CSX Corp (CSX) 2014 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation third-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, Wendy, and good morning, everyone, and again welcome to CSX Corporation's third-quarter 2014 earnings presentation. The presentation material that we will review this morning along with our quarterly financial report, our safety and service measurements are available on our website at CSX.com under the Investors section. In addition, following the presentation a webcast and podcast replay will be available on the 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.

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 actual performance to differ materially from the results anticipated by these statements.

In addition, at the end of the presentation we will conduct a question-and-answer session with the research analysts. With nearly 30 analysts covering CSX I would ask as a courtesy for everyone to please limit your inquiries to one primary and one follow-up question.

Now before I turn the call over to Michael I would like to remind all of you that today's call will be focused on the discussion of the Company's strong third-quarter results. As a long-standing policy here at CSX we do not comment on rumors or market speculation and we will not address questions that do not pertain to our quarterly results. We appreciate your cooperation.

And 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 third-quarter earnings per share of $0.51, a 13% increase from the $0.45 in the same period last year. CSX also generated record third-quarter revenue of $3.2 billion, up 8% on a 7% volume increase. These results demonstrate CSX's ability to capitalize on the continued economic momentum that is driving broad-based growth across nearly all markets coupled with the secular growth trends in intermodal and the gas and oil markets.

Even with the high level of demand CSX operations have remained stable. We are continuing to work with our customers to meet their current and future needs by adding crews, investing in locomotives and infrastructure to increase capacity. Thanks to those efforts the Company increased operating income by 16% to $976 million this quarter and approved its operating ratio by 220 basis points to 69.7%.

CSX continues to see growth potential across the market. We are confident in our ability to continue to generate substantial value for our shareholders. Now I will 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 macro economy remains strong and the data and our experience suggest a positive outlook for growth. The Purchasing Managers Index came in at 57 in September; a reading above 50 indicates that the manufacturing economy is expanding. This is the 16th consecutive month the PMI index has signaled expansion.

At the same time the Customer Inventories Index declined to 45; a reading below 50 indicates customer's inventories are low and suggests continued strength in the 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 point to continued expansion.

Now let's look at the results on the next slide. Starting at the left side of the chart total volume grew 7% to more than 1.75 million loads in the quarter with strong growth in merchandise, intermodal and coal.

Moving to the right, total revenue increased $236 million to over $3.2 billion in the quarter reflecting overall volume growth and increased pricing across most markets. Merchandise and intermodal account for over 75% of CSX's revenue. Total revenue includes $17 million of liquidated damages related to contract shortfalls in coal shipments which compares to $51 million in the third quarter of last year.

Next the average revenue per unit was up slightly. Here core pricing gains in our merchandise and intermodal markets offset 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 represented about 75% of CSX's traffic base for the quarter.

On this basis all in pricing was a positive 0.2% in the quarter reflecting continued great pressure in export coal markets and the impact of fixed variable contracts in the domestic utility market where volumes are now increasing.

Since the pricing environment for coal has become more dynamic, reflecting global market conditions for exports and our fixed variable contract structure for domestic utilities. And since our merchandise and 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 2.5% for the quarter. This pricing gain is smaller on a year-over-year basis and essentially flat sequentially while still representing a small spread over rail inflation. That said, we remain confident that the value we create for our customers, combined with increasing demand for our service product, provides a solid foundation for growth and sustained pricing above rail inflation.

Now let's look at the individual markets in more detail starting with merchandise. Overall merchandise revenue increased 12% to more than $1.9 billion in the quarter. Volume in the agricultural sector was up 7%. Feed grain shipments continued to benefit from the strong 2013 harvest and ethanol shipments grew as lower corn prices resulted in higher ethanol production levels.

The construction sector group 5% overall reflecting the ongoing recovery of housing and construction activity. Finally, the industrial sector grew 13% led by strength in energy-related commodities including crude oil, liquefied petroleum gas and frac sand.

Moving to the next page let's review the intermodal business. Intermodal revenue increased 6% to more than $450 million. Total volume grew 5% setting a new quarterly record for intermodal. Domestic volume was up 7% driven by continued highway to rail conversions and international volume was up 3% reflecting an economy that continues to expand.

Total intermodal revenue per unit was flat as continued core pricing gains and higher fuel recoveries were offset by mix changes. Finally, we continue to grow our international business by adding new service offerings and making strategic investments. We anticipate opening our new terminal outside of Montreal and completing expansion of our Northwest Ohio hub late in the fourth quarter.

Moving to the next page let's review the coal business. Coal volume increased 7% while revenue was essentially flat in the quarter at $721 million. Domestic coal volume increased 14% with growth in both northern and southern utility shipments, reflecting higher natural gas prices, replenishing of stockpiles and a competitive gain.

Export coal tonnage declined 13% as global market conditions for both thermal and metallurgical coals remain soft. The current API2 spot price of about $72 per ton remains well below the $80, the price level where US coals are more competitive. The Queensland metallurgical coal benchmark has also remained at low levels with a rate of about $120 per ton in the third quarter.

Finally total revenue per unit was down 6% 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 fourth quarter. Looking forward we expect a positive demand environment in the fourth quarter with stable to favorable conditions for 96% of our markets and unfavorable conditions for the remaining 4%.

Looking at some of the key markets: chemicals is favorable as we continue to capture opportunities created by the expanding domestic oil and gas industries. In metals we saw production increase in the third quarter and we expect this trend to continue with demand in the automotive and energy markets being the key drivers.

Strong intermodal growth will continue as our strategic network investments support highway to rail conversions. We expect strong domestic coal volume growth in the fourth quarter as utilities continue to rebuild inventories. Forest products is neutral as continued strength in building products is expected to be offset by lower shipments of wood pellets.

Automotive is neutral as slight growth in North American light vehicle production continues to be offset by modal conversions that occurred earlier this year. Export coal volume is expected to be significantly lower in the fourth quarter. And our best estimate of 2014 volume is now in the mid-high 30 million ton range.

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

Thank you, sir, good morning, everyone. Let me start with a review of our safety as it is our first and foremost priority. In the third quarter the personal injury and train accident rates both increased versus last year's near record lows.

While we are disappointed that the metrics have ticked up slightly this quarter, we remain focused on continuous improvement in safety. We remain a leader in the nation's safest industry and we're committed to both community and employee safety.

Let's turn over to the service performance on the next slide. As you can see on the left, third-quarter on-time originations and arrivals, along with velocity and dwell, were all stable sequentially. While CSX's overall service performance is still below the level our customers and we have come to expect, demand on our network has remained strong.

As you can see on the chart on the right, service levels have remained steady since the end of the first quarter and have continued to support volume growth. And as importantly, our cost of service is improving.

We are working with our customers to meet their rapidly increased demand levels. But as you know, resources in the rail industry take time to be put in place. In that regard, let me discuss the framework on the next page which we've been sharing with our customers to keep them updated on our service recovery efforts.

Now, while elementary, the chart on page 15 conveys the four primary service components, all of which are highly interrelated. We tell our customers there's a need to ensure not only that we have the right level of train crews but the necessary infrastructure and appropriate number of locomotives with a process that anticipates and reacts to changing business conditions. Let me briefly touch on each of the four areas depicted on the chart.

Starting with trained crews -- we have hired about 1,250 T&E employees this year for a net increase of over 300 crews and revenue service this year. We currently have 900 crews in training expect to have over 1,300 by year end. Hiring crews, as you know, takes six to nine months to find the right individuals and train them. I'm happy to report that given the hiring we are doing we're well on our way to having the train crews we need to support both recovery and future growth.

Turning to infrastructure, this is the longest lead time area there is in the rail space. In addition to the actual construction, new projects can take years of planning and getting the necessary approvals from local, state and federal officials.

The good news is that we have finished several projects and have many more underway to help improve network fluidity in Chicago as well as our water level and river line routes in the northern tier. Additionally, we have been steadily increasing our intermodal investment such as the expansion of our Northwest Ohio intermodal terminal which is nearly complete.

Next, and as you can see on the bottom of the chart, the locomotive icon is colored red. While we have added over 400 active units on a year-over-year basis, unfortunately the unanticipated rapid volume growth that we're experiencing has exceeded the current capabilities of our locomotive fleet and is a major cause of our service challenges.

Earlier this quarter we signed an agreement to purchase 300 new locomotives over the next few years with deliveries beginning early next year in 2015. This combined with our own heavy repair program will generate the locomotives we need to enable recovery and again support future growth. Now because these units will not be arriving until after the first of the year we anticipate locomotives will continue to be a challenge for CSX into next year.

Lastly, let me focus on the process bubble for a moment. This is the area most in our control with the fastest cycle time. We are actively working to improve planning with other railroads, especially in the critical Chicago Gateway. We are nearly complete with our winter preparations and, also very importantly, we've been holding ongoing dialogue with our customers to keep them up-to-date on our service recovery progress in order to better meet their continued volume growth.

Now wrapping up on the next slide. While the service is critical our team understands that safe operations is still job number one. This team remains committed to safety and service and I greatly thank them for it and I'm proud to be part of it.

The network performance remains stable and we'll continue working on maintaining the delicate balance of meeting increase customer demand and service recovery. While costs are temporarily higher as we work through our service issues, they have improved sequentially and we expect them to return to normal as fluidity is restored.

Lastly, we remain highly confident that our dedicated operating team gradually restore service to the levels our customers have come to expect from CSX. So with that let me turn it over to Fred for his review of the financials.

Well, thank you, Oscar, and good morning, everyone. Let me begin by providing a summary of our third-quarter results. As Clarence mentioned, revenue increased 8% versus the prior year on 7% higher volume driven by broad-based strength across our merchandise, intermodal and coal markets. Expenses increased 5% versus last year driven primarily by higher volume which I will discuss in more detail in the coming slides. Operating income was $976 million, up 16% or $136 million versus the prior year.

Looking below the line, interest expense was relatively flat to the prior year at $137 million. In addition, other income declined $31 million versus the prior year on two unique items. First, following our recent $1 billion debt offering we used some of the proceeds for early retirement of existing debt for which we incurred an additional expense. Redeeming the debt early generated a positive value of holding the proceeds in cash.

Second, we also incurred some environmental clean-up costs during the third quarter related to a non-operating site. Income taxes were $304 million in the quarter for an effective tax rate of 37.4%. Overall, net earnings were $509 million and EPS was $0.51 per share, up 12% and 13% respectively versus the prior year 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 favorable by $14 million. This reflects $8 million of positive in-quarter lag during the third quarter of 2014 versus $6 million of negative 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 fourth quarter.

Turning to the next slide let's review our expenses. Overall expenses increased 5% in the quarter. I will 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 5% to $291 million due to a higher net asset base. Going forward we are reviewing an asset light study that we normally conduct at this point in the year. Absent any changes we continue to expect depreciation to increase sequentially a few million dollars per quarter reflecting the ongoing investment in our business. Equipment rent was 13%, up to $106 million, driven by higher freight car rates, incremental volume and longer car cycles.

Now turning to the next slide let's discuss our other expenses. Before I discuss the details of these expense categories let me first highlight the shift between our labor and MS&O lines. During the third quarter CSX fully in sourced the management of its locomotive maintenance force. As a result of this change, labor fringe expense increased by $15 million and MS&O expense decreased by the same amount. So overall the change was expense neutral in the quarter.

Looking ahead we expect this trend to continue given the long-term nature of this agreement and future quarter results should reflect this new baseline from labor and fringe and MS&O expense.

Now let me discuss the main drivers for each of the expense categories beginning on the left with labor and fringe. Total labor and fringe increased 7% or $54 million versus last year. Excluding the in-sourcing impact labor and fringe increased $39 million year-over-year of which $25 million was related to incremental volume and $18 million was inflation.

Looking at efficiency and other, labor productivity from volume absorption was offset by incremental overtime and relief crew expense as we continue to incur some incremental costs related to network performance. However, these labor-related costs declined sequentially from the second quarter.

In terms of fourth-quarter expectations, we expect a similar level of labor inflation in the $15 million to $20 million range as well as higher year-over-year expenses related to volume growth. Our ending third-quarter headcount was up 1% versus the end of the second quarter as T&E employees increased to accommodate higher volume. Looking ahead we expect overall headcount to increase an additional 1% or about 350 employees by the end of the year versus our September level.

Moving to the right on the slide MS&O expensed increased 6% or $34 million versus the last year, which includes $23 million of expense related to incremental volume and $10 million of inflation. In addition, there was a $16 million increase in casualty and other MS&O with the majority related to the resolution of claims from prior years. And of course you can see the in-sourcing impact on MS&O that I mentioned earlier.

Looking ahead to the fourth quarter, we continue to expect higher year-over-year MS&O expense related to inflation and volume growth. Finally, expense -- fuel expense declined 3% or $14 million versus last year as the impact of higher volume was mostly offset by favorable price and efficiency. In addition, we cycled an adjustment to an interline fuel receivable from the prior year which drove most of the favorability in the other category.

That concludes the expense review. Turning to the next slide I'd like to highlight our core earnings growth and incremental operating margin.

Looking at the third-quarter financial results and excluding the $34 million in lower liquidated damages that we were cycling from the prior year, the Company generated $270 million of revenue growth that was partially offset by $100 million of incremental expense. This netted to an increase in core operating income of $170 million versus the prior year or an incremental operating margin of 63%.

As we highlighted last quarter, the core earnings strength of CSX's business is again more evident and this quarter's results again underscore our positive outlook for the future. Now let me wrap up on the next slide.

First, we continue to see broad-based strength across our diverse business portfolio and that strength is translating into more visible and more meaningful earnings improvement. As Oscar highlighted, to effectively serve this growth we are executing a resource plan and investing in infrastructure, locomotives and crews to return service to the superior levels that our customers expect.

Looking at the fourth quarter, we expect EPS will grow at a rate roughly similar to the reported EPS growth we saw here in the third quarter. Of course this assumes operations remain stable and volume growth remains strong, albeit at lower level than we saw in the third quarter recognizing that we're not cycling the strong harvest from last year.

For the full year we continue to expect modest earnings growth. As we look ahead CSX still expects to achieve double-digit EPS growth in 2015 and an operating ratio in the mid-60s longer-term. With that let me turn the presentation back to Michael for his closing remarks.

Well, thank you, Fredrik. over the past few years CSX has overcome the challenge of an energy transition in America, absorbing a loss of nearly $1 billion in coal revenue and leveraging new opportunities to sustain earnings growth.

CSX has emerged from this transition a stronger Company. That strength was evident again this morning as CSX delivered record third-quarter earnings for its shareholders and stable service for its customers while reaffirming the Company's bright future.

That future is built on the continued execution of CSX's core strategy. That means enhancing our ability to grow faster than the economy, price above inflation, make strategic investments and produce ever more efficient operations to continue delivering superior shareholder value. That is what you saw drive our performance in the most recent quarter and we expect that strategy to drive our growth going forward.

In short, we remain confident CSX will continue to deliver compelling customer value which directly translates into superior value for you, our shareholders. Now we would be glad to take your questions.

(Operator Instructions). Allison Landry, Credit Suisse.

I was wondering if you could talk about crude prices spiraling downward. And maybe how worried are you about this given that a lot of your recent growth has hinged on energy markets? So I was just wondering if you could maybe help us frame the risk here.

Allison, this is Clarence Gooden. Obviously we have our eye on it with the crude prices this morning approaching $80 on West Texas' Intermediate. But in the near-term we don't see any impact on our crude business at this point in time. We will watch those prices as they test the ceilings of what the Bakken crude is, but we don't see any near-term impact on that at this time. We think it is sustainable.

Okay. And is that view sort of similar for frac and NGLs that you are moving?

Yes we see the same for that, yes.

Okay. Okay, thank you.

Rob Salmon, Deutsche Bank.

Clarence, as a follow-up to Allison's question, you've done a really good job of kind of framing the export coal outlook predicated upon how the prices move. Are there certain price thresholds that we should be thinking about for the crude by rail where it comes more challenging based off of kind of what you see?

And I realize there is more moving parts given there is net backs involved. But I would be curious to get your thoughts around that as well as any early comments you might have about the export coal outlook for 2015.

Well, let me take your second question first. It is really too soon for us to give you any commentary on the export coal for 2015, but we will certainly do that on our fourth-quarter call.

On your first question, I am certainly not an expert on crude spreads here. I did see a discussion this morning, however, by the former President and CEO of Shell Oil in which he said he thought it was very interesting that the OPEC countries may in fact be -- one of the reasons they are bringing down their price of oil is to test to see where American fracking companies would in fact start to shut down wells.

Since nobody knew what that number was; it was a closely guarded secret. So your guess is as good as mine when those would start coming in. But there would obviously be some number. But to my knowledge we are nowhere near close to what that number is.

Fair enough. Appreciate the color.

Thomas Kim, Goldman Sachs.

I just wanted to ask on the intermodal side -- first off, can you give us a little bit of color in terms of where your Intermodal -- domestic intermodal rates are versus TL presently?

They are running in general on the contractual side about 10% to 15% below where the truckload rates are. The spot market, however, is much closer to what the truckload rates are. They would have closed that spot market in the -- due to the tightening up of the truckload demand. So we are probably within 5% of those.

Okay, great. And then just with regard to the comment on the mix shift, can you help us understand what exactly it is? Because when we look at the mix between domestic and international, they are actually -- the shift has been only about 1 point year on year.

So I am wondering if there is more in mix and commodity or is there a mix between increase in long-term customer versus spot. Just if you could maybe give us a little bit more color with regard to that.

And then just I guess also related, is there any reason why the domestic intermodal hasn't -- the share hasn't grown more significantly just given that there has been more growth that we would have thought over the last year with regards to domestic over international?

Well, in our door-to-door service product, which has traditionally carried a higher RPU, it was roughly flat this quarter. And in addition, we saw pretty strong growth in what were traditionally backhaul lane markets and that has had a negative impact.

For example, our UMAX product which moves from the East to points beyond Chicago, which are traditionally back haul flows, has had a healthy volume growth. Even though it has had in RPU growth of around 3.5% that volume has still had a negative impact on the mix.

And the rest of the intermodal business, as you know, is managed on long-term contracts, it has price escalators built in. So it is difficult for us in the short term to get some of those rates up.

All right, thanks a lot.

Bill Greene, Morgan Stanley.

Fredrik, I wanted to ask you for a little bit more color on the 2015 commentary. I think we have all been surprised at the volume growth so far in 2014. And so can you talk a little bit about the confidence on that double-digit growth rate?

Does it suggest that the pricing outlook is superior and therefore incrementals should look better? Is that kind of the key to getting to double digit? Because I would assume volume growth would slow just given the comps. But maybe you can offer some views there.

Well, I mean as I think we said in our prepared remarks, in the fourth quarter we already expect volumes to come down slightly from what we saw -- seen here over the last few quarters. But we still expect a pretty robust macro environment next year and that coupled with some of these more secular things that we're seeing in the energy environment and our intermodal trends continue to point towards a pretty healthy volume environment for 2015 as well.

Clearly, as Clarence mentioned, it is a little early right now to talk about what export coal is going to do, but that is the wild card. We have said that repeatedly and there is probably more downside than upside. But we continue to produce pretty good results, we continue to bring a fair amount to the bottom line even though we are not operating as efficiently as we can.

So the fact that we are going to cycle some pretty significant headwinds we had here this year in the first quarter and even in the second quarter coupled with a good, healthy top-line environment gives us the confidence that we should be able to produce double-digit earnings growth next year.

And, Bill, this is Oscar. The cost structure part, that is mine, we got that one. That is going to be a key focus for us next year. And I think that will be a contributor factor.

Yes, that makes sense. Oscar, in the third quarter -- I think in the first half we talked about a little over $120 million of weather and inefficiencies due to the network challenges. Was there an impact that you can give us for the third quarter how much that might have cost?

Sure, so you are right, it was about $32 million in the second quarter. We estimated about $16 million here in the third quarter. The difference was predominantly that we had less reliance on foreign horsepower here in the third quarter than we had in the second quarter as we've been able to ramp up additional leases and other repairs that we've been doing on our equipment. Overtime it is still running relatively high. But the big delta between the second and third quarter was just that, it was the locomotive costs.

And you said 1-6?

16, yes.

Yes. Okay. Thank you for the time.

Ken Hoexter, Merrill Lynch.

Great bottom-line performance, great to see. Can you maybe, Oscar, address -- the on-time origination and arrivals continue to remain so low and we can see the velocity improving. But why are those measures and metrics stuck at kind of really reduced levels compared to the 85%, 90% we've seen and the past. And what needs to turn? Is that just the employees and locos coming online or what else needs to happen to get the actual rails running on time?

Yes, Ken, great question. Yes, I think the public measures have always been and will continue to be sort of trailing indicators. I think getting back up to the pre-service recovery levels is going to take locomotives primarily.

I think we have got a lot of the crews but we need 100 or 200 more locomotives here over the next few months. That would take us back to those 85%-90% levels, that is the biggest factor. That is why on that service framework, again, as you know, it takes all of those things being interrelated, but for us the red icon is power at this time.

And then we can presume there is no issues with one manufacturer making them or with the new Tier 4 or anything else in terms of getting those locos?

Well, getting them is difficult, right, everybody is sold out. There is not a single piece of power you can acquire. We have got -- we have ordered 300, we will be getting our share of them. With your question regarding Tier 4 that is being tested, the Western roads in particular are doing that.

And the one model that is going to be coming out of one of the suppliers has actually fared well under heavy service. So we are confident that those new locomotives will do well. Now half of our order is new and half of our order is new versus old.

And just a follow-up on the share pricing. Is there, Clarence, any thoughts on the decelerating peer pricing? Given demand is so strong why we continue to see the peer pricing metric fall. It is half a point but just why we see that downtick?

Ken, that was mainly in one of our market areas. I think you are going to see very robust pricing going forward. We are concentrated and focused on our pricing. So in regards to the question that Bill Greene asked earlier, pricing you will see going forward being very strong and very robust for us.

All right, appreciate the time. Thanks.

Chris Wetherbee, Citi.

Maybe a question on that utility coal side; just curious how that restocking is playing out. Just wanted to get a rough sense of how your utilities that you serve are, in terms of historical inventories or inventories relative to its historical levels. Are we getting closer? How much longer do you think this plays out?

The North, Chris, is almost at their target levels. In fact, you could say they are at target levels. The South is still building, and by the fourth quarter should be at target levels.

Okay, so there is about -- it feels like there is about one more quarter or so to get prepped, and then we will see what the winter brings us.

That's right.

Okay. And then my second question, just a little bit of a bigger picture stepping back and thinking about the 65% OR target. As you stand with it now and the market as it stands today, could you give us some sense of sort of what you need to see happen to get toward that target, move towards that target? You made great strides on OR in the third quarter. Just want to get a rough sense of sort of how to think about the puts and takes towards getting to that 65%, and maybe a little bit of color when that could potentially happen.

Sure. So obviously this is -- we've put together two quarters now in a row below 70%. And we have said we want to move to the 65%, is kind of the target that we have out there. And clearly the foundation for that is service excellence. We need to restore service to a level that we expect from ourselves and our customers expect from us.

And as we do that, we think three good things will happen and we have seen that in the past, which is that we continue to price above inflation. And we see the market tightening up and we see opportunities to accelerate our pricing.

Two, we continue to see robust economic environment, and we see now the positives of a new energy environment that should allow us to grow faster than the economy as a whole. And then as we get our network velocity up to the level we expect, we should also see costs coming out of the system again. Between those three, which are really the levers we've been pulling for an extended period of time, we see the math is pretty compelling. It gets you there over time.

But over the last two years, as you have seen, with $800 million of coal coming out in terms of our top line, we have stood still for a period of time. As we know transition out of that period, we feel the momentum is coming back again. So we feel pretty good about where we are heading now.

So natural progression over the next couple years, I guess?

Yes.

Okay, thank you.

Tom Wadewitz, UBS.

Good morning. Wanted to ask Clarence a little bit about how much visibility you have to pricing at this point. I would think that with some of the multiyear contracts that would be expiring next year, you probably would have been in negotiations at this point. Maybe you have some of those deals signed already.

So can you give us a flavor of what you are seeing for pricing for 2015, just in terms of either the multiyear contracts or other business? And perhaps also what -- how much has already been repriced for 2015?

We are well along in our pricing for 2015. I would tell you that in excess of 50% of our contracts that we have to renew for 2015 have been repriced. It is looking very good. That is why I made the statement earlier that prices were going up for 2015. I felt very positive about what 2015's pricing is looking like. It will be much more robust than you've seen probably in the last three to four years for CSX.

So when we think about that -- what more robust means, does that mean a percentage point higher? Does that mean more than that? Could it be 2 or 3 percentage points higher than the pricing you have seen the last couple years?

It means significantly improved.

Okay.

Welcome back, Tom (laughter).

I don't know if that counts as my second or not. I will try to -- Oscar, do you have a quick thought on the timing of the locomotives coming up? You said 300 I think is for multiple years. You need 100 to 200 more, but when do you get 100 to 200 more? Is that first half next year or --?

Yes, thanks. So the early part of next year we'll get 100 new and then we are hoping for early delivery of a couple hundred -- of the second hundred later in the year. But we also have our internal what we call heavy repair process that should deliver roughly between 100 and 150 over that same -- between now and the middle part of next year. So we have got another outlet just other than purchases -- it is just timing.

That is great. I appreciate the time. Thank you.

Cherilyn Radbourne, TD Securities.

My question relates to Chicago. It is my understanding the rails have agreed to a series of protocols that will be triggered automatically if certain thresholds are tripped this winter. And I was just wondering if you could give us a bit of color on how that will work and how you think it will improve the industry's recoverability?

Yes, Cherilyn, this is Oscar. Yes, certainly there is a broader set of issues and a very complex environment, right, kind of spider network, six Class I's, heavy commuter and passenger rail on the plays. So it does require a what of coordination.

What is called the CTCO, which is in essence the terminal operating team that is represented by most of the railroads, it has been a coordinating factor there and has done a pretty good job. Remember we forget that Chicago just got slammed with a huge amount of volume which has created a little bit of a tangent.

So knowing that, knowing that another winter is coming and that heavy volumes continue, we have been working across most of the industry to sort of get CTCO to act more like a single terminal. We're going to 24X7 operations during the period. A lot more engagement between all levels and most of the railroads again.

And then importantly to your question, improve the informational planning tools. Because for a while there was kind of word of mouth. I called you and said I was in trouble and then you tried to fix it. Or you didn't see that problem.

And so rather than taking the human aspect of that, let's put it in a system, put it in a scorecard, if you will, and then that will drive what we call an alert status that will increase the level of interaction and coordination.

So it is a combination of people communicating more, using tools to get facts and data so that we are not guessing. And then really there is kind of a great level of trust, desire and capability for everyone to work together there. So it is a broad, complex environment and we are focused on getting that done for the next few months.

That is great, and that is all for me. Thank you.

David Vernon, Orenstein.

So, Fredrik, as you think about the incremental margin performance going forward, what do you think is the right sort of range we should be looking at into 2015? It seems like the volume driven leverage is having a good effect, and if Clarence is right you are going to get more pricing. Should we be actually expecting the incremental margin performance to step up next year?

We have said that in order to get to our mid-60s target that we need to have incremental margins above 50% this quarter depending on how you look at it, somewhere between 50% and 60%. And I think that is a good place to be.

As you think about 2015 specifically you are right, we're going to have I think an improved pricing environment. But you are also going to have a period of time where we are going to have to essentially over resource slightly in order to get the velocity of our network up and running.

So there are some puts and takes there, but you clearly have to be in the 50% to 60% range long-term in order to get to the place where we need to get to.

Okay. And then maybe just as a follow-up, Michael, we are talking a lot about the tightness of the rail infrastructure. And I would love to get your perspective on an industry issue which would be not specific to any type of specific deal.

But do you think that consolidation across the larger Class I's could actually improve the capacity in the network in a way that would not be achievable without a further consolidation or do think that that it is less of a reality going forward?

I think what we see out there, David, is that all the railroads are increasing their capacity similar to what we are doing. And I think those will produce the capacity needed to move America's freight.

So you don't -- we wouldn't see an extra step up in efficiency through consolidation across some of the Class I's?

You might actually see a step back. As you know, in the past mergers there have been severe service disruptors after one of those transactions.

Great, thanks very much for the commentary.

John Larkin, Stifel Nicolaus.

Just wanted to bore in a little bit more deeply on the $16 million that was the cited cost of the congestion in the third quarter for the Company, quite a bit down from where it was in the second quarter. But that strikes me as being a relatively low number given the extent and far-reaching nature of the congestion.

So as you resource up by adding more people, add all these locomotives and so forth, presumably that is going to cost more on the other hand than the cost of congestion is costing you presently. Is that going to provide a little bit of a margin headwind over the next say two to four orders as you go forward?

I think you are pulling on one of the reasons why we are not putting that explicit number into our earnings report at this point because the calculation itself becomes more complicated as you start to ramp up additional hiring and so forth.

But if you look at where we were here in the third quarter, while we've had some additional people in training, the big driver really was the difference in terms of how we have sourced our locomotives for the quarter. And so it has come down because it is a lot cheaper to get our leases -- use leased locomotives versus the [foreign] horsepower.

And as you think about the next couple of quarters, to your point, there will be incremental cost that will come in as we bring on additional locomotives, as we bring on additional maintenance for those and additional hiring that we are doing. But -- so I think that is a fair point.

But then again, all those resources -- again remember, investment equals better service and service equals better volume and margins. And that is what we are -- that is the reason we do all this. And I think other than just bringing on equipment our process -- we are spending a little bit better. Again, the indicators you see out there are trailing and you will begin to see more of the financial -- better financial impact here over the next couple of quarters.

Thank you for the answer. Just maybe as a follow on. A while ago you shifted to the fixed and variable cost pricing approach for utility coal contracts, volume has spiked as utilities have scrambled to sort of replenish their inventories and stockpiles.

Has the fixed and variable pricing model worked the way you thought it would? And was but one of the reasons why you were able to pick up a little competitive market share that you touched on just briefly during your formal comments?

John, this is Clarence. One, it has worked the way we at expected it to work. And two, it is not the reason we made a competitive pick up.

Okay. Thank you.

Jeff Kauffman, Buckingham Research.

Congratulations. Two questions, one financial and then one a follow-up to the system fluidity question. Fredrik, how have these changes in investments affected your capital budget thoughts for 2014 and 2015? And can you address the drag on operating cash flow from the reversal of bonus depreciation? How much is that weighing on operating cash flow and will that change as we get into 2015?

Sure. So on -- in terms of capital I think we have a better idea in the fourth quarter. But clearly because of the locomotives we are going to be purchasing next year, we are probably looking at the higher end of the 16% to 17%, probably around 17% realistically. In terms of the cash flow, just ask me that question again?

Well, bonus depreciation reversed and that has been a drag I thought of about $200 million to $300 million on operating cash flow. And I was just wondering if we are going to start to mitigate that in the next year or two and what that drag is likely to be.

Sure. So next year I think will be the height of that drag. We started seeing a little bit here in this year, but next year essentially our cash taxes will be almost at the statutory rate, so 36%-37%. There won't be many opportunities to defer taxes next year because of the fact that we have enjoyed that bonus depreciation for so many years.

But as you move into 2016 you will start building up some of that depreciable base again. Now all of this assumes that bonus depreciation will not be extended, which there is still some talk about. But right now it looks like about 250 or so -- $250 million of impact on our cash flow year over year just from the fact that bonus depreciation is going away in 2015.

This is Michael. I would just add when I go to DC I think the general sentiment is they probably will do the tax extenders before the end of the year.

Okay. And then, Mike, a thought question. A lot of people that invest in the stock today weren't around in the 1990s when we had the service issues and that led to the STB's mergers moratorium and then the new rules.

I heard your answer to the earlier question that consolidation would probably muck up the system. But in terms of the concept of consolidation there was a reason the STB made it tougher.

Do you think in this environment when service across the industry is struggling that the argument can be made that service would be better as a result of consolidation? Or that any large consolidation could even be likely in this environment?

Well, I think all this is very speculative. But as you know, the STB is very concerned about the service levels being produced by the industry with this surge of business. And it even asked for new reports on a weekly basis to monitor that.

So I might speculate they would be very cautious about this because in the past they have created disruptions and the industry is already somewhat slowed down by the tremendous growth in the volumes.

So you would argue that the regulators would be very skeptical in this environment anyway?

That would be my speculation, but you'd probably be better to ask them.

Okay, very good. Mike, thanks for your view.

Scott Group, Wolfe Research.

Fredrik, if we take out the liquidated damages this quarter and a year ago, you still saw a pretty big increase in other railway revenue. Can you give us some color on what that was and if that is sustainable or not, how we should model that going forward?

Yes, if you look at where we are on other revenue, I think there is a couple other drivers if you look at a year over year. Clearly we are seeing a little bit of higher incidental revenue predominantly in intermodal because of the tight capacity environment that we find ourselves in. We see some of the subsidiary railroads have done a little bit better than they did a year ago.

And then last year with a little depressed because of some of the revenue adjustments that we had. So that kind of explains it. So I would say that this quarter was a pretty good run rate. I think historically I have said $80 million to $90 million is probably a good place to be, we were slightly above that here this quarter. But somewhere around $80 million to $90 million is probably a pretty good place to be in other revenue, excluding any liquidated damages.

That is great. And then the guidance for next year, if I remember when you first laid it out for us there was this assumption that coal would stabilize. And now you don't add that caveat as much about coal stabilizing.

So do you think you need coal to be flat next year? Or is there enough going on in pricing and merchandise growth where you can still get to the double-digit earnings growth next year even if coal gets worse next year?

I think we're trying to stay away from any specific market and try to predict what it will do. Because as we have tried to do that in the past we found ourselves that we usually are wrong -- either good or bad for that matter. And so, we try to stay at a high level.

As we look at next year we still feel that double-digit is the right place to be. But clearly there are lots of pluses and minuses. We got the fact that the macro environment, as I said earlier, is positive. We've got a tightening capacity environment that should be helpful in the pricing side.

But then you do have export coal and you do have the fact that we need to see the cost coming out of our system as we short-term over resource but then see the cost coming out.

And then the thing that you don't know what is going to happen is obviously weather. We just don't know the impact of weather both in terms of utility coal stockpiles and we don't know weather in terms of the impact of our network performance.

So take all of that together and when we add that and we'll look at it and we still say that double-digit is the right place to be.

Okay. Thank you, guys.

Jason Seidl, Cowen.

Good morning, this is actually Matt Elkott for Jason. Thank you for taking our question. I want to go back to the locomotive topic. My question is assuming current freight demand levels, when you guys start receiving the new locomotives is the focus going to be on moving more freight or is it moving similar freight levels more efficiently?

Yes and yes, I think. Interesting question, but, no, absolutely. I mean, I think there is -- whatever pent-up demand in customers that we have some areas where we can easily use more power will generate more business. But also importantly, to sort of turbocharge our system to spin more rapidly. So it will be used for both of those areas.

Okay. And just a quick follow-up on the export coal topic. Have you guys had to do more on the rate front in order to keep producers competitive with your fixed variable structure?

Matt, this is Clarence Gooden. First, we don't have fixed variable rates in the export coal. But to answer your question I think you were driving at, we said earlier -- on last quarter's call and to reiterate on this one, we are at the bottom on the export rate. So we are doing nothing -- we are as low as we can go. Everything from here forward is up.

Okay, great. Thank you very much.

Ben Hartford, Robert W. Baird.

I guess this is for Oscar. I just want to get a little bit more specific in terms of service expectations. You had talked about gradual improvement and I think Fredrik had talked about returning to service levels that you and your customers expect. I'm just wondering more quantitatively what does that mean.

Do you think if we use the high watermark of train velocity for let's say it was 2013, is it reasonable to expect that you can get back to those levels, the cycle, and we can define a cycle for as long as we need to? I mean 2015, can train speed velocity get back to 2013 levels? Is that a realistic target?

Do you think that -- have you seen enough to think that surpassing those levels is unreasonable as well? I am just trying to think -- trying to get a perspective on how quickly and how fully we should expect service to be restored.

Yes, I think to reiterate what was said before it is a gradual and not linear as we go into really the first half of 2015. I think after that fact I think you -- again, these things being trailing indicators, you will begin to see them markedly increase. And, yes, to current -- to previous levels and not necessarily static of that.

I think as we spend more -- we had two record years before this particular issue. I think it is easy to forget that. But I think once we get past this, really this power resource and again our volume sort of begins to stabilize as opposed to the surges that we have had I think is important.

I'll tell you the confidence that I have from seeing all this just in this quarter alone, July we had about 14% GTM growth and that is a month where everyone takes off for vacation in our employee workforce in the union. And we struggled with that. I mean that was a power and crew issue.

In our business the ability to recover is critical. And the fact that in this quarter you are seeing the results that we have, given the fact that a good four to six weeks was really a struggle period I think sort of gives me the confidence that our recoverability process is there. Even with limited resources. So as we get more I think we will improve again gradually but not necessarily linear.

Okay and then I guess just a follow-on on that point. In terms of the employee count, it did -- growth on a year-over-year basis did accelerate modestly through the quarter. Is there an idea when that growth rate will peak and then begin to decelerate?

I think we expect by the end of this year to be up about 2%. And I think you will see a slight increase in the first quarter as well. But it is nothing significant. The predominance of our hiring right now is in the T&E ranks and some on the support side and the mechanical side. But it is not a significant increase.

Okay, thank you.

Keith Schoonmaker, Morningstar.

Kind of a question also related to crewing and labor. Longer-term question. What portion of TD labor works on hourly contracts now and do you see moving to hourly based compensation as beneficial for productivity and quality of life?

I don't think in terms of our T&E folks we have any hourly workforce. I think that obviously that could be a benefit. The question is ultimately what do you have to do in order to make that work economically with the unions as you do go through those negotiations.

Maybe, Fredrik, I could switch to a CapEx question in light of the locomotive orders in your remarks that around 17% of sales would be invested next year in CapEx. There has been a big slug of CapEx with PTC and maybe can you give us a quick update on where the spending is this year and next? And do you expect that CapEx would remain still in the 16% or 17% range even after PTC is fully invested at least for the heavy capital portion?

Yes. So, PTC is above our core capital guidance, so that 16% to 17% -- around 17% next year excludes PTC. If you look at PTC in itself, we are spending about $300 million this year and by the end of this year we will have spent about $1.2 billion.

We've said that cost is approximately $1.7 billion in total at least. And we will probably spend somewhere in the neighborhood of the same amount we are spending this year next year, and then it will start coming down after that.

Okay, great. Thank you.

Walter Spracklin, RBC.

So two questions here, one for I guess Clarence, one for Oscar. And, Clarence, just really a clarification on your fourth-quarter outlook in particular for domestic coal and ag. Given the change in compares going into the fourth quarter 2013 they are quite substantial. I mean you did 15.5 million tons in fourth quarter of 2013, but you are running at a 20 million run rate this quarter -- or this year.

To say that it is favorable I mean it would have to be up 25% to 30% to maintain the 20 million run rate. So are you indicating that we should look at some kind of seasonal drop in the fourth quarter or do we run it at that kind of 20 million clip that you have been experiencing this year even though it means up 20 -- 25%, 30% year over year?

You talking about in coal?

Utility coal, domestic utility, yes.

Oh, domestic utility coal.

Where -- I mean you are 15.5 million fourth-quarter 2013, but 20 million last quarter. So I mean if we are favorable, yes, up year over year you would have to be really up 25% to 30% to maintain 20 million tons. Just curious if that is what you are guiding. Are you guiding kind of continued 20 million or are we looking at a rather substantial downtick given the seasonal nature of the fourth quarter if seasonal at all?

Well, I am not looking at it on my sheet here in terms of tons, I was looking at it in terms of percentages. But I am guiding you to strong, a very strong fourth quarter in coal on a year-over-year basis.

Right, okay.

Utility coal.

Utility coal, okay. And I guess the same question kind of is for ag, right, except the flipside. You had a very strong fourth quarter last year, 113,000 carloads. This year you're -- I mean this quarter you're 98,000. So flat would it mean a significant downturn in ag. Just curious if you are guiding us here relative to third quarter or relative to last year fourth quarter?

Relative to the last year fourth quarter.

Okay, all right. Oscar, just a follow-up on the congestion side. You indicated that there is lots of opportunities that you have internally, all the railroads have internally to increasing capacity through your own strategies. At what point does that get exhausted? In other words, when you have exhausted a good degree of your own capacity expansion issues or initiatives, where does the next pinch point come up?

This is Michael, let me tackle that. I think what we find is we have a fair amount of ability to continue to expand. A fair amount of our network is single track, we can add a second track to that, in fact a long passing siding and making it double track.

So we have the ability on our line of road to incrementally add capacity and we are in the areas that are growing. So I think the horizon with which railroads can continue to increase their capacity on their own I think is fairly long term.

Okay. So you are saying the next pinch point, several pinch points are all kind of inter -- or intracompany, not necessarily between interchange points of Chicago or with your supply chain partners, anything like that?

Well, as Oscar said earlier, Chicago is complex and it is always going to be complex. And we are working cooperatively to increase the throughput there. But I think your categorization and most of the needs to create capacity are internal to the existing individual railroads.

Okay, thank you very much.

Justin Long, Stephens.

First one I wanted to ask was on intermodal margins. You have talked over the last few quarters or so about how they have caught up to other commodity groups with the exception of coal and chemicals. But as you look out over the next several years and think about the opportunity to get price and also build density, do you think that intermodal margins can be significantly better than the non-coal, non-chemicals businesses?

Well, certainly intermodal margins are going up, they are going up for a couple of reasons. The trains are getting longer, the double stack clearances are obviously helping getting more density on the trains. The efficiencies that we have in the newer and more modern terminals with the automation that made the margins better.

And frankly, the price increases that we are getting in the marketplace now, both in our international business and in our domestic business, has gone a long way towards improving those margins. So I think you will see margin improvement in the intermodal marketplace as we move forward.

Justin Long

Okay. And second question I went to ask -- I know there is several intermodal terminal projects on the network, you mentioned Montreal, the expansion at Northwest Ohio in the prepared comments. But is there any way you could quantify how much capacity the current intermodal terminal projects that are underway will add to your network?

Well, I don't have those numbers right in front of me, but we can make them available to you.

Okay, great. I will just follow up on that. I appreciate the time.

Cleo Zagrean, Macquarie Capital.

My first question is about the outlook for rates on coal. You have already stated that you see the export rates only going up from here in terms of your stance. What do you -- where do think we should see coal rates all add up to when we also consider the impact of fixed variable contracts on the domestic front and any mix issues?

Well, I think Clarence -- this is Michael, I think Clarence actually said that the export rates will not go down anymore. I think they won't go up unless we see a change in the world marketplace. So he was not saying there were going to go up, he was saying they would not go down anymore. On the domestic side, Clarence, maybe you could address what you are seeing there.

On the fixed variable, obviously as the tonnage goes up on that part of the fixed variable, and about a third of our contracts are under fixed variable, the average RPU will go down as the volume goes up. If the volume stays flat next year then you will see the rates will stay the same. If the volume goes down then the RPU will go up next year.

But your base pricing is going up.

But the base pricing itself is going up.

Thank you. And my second question was with regards to EPS guidance. Prior to today, I think as of last quarter or even the most recent conference, you were saying that you expect to return to double-digit EPS growth beginning in 2015. And I would have taken that to mean that's the beginning of a series of years.

Now you are saying you expect double-digit growth in 2015. Should we take this to mean any kind of change in long-term guidance for EPS beyond 2015? And any other comment you would like to make for beyond 2015 I would greatly appreciate it. Thank you.

No, I think that overall our guidance has been 2015. I think we tried to stay away from longer-term guidance than that because of the fact that it is hard to predict. But our overall arching goal is to getting our operating margins down to the mid-60s and that is the longer-term guidance that we have. So it is no change in guidance from that perspective.

Thank you very much.

Thank you. Thank everyone, we will see you again next quarter.

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