the Company produced record operating income of nearly $1 billion, and delivered an operating ratio of 69.3%. As we look to the back half of the year, CSX is focused on improving service levels, leveraging the growth opportunities before us, and generating modest earnings growth for the full year 2014.

Now, I'll turn the presentation over to Clarence, who will take us through the top-line results in more detail. Clarence?

Thank you, Michael. And good morning. The underlying macroeconomics remain strong, and our experience in the data suggests a positive outlook for growth. The Purchasing Managers Index held firm at 55.3 in June. A rating above 50 indicates that the manufacturing economy is expanding. This is the 13th consecutive month the PMI index has signaled expansion.

At the same time, the Customers Inventory Index remained at 46.5. A reading below 50 indicates customers' inventories are low, and suggests continued strength in demand for manufacturing output. As a result, many of the customers we serve grew at a robust pace, and most of the key indicators we track, including vehicle production, housing starts and agricultural output, point to continued expansion. Overall, demand for rail service was very strong in the second quarter.

Now, let's look at results on the next slide. As you can see on the left side of the chart, total volume grew over 8% to nearly 1.8 million loads in the quarter, with strong growth in merchandise, intermodal and coal. Moving to the right, total revenue increased $198 million to over $3.2 billion in the quarter, reflecting overall volume growth and increased pricing across most markets. Merchandise and intermodal now account for over three-quarters of CSX's overall revenue. Total revenue includes $11 million of liquidated damages related to contract shortfalls and coal shipments. We expect similar levels in the remaining quarters of this year. Looking forward, we will be cycling $51 million of liquidated damages from the third quarter 2013.

Next, the average revenue per unit was down slightly. Here, core pricing gains in our merchandise and intermodal markets were offset by the impact of mix and lower coal revenue per unit.

Finally, let's move to core pricing. 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 represent 75% of CSX's traffic base for the quarter.

On this basis, all-in pricing was a negative 0.6% in the quarter, reflecting continued rate pressure in export coal markets and the impact of fixed, variable contracts in the domestic utility market where volumes are now increasing. Since we continue to have greater variability in both our export and domestic coal business, reflecting global market conditions and our fixed variable contract structure, and since our merchandise in intermodal markets are becoming a larger portion of our business, we have again provided you with the same-store sales pricing for these two markets on a combined basis.

At the bottom of this panel you can see pricing for merchandise and intermodal averaged 2.6% for the quarter. This pricing gain is smaller on a year-over-year basis, but it's flat sequentially and represents a solid spread over rail inflation. That said, we remain confident that the value we create for our customers, combined with the increasing demand for our service product, provides a solid foundation for growth in pricing above rail inflation over the long term.

Now, let's look at the individual markets in more detail, starting with merchandise. Overall, merchandise revenue increased 11% to nearly $2 billion in the quarter. Volume in the agricultural sector was up 5%. Feed grain shipments, both domestic and export, increased sharply due to a strong 2013 harvest. In addition, ethanol shipments grew as lower corn prices resulted in higher ethanol production levels. The construction sector grew 8% overall, reflecting a rebound in shipments after the winter weather subsided, and the ongoing recovery of housing and construction activity. Finally, the industrial sector grew 11%, led by strength in the energy-related commodities including crude oil, liquefied petroleum and gas, and frac sand.

Moving to the next slide, this will review the intermodal business. Intermodal revenue increased 6% to nearly $450 million. Total volume grew 7%, setting a new quarterly record for intermodal. Domestic volume was up 8%, driven by continued highway-to-rail conversions. International volume was up 6% year over year, reflecting continued economic growth, catch-up from the first quarter, and advanced shipments due to potential port labor issues. Total intermodal revenue per unit declined 2%, as continued core pricing gains and higher fuel recoveries were offset by unfavorable mix. Here, volume associated with our door-to-door domestic business, which has a higher-revenue per unit, declined.

Finally, we continued to grow our intermodal business by adding new service offerings and making strategic investments. These investments include the new terminal in Winter Haven, Florida, which opened early this quarter, and the Montreal terminal, which will open later in the year. These two terminals, together, will add 350,000 in annual lift capacity. In addition, the ongoing expansion of the Northwest Ohio facility will increase this capacity by 50%.

Moving to the next slide, let's review the coal business. Coal volume increased 6% while revenue declined 3% in the quarter to $744 million. Domestic coal volume increased 15% with growth in both northern and southern utility shipments, reflecting higher gas prices, building of stockpiles for the summer cooling season, and a competitive gain. Export coal tonnage declined 12% as global market conditions for both thermal and metallurgical coals remained soft. The API2 benchmark for thermal coal remained below $75 per ton, a level where the US coals are challenged to compete. The Queensland metallurgical coal benchmark has also remained at low levels with a rate of $120 per ton. Finally, total revenue per unit was down 9% with lower export pricing, fixed variable utility contracts, and unfavorable domestic mix negatively impacting revenue per unit.

Now, let me wrap up with the outlook for the third quarter. Looking forward, we expect a positive demand environment in the third quarter, with stable to favorable conditions for 88% of our markets, and unfavorable conditions for the remaining 12%.

Looking at some of the key markets, agriculture is favorable and will continue to benefit from last year's record harvest. We expect growth in chemicals as we continue to capture opportunities created by expanding domestic oil and gas industry. The automotive market will grow, with North American light vehicle production expected to increase 9% in the quarter.

Strong intermodal growth will continue as our strategic network investments and improving service reliability support highway-to-rail conversions. We expect domestic coal volume will grow in the third quarter at double-digit rates as utilities continue to rebuild inventories. Forest products is neutral, as growth in building products due to the continued recovery of the housing markets will be offset by lower paper shipments. Export coal volume is expected to be significantly lower in the third quarter, and our best estimate of 2014 volume remains in the mid 30 million ton range, reflecting soft global market conditions, particularly in the thermal market.

Overall, we expect high levels of demand for our service will continue into the third quarter. Thank you. And I will now turn the presentation over to Oscar to review our operating results.

Thank you, Clarence. It's great news. And good morning, everyone. As you know, we always start our operations review with a look at safety, as it is our first and foremost priority. We are proud to report that CSX remains a leader in safety amongst the class one railroads, with the train accident and personal injury rates both improving year over year. For the quarter, the train accident rate declined to 2.07, and the personal injury rate declined to 0.90, reflecting the Company's and our employees' continued commitment to community and employee safety.

Let's turn to service performance on the next slide. System-wide performance is still below the level customers have come to expect from CSX, especially across our northern tier. In the second quarter, the robust demand we experienced has led to a decline in on-time originations and arrivals, as well as resource constraints in some areas of the network. In addition, line-of-road congestion has impacted train velocity and terminal dwell.

On slide 15, I'll discuss service in a bit more detail. As you can see on the chart on the left, service levels began to decline at the beginning of the year due to the historic winter we experienced. Towards the end of the first quarter we were experiencing a rapid surge in volume. Even with the significantly higher volume, service levels have stabilized, albeit at a lower level. A look at the map on the right, much of that volume growth this year has been concentrated in the northern part of our network. Traffic levels for the northern tier are up approximately 20%, with certain areas experiencing even higher growth rates.

Turning to slide 16, let's discuss some of the actions we're taking to support this continued growth in CSX's business. The map on the left shows four key areas where CSX has been making strategic capacity additions. And notice that many of these projects are along the northern tier and will help facilitate long-term growth across this part of our network. In the Chicago area, the addition of the Elsdon subdivision provides CSX with additional double-track miles. This allows us to operate a shorter, faster route for certain trains, diverting traffic away from other more congested routes in the area.

As Clarence mentioned, we are also extending the processing capabilities at the Northwest Ohio terminal, which we expect to be complete by the end of this year. Along the river line route in New York and New Jersey we are adding more miles of double track to improve capacity along this growing and heavily traveled path from Chicago to New York. Finally, we are investing in a new coal unit train processing facility that will support the increased growth of coal coming out of the Illinois Basin.

Now, let's turn to the next slide and discuss crews and locomotives. The train and engine employee count is already up 200 since the beginning of the year, and we expect it to be up approximately 400 by the end of the year. We also have some initiatives in place to enhance workforce levels in the near term, including temporary transfers, vacation buyouts, and incentives to delay retirements.

On the chart on the right, you can see our available locomotive count has increased by 10% since September of last year, as we pulled units out of storage and taken on additional leases. Looking at the second half of the year, we expect our available count to further increase as we repair and reactivate approximately 100 more locomotives. These actions will help CSX gradually restore fluidity to the network and to support growth.

Turning to the next slide, let me discuss the cost base. Fredrik will provide more specifics on where the cost impacts were this quarter, and what to expect going forward. Let me outline a few of the key drivers behind the $32 million of additional cost in the second quarter associated with our network performance.

On the chart on the left, the number of relief starts continues to be more than double prior-year levels. In addition, overtime across the operating department also remains above prior-year levels, although it has improved sequentially from the first quarter. Now, if I could, I would say a quick thank you to our employees for their continued hard work these past few months. I greatly appreciate your professionalism and dedication to serving customers.

Now continuing with the chart and moving down, as I've discussed, our locomotive fleet has increased 10% since the beginning of the fourth quarter and 8% year over year in an effort to meet the growing demand. With many of our additions coming from short-term sources, lease expense has increased. In addition, maintenance expense is up due to the higher overall fleet count. Finally, average freight car cycle days were up 3%, reflecting the increase in transit time and leading to higher rental expense. Looking forward, these costs will subside as service levels improve.

Now, let me wrap up on the next slide. Overall, service has stabilized with this higher volume, although not at the levels our customers have come to expect from CSX. At a network level, the northern tier has experienced strong double-digit growth, and Chicago, in particular, has been challenged. In response, we are working closely with our rail peers and taking near-term actions to shift resources to these high-growth areas.

We have plans in place to further improve our infrastructure, as well as add crews and locomotives to support ongoing growth initiatives. Also, and importantly, we have been in regular contact with our customers to provide them visibility and sincerely thank them for their patience as we work to increase their increased demand. They, and you, should be confident that our dedicated operating employees remain fully committed to restoring service levels to what our customers have come to expect from CSX.

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

Thank you, Oscar. And good morning, everyone. Let me begin by providing a summary of our second-quarter results.

Revenue increased 7% versus the prior year, on 8% higher volume, driven by broad-based strength across our merchandise, intermodal and domestic coal markets. Expenses increased 7% versus last year, driven primarily by higher volume, the cycling of real estate gains, and cost associated with network performance, which I will discuss in more detail in the coming slides. Operating income was $997 million, up 6%, or $57 million versus the prior year.

Looking below the line, interest expense was down $5 million versus last year, driven by favorable interest rates on debt that was refinanced in 2013, and moderately lower debt levels. Other income declined $21 million versus the prior year, primarily due to environmental charges for nonoperating site. And income taxes were $321 million in the quarter, for an effective tax rate of 37.8%. Overall, net earnings were $529 million and EPS was $0.53 per share, up slightly from $521 million and $0.51, respectively, in the prior period.

With that, let's turn to the next slide and 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 unfavorable by $9 million. This reflects $4 million of positive in-quarter lag during the second quarter of this year, versus $13 million of positive in-quarter lag for the same period in the prior year. Based on the current forward curve, we expect the year-over-year fuel lag impact to be slightly favorable in the third quarter.

Turning to the next slide, let's review our expenses. Overall expenses increased 7% in the quarter. I'll talk about the top three expense items in more detail on the next slide. But let me first briefly speak to the bottom two on this chart. Depreciation was up 4% to $287 million due to a higher net asset base. Going forward, we continue to expect depreciation to increase sequentially a few million dollars per quarter, reflecting the ongoing investment in our business. Equipment rent was up 19% to $114 million, driven by higher freight car rates, incremental volume and longer car cycles.

Turning to the next slide, let's discuss our other expenses. Overall, labor and fringe, MS&O and fuel expense each increased versus the prior year, driven primarily by 8% higher volume in the second quarter. As Oscar mentioned earlier, we incurred $32 million of additional expense in the quarter related to network performance. Of that amount, $14 million is attributable to labor and fringe, $9 million is in MS&O, and, finally, there was $9 million of impact in equipment rent expense.

This cost of network performance represents a significant improvement from the $90 million impact we experienced in the first quarter. Looking forward to the second half, we expect these costs to remain relatively consistent with the second-quarter levels until we see meaningful improvement in network fluidity and service levels.

Now, let me discuss the other drivers for each of the expense categories, beginning on the left with labor and fringe. Total labor and fringe increased 4%, or $32 million, versus last year. $25 million of this increase was related to incremental volume and $14 million related to inflation. For the second half of 2014, we expect labor inflation to continue to be around $15 million on a year-over-year basis each quarter. The $21 million improvement in other labor and fringe is driven by lower incentive compensation and pension expense versus the prior year, and is split about 50-50 between those two items.

Headcount was up about 1% versus our first quarter level, as T&E employees increased to accommodate higher volume. Looking ahead, we expect overall headcount to gradually increase during the second half, such that by year-end our headcount will be up 1% to 2% versus the end of 2013.

Moving to the right on the slide, MS&O expense increased 11% or $61 million versus last year. This included the cycling of $36 million of real estate gains, $19 million of expenses related to incremental volume, and $10 million of inflation. In addition, there was $13 million of decrease in other MS&O spanning multiple items, none of which was individually significant.

Looking at the remaining quarters of 2014, we continue to expect higher year-over-year MS&O expense related to inflation and volume growth. And there are no further real estate gains to be cycled in the second half. Finally, fuel expense increased 5%, or $19 million, versus last year, as the impact of higher volume was partially offset by favorable price and efficiency. That concludes the expense review.

Turning to the next slide, I'd like to highlight our core earnings growth and operating margin in the second quarter. Looking at the second quarter financial results, and excluding the $36 million of real estate gains from last year, the Company generated $198 million of revenue growth that was partially offset by $105 million of incremental expense. This netted to an increase in core operating income of $93 million versus the prior year, or an incremental operating margin of 47%. As a reminder, these results included the $32 million of network performance costs that I discussed earlier.

With a positive outlook across most of the markets in our portfolio, the core earnings strength of CSX's business is now becoming more evident. We expect the core momentum experienced in this quarter to carry over in the second half and produce modest earnings growth for the full year and double-digit growth starting next year. This expectation is the foundation for the increase in capital that we are now planning for 2014, which I'll discuss on the next slide.

Total investment is now expected to be $2.4 billion, up from $2.3 billion we initially budgeted for the year. About $100 million of additional capital will be deployed for infrastructure and freight cars, both of which will support long-term growth. As a result, our revised core capital budget is now $2.1 billion, which is consistent with our guidance of 16% to 17% of revenue. In addition, we still expect to invest $300 million in Positive Train Control this year.

Now, let me wrap up on the next slide. First, the core earnings improvement of CSX's business is becoming more apparent in our financial results, and we see broad-based strength across our diverse business portfolio, which will be key to drive sustainable, long-term earnings growth. As a result, we are investing in infrastructure, crews and locomotives to effectively serve demand and gradually return service to the superior levels that our customers expect.

Looking forward, we expect third-quarter earnings to be roughly flat versus the prior year, as we cycle $51 million in liquidated damages and tax favorability of $0.01 in EPS, while continuing to incur network performance costs. We expect more meaningful earnings growth in the fourth quarter. As I mentioned earlier, we still expect modest earnings growth for the full year 2014. And we remain confident in CSX's ability to sustain double-digit EPS growth starting in 2015 and operating ratio in the mid-60s longer term.

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

Thank you, Fredrik. As we discussed this morning, CSX experienced substantial demand across nearly our entire portfolio, and delivered record financial results for the quarter. Going forward, we see a strong economic environment that is expected to continue, and operations that are stable and expected to gradually improve with the actions we are taking.

What's even more exciting is that in a reshaped energy environment, and with intermodal and merchandise an ever-growing part of our portfolio, the core earnings strength of this Company is apparent and attractive. For those reasons, we continue to expect double-digit earnings growth and margin expansion beginning in 2015.

Now, we'd be glad to take your questions.

(Operator Instructions)

Rob Salmon from Deutsche Bank.

To follow-up with regard to the service discussion, could you give us a little bit of a sense in terms of the time line of how the network fluidity should be improving with regard to some of the capital investments that you are making, particularly on the intermodal side where we basically have been seeing the velocity come down since basically the May timeframe? I'm assuming this is related to the headwinds that you guys called out in the northern region. Any sort of incremental color and how we should be thinking about those costs coming out? It sounds like it's more of probably a 2015 story in terms of getting the velocity and the dwell down to levels that you guys like.

Yes, Rob, this is Oscar. I think all you say is generally correct. I just would re-highlight what we talked about before, is we do have a lot of plans to add the resources, and are in constant communication with our customers across all areas.

Now, assuming that demand remains as strong as we expect, which we do, the recovery will be gradual as we work through the challenges, especially across the North. I can't provide a specific timeframe at this point for a lot of different reasons. But the recovery will not be necessarily linear. That said, as you've seen in this quarter, even with these additional operating costs that we are seeing, our incremental margins are improving, so there is a lot of value and good things to look forward to.

Okay. And then, Fredrik, with regard to a follow-up on the guidance for the third quarter, what sort of volume growth are you assuming in that guidance?

I think, overall, right now what we are seeing here over the last month or so is in the mid-single digit range that we are seeing volume growth. So, I think that's probably a good place to start.

Okay, that's helpful. Appreciate the time, guys.

Thomas Kim from Goldman Sachs.

Could you provide a little bit more color on the incremental CapEx and where you plan to be allocating it, and the time horizon as to when you anticipate revenue generation from that? Thank you.

Sure. About half of it is related to rolling stock that we think we'll be able to put in revenue generation next year. And about half of it is in infrastructure around the northern tier of our network. Obviously, as we put that into effect throughout the fall, that should generate incremental fluidity in that part of our network.

Okay. That's very helpful. And then just with regard to intermodal and the capital reinvestment there, to what extent can you elaborate on how much spillover traffic you see? Given the strength of demand and your network, how much revenue do you anticipate, estimate actually being lost because you don't have the capacity? And if you could just try to give us a sense of the ramp on the utilization of the two new facilities by year end, that would be helpful, as well. Thank you.

Thomas, this is Clarence Gooden. I think it's going to be very difficult for us to say how much business we lost or gained during that period of time that you are asking. On the facilities coming online, are you referring to Valleyfield and Winter Haven?

Yes, that's right.

Okay. Winter Haven is progressing along as we expected it to be. Most of the volume that's in Winter Haven now was moved out of our Orlando facility, which was part of the SunRail deal we had done earlier, several years ago with the state of Florida. So, it will be several years before we reach capacity, full capacity, in Winterhaven.

Valleyfield, which will open up in the early fourth quarter, late third quarter, we're in the process right now of seeing just how big that market total is going to be on day one when we open. We expect we'll be running initially a train in and a train out per day.

Okay. That helps a lot. Thank you.

Bill Greene from Morgan Stanley.

Clarence, I wanted to take your pulse on something. We are starting to see throughout transportation a lot of tightness. And it's not just rails, but obviously you are seeing it in some of your markets, as well. When do we get to the point where capacity is tight enough that you've got to start looking at ways to meter out the scarce capacity of your network? -- in other words, using price as a way to encourage the customers to get in line for access to that network. How do you think about where we are in that tightness on capacity?

I think we're a long way from where we should be on the tightness on capacity from just a sheer standpoint of how much we can handle. Remember that today we are essentially at 2007 volume levels. The problem that we had was that the surge came fast and quick and furious on us. And that's what's tipped our hand here. So, we have plenty of capacity to meet the demand of our customers and our common carrier obligation now.

So, when you look at your corporation that you just reported, all-in down a little bit, is service an impediment to changing that direction? Even without coal we've seen a deceleration. What changes the direction in pricing in your mind?

I think the deceleration that you saw, particularly on the merchandise side, on a year-over-year basis was a result of a weakness in the economy that we had had in the previous years and some duration lingering effects of that in contracts that were in place. Going forward, I think all modes of transportation have an opportunity to price up -- price up significantly -- particularly in this type of economic environment.

When you couple that with what is happening in 2014, and you look at the projections for 2015, we are at a very robust pricing market in virtually all modes of transportation. So, up is the way the direction looks to me.

Okay. Thanks for the time. Ken Hoexter from Bank of America.

Clarence, just jumping back onto, looking at the revenue outlook there a bit for the quarter, domestic coal, you mentioned double-digit growth for this upcoming quarter. But when you look at 2015, what are your thoughts in terms of volumes, knowing that you still have that 7 million tons that needs to be phased out or even moved to others? Is that why you are sourcing more to Illinois Basin? Does that make up for it? What are your thoughts as you're looking at 2015?

Ken, I think 2015 for domestic utility coal is still going to be a robust year for multiple reasons. One, the stockpiles now are way down. Two, as long as gas stays, particularly for Illinois Basin, above $3.50, for the Southeast it makes coal competitive in the mix. Three, is that we still don't know if we are going to have what will be the winter of 2014's effect that's going in. Four, I think the utilities are tending to lean more now to having sufficient stockpiles rather than having insufficient stockpiles to meet their customers' demand.

That's great. So, you are still seeing the outlook for growth as you move forward, not falling back to the continued annual declines?

Absolutely. Growth for coal in 2015.

Wonderful. And, Oscar, just a follow-up with you on the service side. You mentioned the $32 million of internal cost. And I know you were talking about velocity before, but with on-time originations down at 56%, what can you do to get back on track on those metrics? Is there anything you need to do differently or reset operations to get back to running fluidly?

Yes, Ken, as you might expect, we have pretty much pulled out every playbook and every play in the playbook over the course of time. Service performance has such large interrelated issues. We talk a lot about power and talk a lot about crews, but infrastructure is important to some of this growth in the northern tier, has caused a little bit of congestion. What we feel very confident is our process. And we do have a really good playbook.

So, really, we are focusing on service and safety, keeping in constant contact with our customers, and getting this business moved. It's costing us a little bit, and that cost will decline, but there really isn't a whole lot else to be done than what we're already outlined as doing.

Appreciate the time. Thanks.

Brandon Oglenski from Barclays.

This is Keith Mori on for Brandon. Congratulations on the strong quarter. Just one question here on service, Oscar. We saw $32 million in the quarter. Can you maybe help us split out what was needed for just returning metrics to after winter, and how much of the costs were actually geared towards an increase in volume that we could think about going forward? How should we think about those costs going forward to meet that rise in volume Clarence was speaking to?

Yes, I think we've already bifurcated the volume-oriented cost in that $30 million unfortunately is all related to service impacts. I'd break that out between crew cost, leased horsepower hours, and the car hire that we're having to work through in those categories. It's roughly about $10 million a month, split between the three components.

Should we think that could accelerate into the third quarter given that we are going to pick up a little bit here on labor and some other items that we didn't speak to?

Our plan is to decelerate. I'm not sure how you are using that term. Our hope would be to reduce that cost as the additional crews and power come on.

Okay, thank you.

Chris Wetherbee from Citi.

Just touching on the volume outlook for the second quarter, just want to get a rough sense. It looks like the last three weeks or so we've seen some pretty elevated numbers. Is this just a blip that we are working through when we think about the full quarter? Is mid single digits, Fredrik, to your point, the right number to use? Just want to roughly understand what's going on now and maybe how we see the next month or so playing out.

The numbers you've been seeing the last couple of weeks represent year-over-year comparison in July, which is normally a very down time of the year for us. Fortunately, it's been a very positive time of the year for us. So, that's a reason that you are seeing the numbers that you've seen in the last two weeks. But I think Fredrik's number of 6% to 7% going forward for the back half of the year is pretty strong.

Okay. That's helpful. And, then, when you think about the pricing outlook as we roll into 2015, you have a good domestic coal environment, you have a couple of other things working in your favor. If you have these trends continue, can you grow earnings double digit if core pricing is flattish? Or, do you need it to pick up? And is that inherent in your thoughts about growing double digits? Just want to get a rough sense of how we think pricing might translate into 2015 with a still good volume environment.

This is Fredrik. I think the key thing for us that we follow is the spread between RCAF and our pricing. So, as Clarence indicated, we think the pricing environment is favorable, it's getting more favorable. We are going to continue to push price. But it's the spread that is the most important part of this thing. And it is assumed that we will get inflation plus pricing as we think about next year and double-digit earnings growth.

Okay, that's helpful. Thanks for the time. I appreciate it.

Allison Landry from Credit Suisse.

In terms of the resource additions, how do we think about the incremental margins in the back half of the year? And, particularly curious to see if there's any parallels that we could draw thinking back to the second half of 2011, when you guys also had to add some additional resources to meet demand. Obviously, we are in a much different volume environment. But I wanted to see if there was any consistent way to think about that, relative to a couple of years ago.

Obviously -- you're right -- volume environments look different and the mix of business is different, but the outcome in 2011 was positive. As we added the resources we got the fluidity back in the network and we got to a better place. And that's essentially what we are trying to do here, as well.

In terms of the incremental margins, we've said longer term we need to be in that 50% and above range, and we expect that that will continue. We will see here in second half, especially in third quarter, as we're cycling the liquidated damages and continue to have network performance-related costs. It might not get all the way there, but longer term our view is we should clearly, especially in this robust environment, be over 50% in terms of incremental margins.

Okay. That actually was very helpful. And just a housekeeping question -- just given you've made some restatements to the prior-year numbers, could you confirm what the 3Q 2013 EPS number was? Was it $0.43?

The 3Q 2013 number was -- let me make sure I have it -- $0.45 last year.

Okay. $0.45. So, the guidance for flat is relative to that. Okay. Thank you so much.

David Vernon from Bernstein.

Just a question for you on the intermodal yields and the RPU developing there. The door-to-door intermodal product, is that a conscious choice you guys are making to demarket that door-to-door service? Or is that just what's shaking out given the difficulty finding drayage and the market conditions?

The main factor was that the transcon part of that door-to-door business is what declined, and that carries a very high RPU. The Eastern core part of that business remained reasonably robust. It just doesn't carry quite as high RPU as does the transcon.

And would you expect that to continue the rest of the year? Or was it a temporary thing associated with maybe some of the service issues coming east-west?

I would expect right now, for the third quarter at least, for it to continue.

Okay. And then, Fredrik, maybe just a longer-term question. As you think about the model you need to get to that mid 60%s OR, the high 50%s incremental margin, what kind of top-line growth assumption do you think about as a longer-term sustainable level of growth for you guys?

The guidance we've given is that going forward we think it's going to be a little bit more balanced between volume, inflation plus pricing, and productivity than perhaps it's been in the last decade. We like to think that a large part of our business can grow faster than the economy as a whole because of opportunities and the secular trends that we're seeing. But more specific than that, I think it's really hard to beat because it really depends on individual years and what sectors are doing well.

But clearly we feel that the volume environment is much more robust going forward than it's been in the last decade after having gone through, obviously, the housing collapse, the recession that we saw, and now this energy transition that we've seen over the last few years. We think the volume environment is going to be much more constructive going forward than it's been in the past.

And then the pricing stuff will obviously be suffering a little bit on some of the fixed variable stuff with coal, though? Would that also go forward in terms of yield pressure for next year? I'm just trying to get a sense for the top-line growth rate that's reasonable.

I think that the fixed variable, we have to see. We obviously have cash in terms of how much the utilities can grow within this current rate structure. So, as we go through this year, we'll see what the impact is next year. But clearly right now it's a big negative.

But as part of the way that we look at this, we think that's the right strategic move on our part to make sure that we incentivize additional volumes. And as we go through next year it might be a little bit different, as we cycle some of these large gains. I don't think that's going to be as big of a drag next year as it was this year, at least.

Great. Thanks very much for the time.

John Larkin from Stifel.

I had a question related to the surge in volume on the northern part of the network, and how much of that was originating and terminating on CSX, and how much of that is being delivered to you, or you are delivering to the Western railroads, which have had perhaps even more congestion problems, particularly the BNSF.

John, this is Clarence. I would say that most of the surge that we had on the northern part of the railroad was interline business that came. The biggest part of our surge in the North was driven by crude-by-rail and by our coal business. Our coal business, particularly, was much higher than what we had expected it to be, primarily as a result of the gas prices, as a result of the colder winter, and as a result of the Great Lakes themselves, the utility Lake coal, closing much earlier due to the weather, and opening much later due to the weather.

So, is it safe to say that the recovery on service is at least partly a function of how soon Chicago cleans up its service act, and how quickly some of the Western carriers return to normal service levels?

John, it's Oscar. No, I wouldn't ascribe it to anything. Remember, there's a lot of component pieces and all of us are having difficulty across that interchange. I think the heavy degree of volume concentrated in one area is a problem for all of us. So, I think as we all collectively get our stuff together, I think that will all improve.

Is there any possibility of a change in routing protocol to use, perhaps, other less congested hubs that could help solve the problem?

Absolutely. And we are in active communication and conversations with almost every other carrier to do exactly that. And we have some great options around that, that I think make sense, both from a service perspective and also, frankly, economically, as we see longer-term growth coming through that same corridor.

Got it. Thanks very much.

Bascome Majors from Susquehanna.

We should see new draft safety regulations from PHMSA moving flammable liquids by rail in a few weeks here. And they're talking about an operational restriction taking crude trains down to 30 miles per hour. Can you talk a little bit about how that could impact your business versus how you're moving that commodity today? And whether and how that could spill beyond crude oil if they do decide to go in that direction?

This is Michael. I think you are quite right. We have heard, as well. We've not seen the proposals. Nobody really has, yet. But, we have heard, as you have, that 30 miles an hour is one of the options they're considering.

We think that would severely limit our ability to provide reliable freight service to our customers and to support timely, efficient passenger and commuter service. So, there's all kinds of corollary impacts of this. And I would hope, as we look at this with the federal government, we could show them the modeling of how disastrous that could be to the entire fluidity of the US rail system, as well as the adverse impact that will have as trucks spill over onto the highway system. So, our view is it would be very bad. But our view is also that cooler heads will prevail when they see the facts behind it.

All right. Thanks for that. Are there any other parts of this rulemaking that you are watching very closely that could potentially impact your business, whether operationally or from a risk management standpoint?

Actually, we are quite excited about the potential for the new car design, as well as the retrofits to the existing cars. And I know that is part of the proposed rulemaking. As you know, as a railroad, we've done a number of things to improve our already very good safety record to make it even more safe. And we think the next big movement to make it even better is for a stronger car on new builds as well as retrofit to existing cars.

All right. Thanks for the time this morning.

Jeff Kauffman from Buckingham Research.

Mike, it's really great to hear you talking about coal being up double digits and it may continue for a while. I'm just curious -- if export coal didn't exist, give us a sense for what's going on with the yield on the domestic product.

Jeff, this is Clarence. If export coal didn't exist, what is going on with the yield on the domestic coal?

Yes.

I don't think export coal has any direct impact at all on what the yield is on our domestic coal as it currently exists. Our yield is very positive on our domestic coal. Actually, it's improving in our domestic coal business, as it's coming along.

The fixed variable contracts and the nature of them have proved very positive to us. They cover a good percentage of our contracts now, especially in our southern utility markets. There is coal that we are now moving and hauling that we would not have moved and hauled had we not had the fixed variable contracts, with the caps in it obviously to help control how much of that moves at those rates, that we are handling now that we would not have handled. I don't know if that helps or not.

Let me try little bit. So, if we just look at our domestic portfolio, Jeff, if I had to say, in general, are those rates heading upward, the answer is yes. On the two-thirds it's not on fixed variable, those rates are moving up. On the one-third that is fixed variable, the base -- there's a minimum and a maximum -- that base is moving up. But where they are in that range can have a fairly significant impact on overall RPU in coal. So, all of it has an upward bias, but the fixed variable make it confusing where they are in that scale that's allowed within the contract.

That's exactly what I was looking for. Thank you.

Scott Group from Wolfe Research.

I had a few things on coal. One, Clarence, do you have a view on coal yields sequentially, from 2Q to 3Q? They were pretty flat this quarter. A view there. That's one.

Next, do you think that that mid 30s export number for this year -- do you think that's a good bottom, or do you think that can grow next year, or do you see more risk to that? And then, just lastly, the 7 million tons of coal that you guys have talked about that's shutting next year, is that number changing much this year? Meaning, is that growing a lot with coal this year or that not really seeing that much movement?

Let's go in reverse. It's 4 million tons, not 7 million. And we don't see that number changing. It appears to be what it is. We think the other plants that remain open will burn at higher burn rates and it will be a non-event number, essentially, for us.

Number two was export rates for next year. Too early to tell. We will revisit that in the fourth quarter.

He was asking about volumes.

Volumes -- still too early to tell. We'll know more about that in the fourth quarter. And your first question was what?

Just coal yields sequentially from second quarter to third quarter, should we think that they stay flat? I don't know if you made any additional pricing adjustments on the export side.

Flat -- you should expect them to be flat.

Okay. Great. And then just one other question, Clarence. It wasn't so clear to me, some of the questions on pricing earlier. Are you starting to or thinking about entering somewhat of a demarketing phase to push pricing a little bit more aggressively, even if it means giving up a little bit of volume?

No. We are not the demarketing, but we are aggressively pricing our products.

Okay. Great. Thanks for the time, guys.

Jason Seidl from Cowen.

Real quickly, when you think about the impacts of the service levels, obviously you talked about on the cost side, do you think you left any money on the table on the intermodal product in terms of your ability to take prices up, especially in a tight truckload market?

I tell our team that we always are leaving money on the table. (laughter) I don't know what you want me to say -- yes.

Okay. That's fair enough.

As the truck market changes, we will respond to the marketplace.

Absolutely.

Okay, that's what I want to hear. When I'm thinking, also, about all the equipment that you are bringing on, obviously some of it is because service is down, and some of it's because you are just getting more business. How much do you think you guys can start shedding in 2015, assuming your service levels come back?

In terms of the locomotives, I think you are referring to, predominantly?

Locomotives and even in terms of headcount, how should we start thinking about that? Because some of them, it seems like you are just trying to extend some people and put off their retirements a little bit.

On the locomotive side, for some reason, if there's no need for those locomotives, if the network fluidity comes back, we do have a fair amount of leases that we can turn back. So, that's part of the safety lever, so to speak, if the demand profile is not a strong as we currently think it is.

On the crew side, we are hiring, obviously for attrition, but also for growth. And we always have the flexibility, if we need to, to do furlough retention. That's something that we normally don't look at unless we think it's a longer, more sustained period of time that we don't need those crews. Because we do hire them and they are expensive to go put through training school. You spend a fair amount of time and effort on there, so you don't want to do that unnecessarily. But we do have that ability if we are incorrect in our forecast that the growth will continue.

So, Fredrik, in terms of the total headcount for 2015, you would expect growth over 2014?

I think that based on the current volume assumptions that we have, that continues to be robust, I think the answer is yes. I don't think it's going to be significant, because I think the operating leverage is going to be, especially as we get the network fluidity back, I think there's an opportunity to see great leverage there.

Fantastic. Gentlemen, I appreciate the time, as always.

Ben Hartford from Baird.

Fred, just wanted to clarify the comment that you made about the third-quarter 2013 EPS. You had said that the number you are referring to is $0.45 from a year ago, correct?

That's correct.

Okay, good. Not to beat this pricing discussion to death, but I understand that you guys look at the spread between RCAF and price. But you are entering a bit of an unprecedented period with regard to pricing and the truckload rate growth, contractual rate growth is accelerating, and faster than what you guys are realizing within the merchandise and intermodal product, first time in at least a cycle. Is it incorrect to look at core contractual truckload rates as setting the tone for both the intermodal business and even some of the merchandise business when you do set and reprice, say, on an annualized basis?

So, to the extent that truckload pricing growth continues to be above what you are seeing within those core segments, certainly above that 2.5% number that you saw this quarter, that there can be upside, or that you can price to market. You are not beholden to some sort of fixed spread internally between RCAF and what you feel like the market can digest, correct?

That's correct, Ben. I think it's absolutely the right way to look at it.

Okay, good. Thank you.

Cherilyn Radbourne from TD Securities.

I'm just going to ask one. And that relates to international intermodal, which for me was probably the biggest surprise in terms of the volume performance for you and for the industry in the quarter because it's been pretty tepid for a while. So, I just wondered if you could give some color on how much of the growth you think was catch-up from Q1, how much was a pull forward related to the labor contract expiry on the West Coast, and how much you think was organic.

Cherilyn, this is Clarence. I think it's difficult to segment into those three areas, but I will tell you this. Our customers told us that they shipped earlier this year, significantly earlier, in anticipation of a ILWU work stoppages on the West Coast. So, all the ships out of Asia were fully profiled, coming to the West Coast and via the Canal, in order to avoid that. So, that certainly had an impact. There was some impact due to winter weather. And we expect to see that international traffic in the low single digits going forward.

Okay. That's helpful. Thank you, Clarence. That's it for me.

Walter Spracklin from RBC Capital Markets.

This is Erin Lytollis in for Walter. I was just hoping to get some more color on the expansion of crude capabilities across your network. You saw some fairly strong growth and I was wondering where you see that business going forward and the timing of that coming online.

Where do we see crude expansions? Is that your question?

Yes.

Obviously, there's expansions going all on the East Coast, as we speak. They're predominantly in the Philadelphia area. Some are in the New Jersey areas where we are seeing the current expansions. We have two customers that are looking at expanding in the Jersey area. I'd rather, for obvious reasons, not mention their names. But that's where you're seeing the expansions occur.

Okay. And then this is all coming on your network. What sort of volume opportunity do you see from these expansions?

Right now we're averaging around, for 2014, plus or minus 20 trains per week. We could see some slight increase in that as we go forward. There's a finite capacity number, both, as you know, from what the Bakken can produce and from what the refiners can consume.

Okay. Thanks very much for your time.

Justin Long from Stephens.

I just wanted to clarify one thing quickly. Could you talk about the congestion-related costs that you are assuming in your guidance for the back half of the year? Are you assuming they stayed pretty consistent with what we saw in the second quarter?

Yes. What we said in the prepared remarks was that until we see meaningful improvement in the network fluidity and velocity, it is reasonable to assume that that run rate of about $10 million or so a period, or $30 million a quarter, is the right place to think about it.

And you're not assuming that that fluidity improves until 2015?

No, I'm not saying that. I'm just saying right now, from what we are seeing, we're saying if it doesn't improve, it's the right place to be in terms of thinking about what the incremental costs will be. If we see meaningful improvement here during the summer months, which is a possibility as the demand is a little bit lower during the summer as we go through the period here until Labor Day, there is an opportunity we can see meaningful improvement and costs could come down. But that's yet to be seen.

Okay, fair enough. That's helpful. And as a second question, I was wondering if you could talk about what you are seeing in the intermodal pricing environment. Would you say that core pricing in intermodal is pretty close to that 2.6% average between merchandise and intermodal, or is it a little bit more competitive and tracking below that level?

I think you would say intermodal is a little bit more competitive and tracking a little lower than that level that's in there right now.

Okay. Great. I know it's been a long call. I will leave it at that. Thanks for the time.

Cleo Zagrean from Macquarie Capital.

I have to follow-up on the prior questions and some before it in terms of intermodal pricing. Can you help us with a little more detail on the [sliprocene] door to door and what you would call your main business, and the trends for price there, and where do you see that going forward?

You were fading on me there. The intermodal pricing on the domestic door-to-door and where do we see that going?

What is the share of door to door within your entire intermodal business? How come that had such a significant impact on price? If you could break up what you would call core intermodal pricing trend versus door to door.

It's a relatively small percent, the door to door is, of our overall pricing, if that's what your question is.

Okay. So, therefore, we can infer that intermodal pricing across business was relatively weak? In other words, the decline was broad based?

No. I wouldn't infer that at all. I would say that our intermodal pricing was somewhere in the range of around 2%, a little bit above that.

Okay. The second question I had was in terms of the impact of business mix on margin as opposed to price. Can you help us understand how mix would play into your aspiration to get continued strong incremental margins in that 50% range? Thank you.

The margin mix continues in terms of favoring more intermodal. But because of the work that we've done over the last few years to improve the profitability of that business segment, it is now par with the rest of our merchandise business. This quarter we saw an increase in some of our coal business, which is a welcome sign. So, that's certainly helpful, too.

And, so, as we think about the future and the guidance we have in place, I think we have the right mix thoughts there. All our business is profitable and we would like to grow all our business as much as we possibly can going forward. So, we're somewhat indifferent to the mix that we are seeing.

Thank you very much. Really appreciate it.

Everyone, thank you for your attention. We'll see you next quarter.

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