CSX Corp (CSX) 2015 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation second-quarter 2015 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, Treasurer, and Investor Relations Officer for CSX Corporation.

Thank you, Shirley, and good morning, everyone. Again, welcome to CSX Corporation's second-quarter 2015 earnings presentation.

The presentation material we'll be reviewing this morning, along with our quarterly financial report and 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 that same website.

This morning, our presentation will be led by Michael Ward, the Company's Chairman and Chief Executive Officer, and Fredrik Eliasson, our Chief Financial Officer. In addition, Oscar Munoz, our President and Chief Operating Officer, and Clarence Gooden, our Chief Marketing Officer, will be available during the question-and-answer session.

Now before I turn the presentation over to Michael, 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 disclosures and the accompanying presentation on slide 2. The 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 approximately 30 analysts covering CSX today, and out of respect for everyone's time, including our investors, I would ask as a courtesy for you to please limit your inquiries to one question and, if necessary, a clarifying question on that same topic.

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

Well, thank you, David. Good morning, everyone. I am pleased to report that yesterday CSX announced second-quarter financial results for its shareholders that included all-time Company records for operating income and operating ratio as well as earnings per share which were $0.56, up from $0.53 reported in 2014. Overall, significant operating efficiency helped offset year-over-year declines in revenue and volume.

Starting with the top line, revenue in the quarter declined 6% to $3.1 billion. Pricing gains were more than offset by lower fuel recovery, a changing business mix and a 1% volume decline as we cycled last year's demand surge.

At the same time, we have the resources in place to meet customer demand across the network, supporting improved service performance and operational efficiency. That efficiency, coupled with lower fuel prices, helped decrease expenses by 9% and delivered all-time records in operating income at $1 billion and an operating ratio of 66.8% for the quarter.

We expect service momentum to continue as we progress toward the record service levels we saw in 2012 and 2013. That service is the foundation for driving long-term growth and value creation for our shareholders as it also supports our ability to price to the value of rail transportation and produce ever more efficient operations.

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

Thank you, Michael, and good morning, everyone. Let me begin by providing some more detail on our second-quarter results.

Revenue was down 6% versus the prior year, driven mainly by $183 million of lower fuel surcharge recoveries. At the same time, the impact of negative business mix and lower volume were essentially offset by core pricing gains.

Volume decreased 1% from last year with low commodity prices impacting coal and crude volumes and some of our merchandise markets, particularly metals, being challenged by the strong US dollar. Core pricing continues to improve sequentially and for the quarter was up 3.5% overall and 3.9% excluding coal.

Other revenue increased $46 million versus the prior year. The primary driver was a cycling of about $20 million negative impact to the in-transit reserve last year, coupled with a positive impact this quarter from a similar amount as network performance improved significantly.

Expenses decreased 9% versus the prior year, driven mainly by the impact of lower fuel prices. Our ongoing focus on efficiency drove $45 million in productivity gains in the quarter, while lower volume resulted in $32 million of cost reduction versus last year. In addition, we recorded a $17 million gain in the quarter associated with the sale of an operating rail corridor.

Operating income exceeded $1 billion for the quarter for the first time in CSX's history and was up 2% versus the prior year. Looking below the line, interest expense was similar to last year, while other income was favorable as we cycled environmental charges for non-operating activities from the prior-year period.

And finally, income taxes were $334 million in the quarter, reflecting higher pretax earnings. The effective tax rate was about 38%, which is consistent with our expectation going forward.

Overall, net earnings were $553 million and EPS was $0.56 per share, up 5% and 6%, respectively, versus the prior-year period. Now, let me turn to the market outlook for the third quarter.

Overall, we expect volume to decline slightly in the third quarter. Although we expect a slight decline of the higher 2014 base, CSX portfolio remains balanced with several growth markets offset by challenging near-term market dynamics in other. We are projecting favorable conditions for 49% of our volume in the third quarter and stable to unfavorable conditions for the remaining 51%.

Strong intermodal performance will continue as our strategic network investments support highway-to-rail conversions and growth with existing customers. Increased infrastructure development projects continue to drive a favorable outlook for minerals. Agricultural is neutral as strength in domestic grain shipments closing out the prior harvest is offset by a weaker ethanol market as a result of higher inventory levels.

Automotive volume is expected to be similar to the strong level we saw in the third quarter last year, reflecting North American light vehicle production. Chemicals is expected to be neutral due to lower drilling activity, stemming from the continued low commodity price environment which would put additional pressure on volumes in our crude and frac sand businesses. Both markets are expected to decline by about 15% in the third quarter; however, strength in plastics and LPG will keep the chemicals portfolio stable.

In the unfavorable category, with sustained low natural gas prices under $3 and high stockpiles going into the heart of the summer season, domestic coal volumes will decline close to 15% in the third quarter and for the full year we expect volume to be down approximately 10%. Export coal volume is expected to be lower in the third quarter, reflecting global oversupply and a strong US dollar, although we still expect about 30 million tons for the full year.

Forest products will benefit from steady housing gains as inventories are worked off, but paper products remain challenged due to the secular trends in that market. The metals market is expected to be unfavorable as steel production remains below prior-year levels with a strong US dollar encouraging higher imports. The phosphate markets will draw down on existing inventories and we expect buying behavior to be cautious going into the new harvest season.

Overall, on a sequential basis, intermodal will experience the typical third-quarter increase going into the peak season, while the merchandise segment will remain essentially flat and coal will be down. Turning to the next slide, let me talk about expectations for expenses in the third quarter.

Beginning with labor and fringe, we expect third-quarter average headcount to decline sequentially by approximately 1% as we align employees to the lower demand environment. We expect labor inflation to be around $25 million in the third quarter, which is a reduction from the levels seen in the first half as union wage inflation becomes less of a headwind. In addition, we expect labor and fringe expense to benefit from further network fluidity improvement and efficiency as we remain focused on increasing train length and aligning crew starts.

Looking at MS&O expense, we expect inflation to be offset by productivity gains. We also expect to incur remediation costs in the third quarter associated with the recent derailment in Maryville, Tennessee. Fuel expense in the third quarter will be driven mainly by lower cost per gallon, reflecting the current price environment and continued focus on fuel efficiency. We expect depreciation in the third quarter to increase $10 million to $15 million versus the prior year, reflecting the ongoing investment in the business.

Finally, equipment and other rents in the third quarter is expected to stay relatively flat to last year with higher freight car rates offset by improving car cycle times. Now let me wrap it up on the next slide.

CSX delivered another strong financial performance this quarter and, as Michael mentioned, we set new all-time records for operating income, operating ratio, and earnings per share. Looking ahead to the third quarter, while service excellence will continue to drive continued efficiency gains and strong pricing to support long-term investment in the business, we expect third-quarter EPS to be relatively flat to the prior year. Included in this outlook we expect to incur a least a penny impact related to the Maryville, Tennessee, derailment.

In addition, we will be cycling a strong demand environment last year, which, coupled with the dynamic conditions we're facing, is expected to impact our volume growth. Domestic coal continues to be a significant headwind and we now expect that market to be down close to 15% in the third quarter.

Looking at the full-year 2015 earnings, we are still targeting mid to high single-digit EPS growth. However, given the current energy environment, achieving the upper end of that range will clearly be challenging.

That said, we still expect to make meaningful improvement to our full-year operating ratio and with improving service driving efficiency and strong core pricing that supports investment in the business, we are confident in the Company's future and our progression towards a mid-60%s full-year operating ratio.

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

Thank you, Fredrik. As you've seen today, CSX produced excellent results in the second quarter for its shareholders in a challenging market environment by driving operating efficiency with the committed efforts of our 32,000 dedicated employees. And we continue to focus on the actions that are foundational to our long-term success.

Delivering excellent service supports growth and operational efficiency, which, in turn, creates customer value that enables strong pricing for the value of the service we provide and allows us to continue driving earnings growth and margin improvement. We are pursuing new opportunities across our diverse portfolio and further improving network performance to serve consumers and producers throughout the global supply chain and to create value for you, our shareholders.

Thank you for your interest in CSX and we're now glad to take your questions.

(Operator Instructions) Brian Ossenbeck, JPMorgan.

Good morning and thanks for taking my call. So, one thing that stood out is this is the first time in the quarter where you've put all-in numbers in core merchandise, intermodal, same-store sales pricing results anywhere really close to one another, including the last quarter.

So I was wondering: how much did the shift in the business mix impact those numbers? Could you have had even higher pricing trends if the commodity carloads didn't drop off about 4% in the quarter? Any other color on that would be helpful. Thank you.

Brian, this is Fred Eliasson. The big driver here is that we're cycling the actions we took last year in the export coal markets, and as a result, we're seeing those two numbers harmonize more now. And we expect that going forward as well.

Okay. So you expect them to be harmonized in the near future at the same level in that 3.5% to 4% ballpark?

No, we -- what I'm saying is that the gap between the two numbers, between our all-in pricing and the non-coal pricing, has been exacerbated because of the actions we've taken over the last year or two in actual coal markets. We are now, as we move into the third quarter, moving past those actions from last year. And I think over time we continue to expect strong pricing in all our markets as we continue to price to market and ensure reinvestment in the business. So I think that gap will be much, much more narrow going forward.

Chris Wetherbee, Citi.

Good morning, guys. Thanks. Wanted to talk about sort of the productivity gains that you are getting. You've seen the cost from efficiencies pick up 2Q to 3Q. Presumably, as service continues to improve, those numbers should get a bit better in the back half, but just wanted to get sort of an update on how you think about the back half in terms of productivity and efficiency gains from a cost perspective.

Yes, this is Fredrik again. We've gone off to a good start here this year. Obviously, $45 million here in the second quarter; about $41 million in the first quarter. We have said that we still think we can approach $200 million for the full year, but probably not as close as we originally had thought because of what we saw in the first quarter because of weather and also because of the fact that the volume environment is not as strong as we had originally anticipated.

However, we're very much focused on driving efficiency gains. And as -- but just implied by the first-half performance and our guidance for the full year, we're going to have a strong second half as well.

Okay, great. Thanks, guys.

Tom Wadewitz, UBS.

Good morning, Michael. Wanted to ask you a question on coal. I appreciate the commentary on third quarter and kind of how to look at things.

If you look beyond third quarter, how might we think about when coal volumes might bottom, both on the utility and on the export side? Do you think that kind of down 15% in fourth quarter and then maybe you are flat next year, or --? How do we think about that?

Because it just seems like the pressures are in place, both utility and export, and it's hard to -- looking out a couple quarters it's just hard to know how to think about how coal volumes might play out. Thank you.

Well, Tom, this is Clarence. It's looking like the fourth quarter could be -- easily, if gas prices remain where they are now, could be a repeat of the third quarter. It's probably too soon to tell about what export is going to look like next year, but it certainly won't be as strong as it is -- has been this year. If the Australian benchmark stays where it is now, the Australian dollar stays where it is now, which is about $0.74, and the API 2 stays where it is now, which is in the high 50s, next year won't be a good export year.

But if you said the current conditions persist, do you think coal is down next year further or do you say, well, it's already been down enough this year, so it's flat?

Well, there's certainly more upside than downside for next year, but could be down.

So a lot depends I guess on the weather and --

Weather and gas prices are.

-- where gas prices are, right?

Right, weather and gas prices.

I think just to clarify what Clarence said, I think there's probably more downside to the coal volume next year than there is upside.

Right.

If the current -- if gas prices stay and the export markets are -- kind of remain challenging?

Yes. Based on what we're seeing right now, both between domestic and exports, there's probably more downside to our volumes for 2016 than there is upside in those two markets.

Okay. Yes, I know it's a tough market to figure out, so I appreciate the color.

Allison Landry, Credit Suisse.

Good morning. Thanks for taking my question. I was wondering, in terms of the fourth quarter, do you think that you could grow earnings year over year, even if the volume environment remained soft, just given the acceleration in productivity gains, getting the network back in balance, and then continuing to see acceleration in the core pricing gains?

Well, I think, Allison -- this is Fredrik again. I think obviously we have two quarters behind us. We've given guidance for the third quarter and we've given a guidance for the full year that range, so that range really depends on what we're seeing -- what we're going to see in the fourth quarter.

So great momentum in terms of what we do on the productivity side. We continue to -- we see a strong pricing environment as well, but it really depends on how massive will this coal headwind be in the second half. And I think how those, the positives and negatives, work out will allow us to see what we're ultimately going to be producing.

We're certainly targeting to produce earnings growth, but I think until we get to -- through a little bit more of this summer to see if the stockpiles stand up as we go into the shoulder season it's hard to exactly pinpoint where we're going to end up.

Okay. So it seems like coal is really the wildcard or question mark for 4Q?

Yes, I think coal is the wildcard and I also think, as we have indicated in the prepared remarks, that we also expect a sequential decline in our crude volumes based on what we see in the spread there. And I think we're going to have to follow that as well to see what the impact from that will be on our volumes there.

Okay. All right, thank you for the time.

Rob Salmon, Deutsche Bank.

Good morning. As a follow-up to some of the productivity discussions, could you talk a little bit about -- if we look back a couple years, the productivity was a couple miles an hour stronger. Maybe could you speak to operationally kind of what additional adjustments need to be made across the network to get back to those levels?

And then, Fredrik, perhaps from a financial perspective, what the bottom-line tailwind would it be if CSX achieves those 2 miles an hour of roughly of improved velocity?

Rob, this is Oscar Munoz. Nice to meet you. Listen, with regards to the recovery aspect of that, I think what we've said for some time is the initial point of recovery was this quarter, second quarter, and then the acceleration and continued performance in getting back to those record levels. I think the timing of that is related to a lot of the other activities that we've been talking about, but I think that's the progression we're making.

And, yes, we still have, here in the second quarter, obviously improved significantly and sequentially throughout the quarter, but we're still at the place where we still have overtime levels that we think would come down. We have re-crew levels that could be improved.

Equipment cycle times can be improved as well, which is part of why we see a very robust opportunity set; not just in the second half of 2015, but also going into 2016 as well. And that is going to be critical for us as we see a top-line environment that from a volume perspective perhaps not as strong and robust as we would like it, at least based on what we're seeing right now.

So good momentum on our productivity side and it should translate into some good numbers from a bottom-line perspective as well.

And just as a clarification, with the productivity, should we be expecting another elevated productivity gains looking out into 2016, given those expected continued improvements?

I like to think that we should be able to exceed our historical average, which has been somewhere around 130, 140 as we move into 2016.

Perfect. Thanks so much.

Thomas Kim, Goldman Sachs.

Good morning. Thanks for your time. Last quarter you disposed of an operating asset and I'm curious if you could sort of frame out for us your opportunity set to monetize what management might deem to be non-core or perhaps maybe less strategic going forward.

Yes, this is Fredrik again. So we did have an operating property that we monetized here this quarter. It was a deal that we had worked on for an extended period of time, frankly. And we do have some more both operating and non-operating properties going forward and when they occur, we will be transparent with those and, of course, you will see them, as I said, when they occur.

I don't think that the opportunity set is big enough or is going to make a huge difference over time for us, because we've done a lot of this over the last couple of decades, frankly. But it is something that we constantly look at to see if there are opportunities to rationalize some of the infrastructure that we have, whether it's operating or non-operating.

Great. And if I could just ask a follow-on question that relates to that. To what extent do these, for example, the most recent asset sale, improve your operating expense?

One more time?

With regard to, for example, the most recent asset sale, to what extent is the sale beneficial to reducing the operating expense? Is there something (multiple speakers)?

This sale specifically I don't think is going to improve our operating expense, because it was essentially a line segment that we weren't really operating much on at all, and so it really won't have an impact. There could be instances in the future where it would, but this one specifically didn't.

Okay. Thanks very much.

Bill Greene, Morgan Stanley.

Good morning, Michael. Clarence, I have a question for you on pricing, because I get asked this a fair amount. And that is, when we look at sort of what CSX chose to do in export coal as things got weaker there, why would you not take a similar approach in the domestic market?

Could you -- or is it your view that you can or cannot sort of preserve some volume, save some utility plants given the low natural gas price? How do you think about the pricing in the coal market? Because that's something, given what you've done in export that folks look to and say how sustainable is the pricing dynamic there?

Bill, we've taken a look at it and, frankly, the gas prices are so low we just cannot materially impact it enough to make a difference.

Okay. And then on the export side, is there -- we said we would lap this; it's done. Is there any risk further that the markets cause you to rethink that at all or at this point have you done what you can do and the volumes will just take care of themselves from here?

We've done what we could do and the volumes will just have to take care of themselves.

Yes, fair enough. Thanks for the time. Appreciate it.

Ken Hoexter, Merrill Lynch.

Great. Good morning, Michael and team. Just on the labor cost here, you dug into cost per employee. It was flat this quarter versus up 5% last quarter. Just your thoughts I guess on a couple things around that and further employee cuts, I think you noticed down 1%. But if volumes continue to fall, how do you think about that, Oscar, maybe in advance? And then cost per employee, what happens to that as we go forward here on your productivity?

Yes, and this is Fredrik. Let me take that one. So, yes, cost per employee did fall here versus what we saw in the first quarter and that is -- obviously, part of that is the fact that we now have close to 600 people in furlough and that reduces it, but also a reduction in overtime. We had a little bit of a reduction in training cost as well, so that helped.

And as we move forward now, as we continue to run better, we probably have an opportunity perhaps to have even greater number of furloughs and reduced overtime and reduced the crew, the re-crews as well. I think there are opportunities to see efficiency gains there because obviously that is our biggest expense component and, therefore, the one that we focus relentlessly around how do we reduce the number of people, how do we become more efficient, how do we become more efficient in terms of cost of employee. And so that you should see a continued improvement there. Thank you, Ken.

Brandon Oglenski, Barclays.

Good morning, Michael. Good morning, team. Frederick or Michael, I think in the past you've talked about how you really need coal to stabilize and I really wanted to hone in on the idea that there is more downside risk to 2016 coal than there probably is upside. We have plenty of shale gas in this country so I think we're resetting into this new reality that gas is just a lot cheaper than it used to be.

But you are getting positive price; you're getting productivity; you're getting growth, especially in corridors like Intermodal. So in the longer term is it possible to get sustainable earnings growth and margin expansion to hit that OR target, even if we're facing continued sequential coal declines? Or is that still going to be too much headwind on the business?

And maybe we don't understand how difficult it is to get the cost out of the coal system. Maybe that's where we've been underestimating.

Well, obviously, coal is a very profitable business of ours in our portfolio, but I do think the fact that we were able to produce a 66.8% operating ratio here in the second quarter with coal being down more than $100 million year over year is a great testament to what our core strategy of service excellence to our customers is providing.

Now clearly, as we look forward, the impact of the coal decline is going to also impact the path of progression. We're going to make meaningful improvement here in 2015 and we feel very confident that over time we can get to that mid-60%s operating ratio and I think this quarter, as I said earlier, is a great testament to that. But if coal is cooperating, we can get there faster and if coal is going to not cooperate, it's going to take us longer, which is why at this point I don't think we have enough clarity around the coal picture to really put a flag down in the ground on when we actually get to the mid-60%s operating ratio. Thank you.

Jason Seidl, Cowen and Company.

Thank you. Good morning, guys. How is everything?

Good.

Quick question here. Obviously you mentioned it a little bit on furloughs and you had some very good productivity numbers in the quarter. Is the network rightsized for the current volumes, or is there a little bit more work to do as we move throughout the third quarter?

Jason, it's Oscar. We are always, always reflecting on where our volume load is and the capacity is, so it's never perfectly rightsized, but we're working towards that. We have a lot of capacity.

Importantly, I think our train size initiatives have been really creating even more capacity and more productivity, so we'll continue to work on that. The team has done a great job of it, but I think there is still opportunity to rightsize.

Okay. Appreciate it, guys.

Matt Troy, Nomura.

Good morning. My question was on Intermodal, specifically just if you could give us a sense -- in terms of the competitive environment you referenced in your press release and competitive share loss, I was wondering if you just put that into context.

And then more specifically, just looking at the rate trends, whether we're looking at revenue per carload or revenue per ton mile, certainly we've seen a step down in those metrics over the last two quarters. Obviously, fuel is a big component of that traffic category. I just want to make it clear as to what's going on with the rates.

If you could just answer those two, that's all I got. Thank you.

Okay. On the competitive loss, as you are aware, we don't make particular comments per -- on individual customers.

On the revenue ton miles, as you surmise, it is all in fuel. On the rates themselves, in the trucking market we still find that truckers are keeping their rate structures up this year in the 3% to 5% range on the trucking renewal rates. Our particular spot markets in our trucking part of our door-to-door product has been very strong this year.

Our trans-con product has been down a little bit because we're still rebuilding our owner-operator base in the LA basin from the strike, but the core part of the Intermodal business and the pricing this year has remained fairly strong, as we been able to price for the value of the service that we're offering. And the competitive markets for our investments we've been very pleased with that.

Clarence, maybe you want to comment on the domestic volumes.

Well, you've seen the domestic intermodal volumes themselves have been up around 9% in our intermodal business, so the highway-to-rail conversion programs that we've had in place have been quite successful this year.

Absolutely. That's what I was pointing out. Thank you.

Ben Hartford, Baird.

Good morning. Clarence, maybe just to continue that point. There's been a lot of debate about the pace of conversions going forward. As the truckload capacity situations normalized a bit in 2015 from 2014, fuel prices are lower; rail service has not fully been restored.

What is your -- let's pick a time frame -- three-year view on the pace of domestic intermodal conversions and the opportunity? What are shippers saying given some of the divergent trends with lower diesel fuel prices, but some of these looming capacity constraints? Has the outlook changed at all meaningfully over the past several quarters?

Ben, I don't think it has. We -- in 2014, it's true that we lost some intermodal business back to the highway due to the service issues, but we've actually seen some of that volume return in 2015 as service has improved. As I mentioned in the highway-to-rail conversions, our estimates this year will be in excess of 40,000 new loads on CSX organically, in addition to what our trucking partners are growing; back to rail that will grow.

As you know, the electronic reporting that will be required next year and the legislation will kick in, and we think that that's going to put more stress on particularly the smaller truckload carriers that will make intermodal more attractive. Nothing's changed in the highway issues that are around congestion that's in the highway, the highways in America. We still have the driver issues and shortages that are facing the trucking companies as we go forward.

If you look at what's happening in Congress today, we still don't have a highway transportation bill; probably will be passed with a continuing resolution, so no new infusion of money to rebuild the highways and the infrastructure in this country. So all the issues that we've talked about over the past few years still remain, so intermodal, to me, looks -- is a very positive thing going forward for the next two or three years.

Great, thank you.

Cherilyn Radbourne, TD Securities.

Thanks very much and good morning. You saw good, sequential improvement in both on-time originations and arrivals, but there was much more improvement in originations than arrivals, which I think is the normal order of things as network velocity increases. Maybe you can just talk about that and when we should expect to see the gap between those two metrics narrow.

Cherilyn, thanks; it's Oscar. Historically, as you probably know, there's always been a small gap between the arrivals and the originations, and we have seen both measures improve as we work to restore our service level.

We would expect the improvement in arrivals to slightly lag that of originations, again as that continuity of service improves. The key thing for us is to focus on how late the average train is and that is a metric we've seen substantial improvement over the last several months, so in effect span. So while you'll still see the [uptick] on arrivals a little lagging, and when we actually look at more internally the number of hours that are late is improving. So I think over the next quarter and two and certainly into next year I think you'll see that gap narrowed to its historical average.

Thank you. That's my one.

David Vernon, Bernstein.

Good morning. Thanks for taking the question. Fredrik, maybe just a bigger picture here. As the volume growth is moderating and your GPMs are down a little bit, do you see any opportunity to pull in the CapEx budget? And then longer term, do you think we should be -- how should we be thinking about the impact of the reduced utilization of the coal network on depreciation going forward?

Yes, in terms of capital, I think we're -- we have the $2.5 billion number out there. We're looking at that, see if it makes sense, but generally a lot of those products have already been sorted so I'm not sure there is many opportunities short term.

We have a self-correcting mechanism in that we -- ties it to revenue and I think that will be correcting it. Ultimately, that is a proxy for gross ton miles because 80% of what we spend is a reflection of how much we run over the network. And so as that -- if that comes down, then our capital will come down, so we'll look at that as we get into the planning for 2016.

Then in terms of the coal network, I can assure you we had a very concerted effort in 2012 to see what we could do to drive our costs there. We were excellent at taking out train starts and crew base to more than reflect the decline we saw in volume. And here now in 2015 and 2016 there is a renewed focus again, because of the step function change that we've seen, to further look not just at train starts and look at the crew base and the locomotive assets we have deployed, but also the fixed infrastructure that is up there and to see what we can do.

It is not as black and white as you would like, because we do have growth up there as well and we run other traffic around there. We've seen a lot of growth in LPG and frac sand in those same areas, but there should be more than we can do and our team is very much focused on those efforts. Thank you.

Appreciate it. Thanks.

John Larkin, Stifel.

Good morning, gentlemen. Clarence was very adamant on the first-quarter call about how pricing was accelerating from the later stages of the first quarter into the second quarter. Is that going to continue into the third and fourth quarter, or are we going to plateau at this relatively high level where merchandise and intermodal same-store pricing is up say 3.9% year over year?

Well, John, as you can see in the past several quarters, we've improved the pricing sequentially. And here in the second quarter you can see that we had a 3.5% all-in and a 3.9% in the merchandise and in our intermodal. As I look forward, we remain focused on that strong pricing, reflecting the value of the service we provide across all these competitive markets, which justifies the reinvestment in our business that drives the long-term value of our shareholders. So that's what you'll see.

Got it. Any pushback from customers given that service levels haven't fully recovered? Are they willing to absorb those ever-higher price increases given where service currently stands?

I think that they see that the service that we're providing right now is justifying that price levels for the reinvestment that they see that we're doing.

Got it. Thank you.

Bascome Majors, Susquehanna Financial Group.

Good morning. So coal miners' financial situation has continued to deteriorate here and we've seen recent reports that one of your smaller customers is going to file for bankruptcy this week. And other larger miners are still working on restructurings here.

Can you just talk a little bit about how you manage your risk in this business given financial situation on that side? Maybe a little bit on the business side, such as pricing pressure, which you addressed a little bit already, but counterparty risk as well?

Yes, this is Fredrik. Obviously, from a credit perspective, we do monitor it very closely. Many times it's actually utilities that pay the bill, so -- but we do have some exposure to some of these producers that are going through very difficult times, so we've already seen some of those go through restructuring.

Generally, we're well-protected through a variety of means through that process and one of the most important things is that if you do want to restructure out of it, you're going to need the rail service that we provide in order to be successful in transforming the company.

And overall, from a broader perspective, clearly we're also looking at our capital deployment and you heard in a previous question, we're really trying to make sure that as we look at reinvestment in coal-related assets that we're really taking a long and hard look at whatever capital we put in there to make sure that we're not leaving capital stranded for 40 years, which is essentially the life of assets that we're putting in. So we work very, very hard across our system to make sure that we are making a prudent decision around that.

Great question. Thank you.

Do you have a sense for how much is paid to the -- or this percentage of your business where you are paying the miners versus utilities? Would it just balance with export versus utility mix, or is it more complex than that?

Well, I think -- on the domestic side, I think the majority is clearly paid by the utilities and on the export side I think it's a little bit of a more mix and more, perhaps, the producer.

All right. Thank you.

Jeff Kauffman, Buckingham Research.

Thank you. Good morning, everyone. Thanks for taking my question.

With the revenue -- I shouldn't say revenue, but the volume outlook taking another step down, have you rethought the capital program at all? And can you talk a little bit about where the capital is going to help in terms of the productivity recovery and get the system back to fluidity?

Sure. In terms of the capital, $2.5 billion is our capital plan here for 2015. We are looking to see if there are some things that we would move out of this year, but as [we're] so far into the year it's hard to affect the current year because a lot of these things are well underway at this point. But we are looking at next year and we do have that kind of self-adjusting mechanism that it's tied to percentage of revenue to where we talk about it publicly, but internally we look at it from a gross ton mile perspective more perhaps.

80% of what we spend is on the maintenance side and 20% is productivity, and clearly, this year our main focus has been to acquire additional locomotives. We're acquiring about 200 locomotives new and rebuilding about 150, and that has been the number one priority for us. Already starting last time this year -- last year this time where that has been a focus of ours to make sure, because that has been the linchpin in order for us to get back to the sort of service excellence levels that we've been looking for.

Other productivity initiatives, we have plenty of them that -- not just is capital driven, but is specifically on capital is locomotive fuel optimizer, for example, to make sure we drive fuel efficiency. We have a variety of other technology products that we're working on and also automation of some of the other back-office functions. So there is a wide variety of things that we put capital towards to drive productivity. Thank you.

Scott Group, Wolfe Research.

Morning, guys. Wanted to follow-up, Oscar, your comment, about more to go in terms of rightsizing the network. Just given the volumes and now the service level is improving, is it possible ahead to start seeing some more material headcount reductions, I don't know, 3%, 5%, 10%? I don't know. Is that possible?

Scott, I think I would answer it by the fact that we always make those adjustments commensurate with where we see the volume forecast and so it's hard to pick specifically a number. But we'll, as you've seen us do before, take the appropriate measures.

And to add to Oscar's answer, we do expect, and I said that in prepared remarks, about a 1% decline sequentially in headcount and we already have 600 people in furlough. It is our largest expense base so we're going to be very, very prudent and very, very thoughtful about what we're doing there, because we do need to reduce our labor expense in order to create the productivity savings that we've outlined.

So just with that, maybe Fredrik, the volume environment changed most notably in the second quarter. How much of the cost response from you guys did we see in the second quarter versus how much are we going to see ahead? If there is a way to kind of bucket it out.

I guess it's a pretty hard question to answer. I do say, though, from an overall productivity, knowing our guidance for the full year and the fact that we've done here about $86 million for the first half, clearly we have at least as much in the second half or somewhere around there. And so there's a lot of opportunity still.

We have done a lot of structural things that we have worked on for a period of time in terms of train length and of course some of the other ongoing initiatives as well. And while we have made some inroads in terms of driving the fluidity of the network back, it was only partly through the second quarter that we really got traction around that, so as we move into the second half we should expect more of that.

And so we're -- once again, we feel very strong and we feel very bullish about the opportunity set going forward on productivity side. Thank you, Scott.

Donald Broughton, Avondale Partners.

Good morning, gentlemen. Help me better understand your guidance of expecting meaningful full-year OR improvement because, through the first half, the gross cost of diesel is down about $325 million, so you're at a run rate of let's call it $650 million. If I just assume that the cost of diesel is down by $650 million for the full year and the fuel surcharge is down by $650 million and all of your other operating costs remain constant on a year-over-year basis, that alone would create 150 basis points of the OR improvement. So is meaningful full-year OR improvement less than or greater than 150 basis points?

Well, that is left to be seen. It's a good question. We have taken out in the first half, if you just look at our quarterly flash, we've gone from about 72%, 73% last year in the first half to 69.5% so that's obviously very meaningful improvement in just one year time frame.

As we think about this quarter specifically, the majority of our gain was actually not fuel related, because fuel this quarter, while it came down, we actually had a negative impact year over year because of the negative lag and the spread differential that we saw. So I'm not going to pinpoint exactly where we're going to end up, but we do clearly expect meaningful improvement despite the fact that the volume environment is less than stellar. Thank you.

Cleo Zagrean, Macquarie.

Good morning. I would like a little bit of help with framing the utility coal volume downside for the next year. Where do you see that coming from? We're potentially hoping for some reversal of gas switching and inventories having normalize, so that is entitlement driven? What are you hearing from your customers that drives your cautiousness on domestic utility? Thank you.

Well, the stockpiles are, both in the North and the South, are higher than normal so there is some inventory hang. We still expect that the gas prices will be relatively low; would be the second point. And the third is there is some research that would indicate the installation of more gas peakers in the region that we serve than are currently in service.

So the combination of those three would lead us to believe that there could be a possibility that the utilities consumption of coal in our area would be slightly less than it is this year.

Okay. And then just as a quick clarifying follow-up, when you give guidance for domestic coal, do you include the domestic met or that refers to utility?

It includes both, everything.

Thank you very much. Thank you.

Rick Paterson, Topeka Capital Markets.

Good morning, guys. Oscar, you put out a service update in May that listed your T&E trainees at 1,235. What's that number today?

The people in -- by the way, Rick, nice to hear you; welcome back.

Thank you.

The number in training we have approximately is about 800 right now.

Beautiful. Excellent.

Tyler Brown, Raymond James.

Good morning. I was just curious if we could get a little more detail on the acceleration of the non-coal pricing. And I appreciate this might be a bit of semantics, but, Clarence, was the sequential acceleration fairly broad-based or was it more housed in, say, intermodal than the other merchandise? Just maybe some broad comments there.

No, it was very broad-based across almost all of our commodity lines.

Perfect. Thank you.

John Barnes, RBC Capital Markets.

Good morning. Going back to the CapEx question -- I hate to beat this to death, but how quickly can you reprioritize the project list and reallocate the capital? And then, if volumes continue to be weaker, how aggressive are you willing to be on, say, maintenance CapEx? Is there any give and take there?

I think from a maintenance perspective, there's a lot of things that you can do that short term would save you money but long term would hurt you. For example, shutting off our teams that are out there replacing the rail right now is something that you could do, but long term doesn't make sense because it -- mobilizing and demobilizing something is more expensive than taking advantage of the fact that you have the teams out there right now.

So there are things you can do, but the key thing is that you do things that are smart. And so that's why I think that making significant changes to the in-year capital budget is not necessarily the right thing to do from a long-term economic perspective.

But as we think about next year we will always -- we always look at what the gross ton miles will be. We look at the line segments and so forth that we need to allocate capital to and that's where I think the coal example is a good place. We really are looking long and hard to make sure that what we are putting in there makes sense, of course, without sacrificing safety in any way, shape, or form.

So we constantly look at that and we will take a look at what next year capital budget will be in the context of what the gross ton mile picture would look like.

Thank you.

Justin Long, Stephens.

Good morning, thank you. I was wondering if you could comment on the final tank car regulations that we got during the second quarter. Assuming everything in this regulation withstands legal pushback, how should we think about the impact these changes could have on your business going forward?

Justin, I think we were, by and large, very pleased with the new tank car standards they came out with. We think it's a much safer vehicle. We were a little bit surprised that the thermal blanket was not included and we will continue to push for that as an industry, because we think it gives an extra layer of safety at not a great expense.

As far as a long-term impact on the business, obviously, as you know, we don't own the tank cars. The customers or leasing companies do. Our early read is that most plan to retrofit their cars or buy new cars that meet those standards. Obviously, it impacts the economics of the movement somewhat, and as Clarence alluded to earlier, there's already a little bit of pressure on the crew move just because of the current spreads between Bakken and Brent.

But we think longer term this car is a better car, a safer car, and I think we'll continue to see the movements in the crude as we go forward.

Okay, great. Thanks for the time.

Thank you. Thank you, everybody; we'll see you next quarter.

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