CSX Corp (CSX) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation second-quarter 2016 earnings call. As a reminder, today's call is being recorded.

(Operator Instructions)

For opening remarks and introductions, I would like to turn the call over to Mr. David Baggs, Vice President, Treasurer and Investor Relations Officer for CSX Corporation.

Thank you, Prima, and good morning everyone and again welcome to CSX Corporation's second-quarter 2016 earnings presentation. The presentation material that we will 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, the webcast 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 Frank Lonegro, our Chief Financial Officer. In addition, Cindy Sanborn, our Chief Operating Officer, and Fredrik Eliasson, our Chief Sales and 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 disclosure 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 nearly 30 analysts covering CSX 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 the same topic.

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

Thank you, David, and good morning, everyone. Yesterday, CSX reported second-quarter earnings per share of $0.47 compared to $0.56 per share in the same period last year. Revenue declined 12% in the quarter as strong pricing across nearly all markets was more than offset by the impact of a 9% volume decline which included a 34% decline in coal as well as negative mix and lower fuel recovery.

Regarding operating performance, CSX continued to deliver strong safety performance and service continued to meet and exceed customer expectations and drive further efficiency. In the quarter, CSX continued to aggressively and successfully reduce its cost structure throughout the network, recognizing that this Company's long-term future is built on a fluid and efficient network serving primarily intermodal and merchandise markets.

Despite these cost-saving actions, operating income declined $177 million to $840 million. At the same time, the operating ratio increased 210 basis points year over year to 68.9.

Now I will turn the presentation over to Frank who will take us through the second-quarter results and third-quarter outlook in more detail. Frank.

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

As Michael mentioned, revenue was down 12% or $360 million versus the prior year, driven primarily by lower volumes. Total volume decreased 9% which impacted revenue by about $260 million. In addition, fuel recoveries declined $98 million.

We continue to see strong core pricing from an improving service product which for the second quarter was up 2.9% overall and 4.0% excluding coal. However, this was partially offset by negative business mix in the quarter.

Other revenue decreased $29 million driven mainly by lower incidental charges and coal-related revenue from affiliate railroads. Expenses decreased 9% versus the prior year, driven mainly by $96 million in efficiency gains, $86 million in lower volume-related costs and $56 million in lower fuel prices.

Operating income was $840 million in the second quarter, down 17% from last year. Looking below the line, interest expense was up slightly from last year with higher debt levels partially offset by lower rates while other income was relatively flat to the prior year. And finally, income taxes were $262 million in the quarter with an effective tax rate of about 37%. Overall, net earnings were $445 million, down 20% versus the prior year, and EPS was $0.47 per share, down 16% versus last year.

Now let me turn to the market outlook for the third quarter. Looking forward, we expect year-over-year volumes to decline in the third quarter in the mid to high single-digit range. Despite some markets growing, the majority of our markets will be down with the most significant declines continuing to be concentrated in coal and crude oil.

Automotive is again expected to grow as light vehicle production remains higher on a year-over-year basis. Minerals volume will be higher with the continued ramp-up of new fly ash remediation business and ongoing strength in construction which drives demand for aggregates. Agricultural products are expected to decline as the strong dollar and low commodity prices continue to pressure both domestic and export shipments.

Chemicals will be down due to the continued declines in shale-related products resulting from low crude oil and natural gas prices. We expect crude oil volume to be moderately lower on a sequential basis.

Domestic coal will continue to be unfavorably impacted by an excess supply of natural gas at a price point that favors gas burn over coal in the East. In addition, coal inventories remain high and year-over-year volume declines will continue to be significant, although less severe than the second quarter due to softer comps in the back half of 2015.

Export coal should be moderately lower in the second half of the year from the first-half tonnage run rate consistent with the seasonality we have seen in recent years. Despite modest improvements in the met and thermal benchmarks the export market will remain pressured by the strong US dollar and global oversupply.

That said, we saw more spot moves than anticipated in the second quarter. As such, we now expect full-year export coal tonnage of around 20 million tons. For the total call market, we continue to expect full-year tonnage declines of around 25% with third-quarter coal tonnage roughly stable sequentially to what we have seen in the first half of this year or approximately 22 million to 23 million tons in the quarter.

Intermodal is expected to be down as we continue to cycle prior competitive losses in international through the remainder of 2016. Domestic intermodal is anticipated to be roughly flat in light of difficult comps that reflected new business shifting to CSX in the third quarter of last year. Overall, our business continues to reflect a market environment driven by low crude oil, natural gas and broader commodity prices as well as continued strength in the US dollar.

Turning to the next slide, let me talk about our expectations for expenses in the third quarter. Since last year we have taken aggressive cost actions which include reducing headcount by about 4,500 versus the prior year. As a result, we have achieved about $230 million of efficiency gains in the first half of 2016 and now expect full-year productivity savings to approach $350 million. We expect third-quarter expense to benefit on a year-over-year basis from our ongoing focus on driving efficiency gains and rightsizing resources.

Looking first at labor and fringe, we expect third-quarter average headcount to be down slightly on a sequential basis. In addition, we expect labor inflation to be around $30 million in the third quarter. Finally, we expect a headwind in the third quarter of $25 million to $30 million versus the prior year driven by higher incentive compensation.

As a reminder, in 2015 we saw incentive compensation decrease in the second half of the year as market conditions drove CSX's financial results below our initial plan.

Looking at MS&O expense, we expect efficiency gains and volume-related savings to more than offset inflation. As a result, MS&O costs are expected to be down moderately versus the prior year.

Fuel expense in the third quarter will be driven by the lower cost per gallon year over year, reflecting the current price environment, volume-related savings and continued focus on fuel efficiency. We expect depreciation in the third quarter to increase around $20 million versus the prior year, reflecting the ongoing investment in the business.

Finally, equipment and other rents in the third quarter are expected to be relatively flat to the prior year with the benefit of improved car cycle times offsetting higher freight car rates and the increase in volume-related costs associated with automotive growth.

Now let me wrap up on the next slide. CSX's second-quarter results reflect success in a challenging freight environment with macroeconomic and coal headwinds impacting most markets, resulting in a 9% volume decline this quarter. This success is driven by pricing for the relative value of rail service, driving efficiency gains and aligning resources to the softer demand environment which partially offset those substantial volume headwinds.

Looking ahead, let me first provide an update on our 2016 capital investment. Projected capital investment has increased $300 million from our initial plan as CSX now anticipates accelerating payments for locomotives delivered throughout 2016 under a long-term commitment. We originally intended to pay for these locomotives in 2017.

As such, 2016 capital investment is now expected to be $2.7 billion. By completing our locomotive purchase commitment this year we simultaneously clear the path in 2017 for CSX to begin returning to our long-term core capital investment guidance of around 16% to 17% of revenue.

As we think about market conditions for the remainder of the year, we expect macroeconomic and coal headwinds to continue. Low commodity prices and strength in the US dollar will continue to impact many of CSX's merchandise markets while natural gas prices below $3.50 and elevated stockpiles are driving significant headwinds in coal. As a result, we continue to expect total coal tonnage to decline around 25% for the whole year.

Looking at our expectations for the third quarter and full year, we remain intensely focused on achieving strong pricing that reflects the value of CSX's service product, rightsizing resources with lower demand and pursuing structural cost opportunities across the network. As a result of these initiatives, we now expect efficiency gains to approach $350 million in 2016.

That said, the impact of current market conditions on CSX's volume, particularly in coal, is expected to outweigh our positive momentum. As a result, we continue to expect third-quarter and full-year 2016 earnings per share to be down from last year. Furthermore, as a reminder, third-quarter EPS is typically down sequentially from second-quarter results, reflecting the seasonality of our business.

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

Thank you. As Frank discussed, it's clear this continues to be a challenging freight environment with plenty of macroeconomic headwinds. Thanks to the extraordinary work of our employees, CSX is delivering record levels of efficiency and rightsizing resources to the business demand of today.

Looking longer term, the Company has a bright future as the men and women of CSX are simultaneously positioning the Company for growth where we have the resource flexibility to serve future demand. This will position CSX to maximize long-term opportunities in both our merchandise and intermodal markets. As a result, we continue to be enthusiastic about the core earning power of the Company as the market headwinds subside.

As we work to transform this Company into the CSX of tomorrow, we must grow and make more profitable the merchandise and intermodal markets which represent our future. At the same time we will continue to preserve the business value of coal recognizing that it will become a smaller but still important part of our Company. Our future involves leveraging a premier highly efficient network that reaches diverse merchandise and intermodal markets and nearly two-thirds of the American consumers.

It requires consistent excellent service for customers which in turn supports efficiency, profitable growth and pricing that allows us to continue investing for the future and includes technology solutions that drive an ever more safe, reliable and efficient railroad. As we manage today's business environment to deliver on the future potential we continue to focus on achieving a mid-60s operating ratio longer term to deliver compelling value for you, our shareholders.

And now we are pleased to take your questions.

(Operator Instructions) Rob Salmon, Deutsche Bank.

Frank, I think on the last call you had indicated that with regard to the earnings cadence you thought the decline in Q2 would be the largest for the year. As I think out to the back half of the year with the puts and takes of coal being a little bit stronger than what you had anticipated in Q2, cost actions being a little bit more, how should I think about that earnings cadence as I look out?

I think as we look at Q3 earnings on a year-over-year basis, we've mentioned that they will be down. We haven't sized that, as you know. We have got the challenging market environment that I know Fredrik will get into later in the call impacting the top line.

There are comps that begin to ease as we get into the back half of the year. Although as we've mentioned volumes in the third quarter will be down mid to high single digits with crude down, international and intermodal losses and the coal as we've mentioned on a year-over-year basis down, as well. So we've got some negative mix.

And then moderating productivity as we get throughout the year. Obviously we have delivered about $230 million in productivity in the first half and that implies certainly moderating productivity level as you get into the Q3 and Q4.

We tried to give you some clarity in the third-quarter remarks about where incentive comp might be and certainly with fuel prices where they are going and cycling some of the fuel positives that we had in the third quarter of last year, we are going to have a net fuel headwind, as well. So we have got some challenges looking ahead of us in the third quarter, but as I'm sure Cindy will mention later in the call everything is on the table on the productivity side and pricing continues to be a favorable given the environment.

When I think about the mix, that feels like it will be a little bit less fat in the third quarter. Fuel is probably going to be a little bit tougher. Do those two net out or does the fuel overwhelm the mix?

Let me hit the fuel and then Fredrik will hit the mix one. So when you look at fuel, we had about a $7 million in-quarter challenge in the second quarter.

You would anticipate given where the forward curves are that the end-quarter challenge will likely be a little bit more difficult sequentially. And then given the fact that we are cycling about a $20 million favorable in the third quarter of last year you are looking at a pretty big obstacle there. Fredrik?

In terms of the mix, I would say that obviously were going to continue to have the overarching mix change between coal going away and we are growing intermodal. We have indicated that we do think things will moderate in terms of overall volume decline as we move throughout the year. However, third quarter is still going to be a challenging quarter and, frankly, so will fourth quarter, but we do expect things to improve from a volume perspective as we move throughout the second half of the year.

I appreciate the time, guys. And I'm sure someone else will hit on the efficiencies but congrats on a good quarter.

Ravi Shanker, Morgan Stanley.

I will hit on the efficiencies. So obviously a pretty impressive pace so far this year and not surprised that you raised that target of $350 million. This then raises the natural question as to what innings we are in with the productivity gains here. Just how deep is that well that you can draw from?

Good morning. This is Cindy. I will respond to that one.

I will tell you when we think about productivity, we've generated some in our network performance as you've seen our service measurements improve. We think about it structurally and streamlining and process within initiatives. So those are the main categories that we look at.

When we look at what we've done so far, clearly we are lapping some of the big initiatives that we took late in 2015 and earlier this year but we see -- we have a very long initiative base. We have pulled some of those forward but I think when we look out to the future, I think we will continue to drive results both in the back half of the year, as Frank has talked about, maybe a little bit last in terms of quarterly numbers.

But it's going to be better than what we traditionally do on a quarterly basis. And as I look into 2017 I think we will be able to overcome inflation. And I think a big part of what's going to help us to do that is our CSX of Tomorrow initiatives around the Network of Tomorrow as well as automation and technology is going to allow us to continue to drive productivity.

I also want to mention that the actions that we are taking are not reactions, they are actual actions that are driving our decision-making relative to our coal portfolio getting much smaller and the importance of providing a safe and reliable service product in the merchandise and intermodal portions of our business. And that is part of our core CSX of Tomorrow strategy and we are executing on that and will help us to be both service sensitive, more service sensitive Company as well as a more efficient Company.

Got it. So just to clarify, the run rate that you expect to see for the second half of this year, is that a run rate to think of going into 2017?

I think what the numbers would imply in the second half would be about $60 million a quarter. It never works out perfectly, as you know, but that's a general run rate in the second half of the year.

As we get closer to the end of the year we'll be able to give you a little bit more guidance on 2017. But I think Cindy mentioned, and I will reiterate, our goal is always to offset inflation with productivity. And depending on how those numbers play out, as you get into forecasting next year's inflation numbers you should see us have confidence in our ability to continue to do that in 2017.

Great, thank you.

Ken Hoexter, Merrill Lynch.

Just wanted to follow up on Frank's comment on the increase in CapEx and accelerating locomotives purchasing. Just wondering why you are accelerating the CapEx. Did you get better pricing on equipment and does that change your thoughts on cash flow, buybacks and use of capital as we move forward?

Honestly it was the avoidance of seller financing charges that we would have incurred if we had stuck with the original deal to pay off the engines next year. So it's just a timing over a couple of months. No impact on cash flow, it's kind of a one-time thing switch between 2017 and 2016.

So it's not a commentary on what you thought on pace of volumes or anything else, just financing to accelerate in a declining volume environment?

Well, we either pay the financing charges or avoid them by pulling it forward. And as Cindy is mentioning, every dollar is on the table and that seemed like a good way to save a little bit of money as we look forward into 2017.

All right, great, thank you.

Brandon Oglenski, Barclays.

So I want to follow up from Ken's question on CapEx. So you talked about the ability in 2017 to get back towards a core investment around 16%, 17% of revenue. But I am assuming that excludes spending on things like PTC.

So you might not be willing to tell us right now what you think the non-core items might be in 2017. But maybe if you could give us some context on what non-core investment has been for the past couple of years?

Sure. So the only thing that we exclude from core investment is Positive Train Control. If you look at what we are doing this year, our all-in number of $2.7 billion has the $300 million increase for the engines that I just mentioned. It has $300 million for Positive Train Control which get you down to the $2.1 billion of core capital that we had started the year talking about.

And as you might remember that was a decline of over $100 million in core capital from 2015. You will continue to see us focus hard on core capital and making sure that we are making the right decisions in terms of infrastructure equipment and return seeking investments. As you think about PTC going into 2017, that number should decline some from the levels that you see here, in 2016, it should step down a little bit and then again between 2017 and 2018 as we set our sights toward being compliant with the FRA's and Congress's mandate that we be hardware complete by the end of 2018.

And then it should leg down even further between 2018 and 2019. And then hopefully all of that will go away as we get to full implementation in 2020.

Then you won't see a scary a Positive Train Control CapEx line after that. It will just become embedded within the broader capital plan.

Okay. I appreciate that.

Brian Ossenbeck, JPMorgan Chase.

I was wondering if you could give us an update on the CCX projects, can we talk about CapEx, what type of CapEx are you expecting there? Is that something we could do a public-private partnership and how close are you to scoping out and finding a site for that investment?

We are very excited about the CCX opportunity. We're finding that we are getting great cooperation from the state and local officials. We are very encouraged that we will be able to work cooperatively with them.

As you mentioned it is a public-private partnership with the state providing about half of the funds and us providing the other half of the funds. And we think it's going to be a tremendous economic development opportunity for the state of North Carolina.

We are very excited about the progress we are making on it. The exact location hasn't been finely determined at this point but we are continuing to make good progress.

Okay. Can you just remind me of the timing and the size of the expense (multiple speakers)?

It's going to be roughly $150 million of ours which is part of the long-term capital plan that Frank evaluated. And the state is putting up close to a similar amount for the facility.

Okay, thanks for your time.

Allison Landry, Credit Suisse.

I was wondering if you could talk a little bit about the mix during the quarter. In particular, it looks like maybe there was some positive mix within the coal segment. So just wanted to see if you could help us understand if that was on the domestic side or export, what drove that and if that's something we should expect to persist in the third quarter?

Yes, so, Allison, on the coal RPU specifically, we did have some positive mix. Obviously, we also had the help of our fixed variable contracts and continued pricing on the domestic side. Offsetting that is, of course, fuel surcharge revenue coming down and then the actions that we've taken on the export coal market.

I do think that it changes quarter by quarter but it is a sustainable level and there will be quarters when it will be up and there will be quarters when it will be down. The focus on our part is to make sure that we continue to do core pricing appropriately and then let fuel and mix fall wherever it's going to fall.

Okay. Were there any contracts on the domestic side that came up for renewal in the second quarter that maybe boosted that a little bit?

Nothing specifically. We have about a quarter, 20% to 25% of our contract coming out here by the end of the year. But nothing specifically here in the second quarter that would have changed the RPU number.

Okay, great. Thank you.

Chris Wetherbee, Citi.

I wanted to follow up on the CapEx side and just talk a little bit about locomotive spend. So you pulled some forward into 2016. How should we think about the change in locomotive spend as we go into 2017 and 2018?

Sure. So if you take just a year or two view of that and you look at where we are from a locomotive storage perspective, we've got about 350 engines in storage and then as you look towards the back half of the year as Cindy gets the deliveries of about 60, 65 of the remaining engines from the purchase commitment that we had started in 2014 I think you should expect in the volume environment that we'll continue to store engines through that period.

As you look forward in 2017 and 2018, assuming volumes stay essentially where they are I doubt you would see us in the market for new locomotives. At the same time, we do believe that continuing to reinvest in our four axle, so our yard and switcher engines, is the long-term right thing to do. So you might see a little bit of capital going toward rebuilding the four axle engines.

But again probably no big purchases in that time period. Cindy, anything you want to add to that?

No, I would say as we look ahead and the engines that we have stored, the 350 that Frank mentions are readily able to be brought back to service if we need them. In addition to that, we have as we've taken locomotives out this year some have gone into a recommended retire status which would not be in that stored count.

So when you look at GTM is down about 10%, our active fleet is also down about 10%. And going forward I would echo Frank's comments.

So is that the right way to think about it on a GTM basis? I guess it's a tough question because of mix but when you think about potential volume growth, how much latent capacity you have a locomotive side for the next year or two, is it roughly 10% when you think about it in GTM terms?

When I think about it, GTMs is how we think about our workload demands but we are obviously cycling a very different type of commodity mix with coal being reduced and lesser GTM intensive business growing hopefully. So we will look at GTMs in terms of workload but when I think about what's available to bring back, it is really in what's in our stored status, not in the total that we have taken out this year.

We are going to recommend to retire some of the locomotives that we've taken out this year. And there's also leases that we have returned, too, I might add.

Okay, so probably a little less than that number, I guess, ultimately is what you are saying?

Less than 10% is what's available to bring back.

Okay, that's helpful. Thank you very much for the time.

Tom Wadewitz, UBS.

Wanted to ask a question, I think it is for Fredrik, it's on the domestic intermodal side. You guys have done a good job of realizing volume growth despite a difficult market, difficult backdrop in truck.

I think you are up 5% in second-quarter domestic intermodal but then you are saying flat in third. Is that just the kind of impact from that one contract or is there some slowing that you are seeing in the market? Just wondering if you could talk on the domestic intermodal a little bit. Thanks.

Sure, Tom. No, it really is impact from the fact that last year in the third quarter we had a significant ramp up in our domestic intermodal business. And as we move in here to the third quarter we are going to start lapping that which is going to make the volume compares a lot more difficult than it's been the first part of the year.

That's really the key driver. The market out there obviously continues to be challenged with a fair amount of excess capacity.

From our perspective, though, the intermodal story is broader than that and we continue to have good success in converting traffic from the highway in partnership with the trucking industry. We also continue to get some pricing even in this tough environment which bodes well for the long term.

Do you have any thought on inventories and whether high inventories are coming down somewhat or is that still an issue that you hear from shippers?

Inventory is still at the high level. Has been a sequential decline just a little bit but it's still high versus historical basis. So that's certainly impacting the international part of our intermodal business more perhaps than it does on the domestic side, which is also why you are seeing the steamship line continuing to struggle quite significantly and demand on that side is very weak at the moment.

Right, okay, thank you.

Jeff Kauffman, Buckingham Research.

Congratulations. A question for Frank.

Frank, there's been a lot asked about the CapEx and I understand what you are doing to locomotive CapEx, but that is going to create a little bit more of a cash shortfall. Since it is just really borrowing from 2017, do we fund that shortfall with debt and continue repurchasing shares at these levels or do we focus on maintaining cash and maybe slow the repurchase until the cash flow gets a little bigger next year?

In terms of the buybacks, you know we are in the midst of the two-year, $2 billion program that we announced in April of last year. You've seen us essentially ratably buy throughout the period about $1.2 billion that we've repurchased so far throughout that program, about $800 million or so left.

I think absent a recession you should see us continue to do that ratably from now through the end of the first quarter of next year. And then reevaluate where we are from a cash and a ratings perspective as well as what the forward view of earnings might be at that time.

Okay, thank you. And one detail follow-up. You never mentioned where are coal inventory days in your Northern and Southern service regions?

Sure. So right now, where we are, we are in the South and we use an external source for this. We are at about 98 days on forward burn in the South and about 71 in the North.

And just to give you the average benchmark I think we've given in the past, in the South we expect the average to be about 70 and in the North 55. So whether you look at days burned or tons, we're up about 5% year over year using that same source.

So we're still at a pretty elevated level as we sit here today. Clearly the warm weather is helping but it's highly unlikely that by the end of the year we will get to normalized level is our best prediction at this point.

Okay, thank you, everyone.

Scott Group, Wolfe Research.

So wanted to ask one more on the CapEx. If we are not buying locomotives for a few years and PTP spending is starting to come down, it sounds like given volumes that maybe growth CapEx in general should be coming down. I would think that there is an opportunity to cut the CapEx below that historical 16% to 17% of revenue and then you guys can really get a good free cash flow story going which I think would probably help the multiple here. How do you think about that and is that a realistic opportunity?

Certainly we are in our planning process for 2017. It's really too early for us to comment on what we think next year's core CapEx is going to be. I think what you are hearing us say is that we are committed to returning to that about 16% to 17% of revenue from a CapEx perspective.

Within that in any given year, there's going to be differences between how much is in infrastructure, how much is in equipment, how much is in return-seeking investments. And as I think I've mentioned in the conferences back in June, we are also committed to making sure that the CSX of Tomorrow initiatives are part of that capital guidance. So it's not something that you are going to see us take that guidance up because of the CSX of Tomorrow initiative. We are going to make all the right trade-offs within that framework in order to be able to deliver on the CSX of Tomorrow, which is a very important part of our future, as Michael mentioned in his remarks.

Yes, I guess I'm just thinking, though, it's historical that 16% to 17% of revenue historically has included locomotives. So if we are not buying as many locomotives, I would think there's an opportunity to get below that historical level. Is that realistic or are you saying not?

I'm not commenting one way or another to be honest, Scott. I'm telling you that we will give you some guidance on 2017 as we get closer to the end of the year. And then as we begin to talk about the CSX of Tomorrow and the associated financial parameters of that, we will give you some guidance longer-term.

Okay. And then if I can just ask one more just kind of detailed question. Just on coal, can you give us the mix of your coal by basin App coal, Illinois and PRB and where do you see the switching points?

Sure. So here in the second quarter we saw an increase in Illinois Basin coal up to about 37% of our overall utility portfolio and really that's what's relevant, I think, just looking at the utility portfolio. So 37% thereabouts was Illinois, PRB about 20%.

So we had about 57% of our coal was either Illinois Basin or Powder River Basin and the rest was Appalachia. And that is up a little bit from what we saw in the first quarter and, frankly, we expect Illinois Basin to continue to do well longer term as part of our utility mix.

Thank you, Scott.

Jason Seidl, Cowen.

I want to focus a little bit on the mineral line. Obviously the new fly ash contract is ramping up and that's distorting the yields a little bit here. How should we look at yields going forward for the remainder of the year as the contract ramps up?

Are you talking about yields overall or specifically in minerals?

Specifically in minerals.

I think overall I don't think you're going to see a much different picture in terms of the yields. Clearly the fly ash is a big initiative on our side. We are also seeing strength in other parts of our minerals business.

But I don't think that that RPU is significantly different than any other part of our minerals business. So I think those drivers are similar within the other parts of that portfolio, as well.

Okay. Just a follow-up question on coal. You guys talked about being 98 days in the South, 71 days in the North.

How should we think about burning that through? If we get a normalized summer and a normal winter, at what point are we going to get back to those levels you talked about 70 in the South and 55 in the North?

Well, most of the external sources we use and also discussions with utilities would indicate on average that we'll get there sometime in 2017, hopefully in the first part of 2017. Clearly, as I said earlier, this summer is helping.

Clearly there are utilities that are below where they want to be and, frankly, we have seen additional calls there over the last month or so. That's a pretty low bar because the phone certainly wasn't ringing for several months. But it is helping, but you have -- some of our utilities that we serve have an awful lot of coal on the ground at this point and it's going to take more than just a really hot summer to get it back to where it needs on average.

And so as we think about coal for next year, I am assuming we should think at least the first half should be still continued to be pressured.

I think there is a high likelihood of that. As I said we have a much better feel for that as we get through here this summer to see where we end up. Usually not just in coal but in all of our markets we go out and really work closely with our customers to get a sense of what the plan for 2017 should look like and at that point as we get into third quarter, definitely the fourth-quarter earnings release, we have a much better sense of where we are.

But overall I think it's important to say two things. One, what's happening here right now in coal in terms of the hot weather and the fact that natural gas price have recovered a little bit is really more of an impact for 2017 than it is short term in 2016. And then I think it's also important, we've been probably been the most vocal on this, from our perspective right now, we are planning for a secular decline in our coal business.

We would love to be wrong about that but in terms of how we approached our business and how we approach our planning we continue to see a secular decline. It doesn't mean that you can't have a year or so where it goes up but overall we think the trend is pretty clear where it's heading.

Fredrik, that is fantastic color. Listen, Fredrik, Michael, team, I appreciate the time as always.

Ben Hartford, Robert W. Baird.

Cindy, just some perspective on current service levels, kind of pick your measure, whether it is well time or velocity. Those measures have somewhat stagnated over the past few quarters, still above 2013's peak level.

Any thought or hope of being able to return those measures back to 2013 levels? Or should we, for the time being, ignore what you were able to do in 2013 and look for improvement but the likelihood of returning those levels are low? I'd be interested in any perspective there.

Okay, well, Ben, we have improved our service levels both sequentially and year over year as you can see from the charts. We were actually a little ahead of where we had planned to be for this year. And obviously improved network performance does provide some efficiency gains for us.

And we are committed to provide a service product that meets or exceeds our customers' expectations, helps Fredrik price for the value of the service that we provide. We have to balance that always, though, with some efficiency initiatives and I think we are doing that. I think we are pretty happy with where we are.

There's always opportunity to improve and we will do that. I think I have also highlighted before, and you've probably heard Frank talk about it before, where we've installed our train length initiative that it's more problematic for us in terms of velocity, let's say, is on the Southern part of our network which is mostly single-track.

So we think that's the right mix. We've made the right decision there. We are seeing overtime down, re-crews down and other measures that give us confidence that we are improving.

But I think we are pleased with where we are. And we will work to improve.

Yes I may just speak from a sales and marketing perspective. I would say the effort here this year has been to really focus on the most service-sensitive part of our business, specifically intermodal business, drive that service up. And that's where we made the most gains and it is markedly different and is really helping our pricing efforts.

Also one of the key things for us is to reduce the span around a mean and that is also improving significantly. Because also as we look at a broader portfolio it is about being able to be there each and every day in a reliable way. Our local service has improved significantly, as well.

And really as we look at the customer facing measurements, not so much the measurements that you are seeing in terms of what we disclosed externally, has improved significantly, as well. So from our perspective I think we are making the right trade-offs between productivity and service and as Cindy says on the productivity side we are never done and the same thing holds true on the service side. We always want to better for our customers, and I think we are seeing that cooperation from operations, so we feel very good about where we are.

Okay, that makes sense. From the metrics that we can see, that 2013 high watermark, are those targets that are credible? Do you feel like you can get back to those levels over time and potentially exceed them?

I think everything is on the table. In terms of the pace and cadence of which we may get there, it is probably a longer-term type of aspiration. But, again, there's nothing that we are satisfied with.

I'm not satisfied with the service measurements nor the efficiencies. And we will continue to work on both. But I think that's a longer-term initiative.

Okay, thank you.

Cherilyn Radbourne, TD Securities.

Wanted to ask a question on productivity, which I think was a highlight again this quarter. And you always do a very good job of disclosing productivity versus the volume-related cost reductions. I just wonder if you could talk about the rigor with which you track that internally and make sure that you are holding people accountable.

Absolutely, we have a lot of rigor within the financial organization which in some respects is the scorekeeper here. What we do in terms of tracking productivity, we make sure that we normalize for volume first.

So to the extent that there are volume variable expenses then those don't count toward productivity. And what you've seen this year is that in the first half we are about $150 million of what we call rightsizing or volume variable cost reductions and then $230 million of structural cost efficiencies. There is a lot of accountability around productivity and, again, that is the way we take costs out long term.

Let me give you just a simplistic example that may help illustrate it. So let's use coal just because coal volumes have come down. So if a coal train ran last year but doesn't run this year then the cost associated with locomotives and crudes and fuel and car costs would come out of volume variable expenses, and so you'd hear us talk about those in terms of rightsizing.

If, for example, and we have instances of this where you have two coal trains that ran last year and this year through the train length initiative and network routing we've actually put those two trains together and run a 200 car train instead of two 100 car trains, the efficiencies associated with less locomotive intensity, crew intensity, fuel intensity, etc., would be allocated toward productivity.

Great, that's helpful. Thank you, that's all from me.

David Vernon, Bernstein.

Frank, this is kind of a great setup to what I wanted to ask you in terms of the size of the absolute productivity number. As we have gotten through the year, it does seem like that number is growing at the same time that our expectations for forward volume are getting worse.

Is it right to believe that you guys are finding more opportunities to drive that productivity because there's less traffic on the network and that that productivity pool is kind of expanding in relation to the volume decline? That's kind of the first question I wanted to ask you.

I think what you will see us do in an environment like this where we realize that the revenue portfolio is in transition and the volume, especially on the coal side is coming down, is we turn over every rock. And you've heard Cindy talk a lot about all the things that she is doing on the operating side, and not to the exclusion of the G&A side.

The G&A side, every department is also looking for ways to challenge every cost dollar. So I think what you are seeing is really an across-the-board focus in our Company to be disciplined on cost.

We've always been disciplined on cost, we've always tried to offset inflation with productivity but just given where we know the business is going we are really looking at these structural things in a way to reduce the overall cost intensity of the business.

And when volumes inflect positively obviously we will be able to grow with that both on the earnings and the margin side and to the extent that growth comes in the batch merchandise business or the intermodal business or the automotive business you should see us grow with healthy incremental margins. So I think what you are seeing is the Company focused on cost given the environment.

I guess the second part of the question is as you are taking that in your example the two 100 car trains and making a 200 car train, I guess when volume does inflect how do you think the cost structure will react? Do you think that the variable cost might go up and you should probably just shouldn't care because the contribution is so high? Or do you think you can actually sustain this lower level of variable unit cost that you've been able to engineer given the extra space on the network?

Sure. It depends in large part on how the volumes come back and where the volumes come back. We have engineered a lot of flexibility into the network through the train length and variable scheduling initiatives that you've heard us talk about.

Again, as I mentioned, if volumes come back in class traffic and part of the scheduled network you should see us be able to grow volumes without adding back variable costs. If the volumes come back in bulk traffic where you are adding a new train start for a new bulk train then you should see us bring that back. But again -- the resources back b- but again that would be at a nice margin so you would want us to do that.

That's kind of what it seems like. Well, those are my two. Thanks very much for the time.

John Larkin, Stifel.

Just wanted to see how much granularity on the accelerated productivity targets you are willing to share with us. There are a lot of initiatives obviously underway, coal network rationalization, longer trains, closing down some excess facilities, eliminating duplicate overhead, all of those are very admirable initiatives.

Are there any two or three of those that have really been the primary reason why you've almost achieved your entire former productivity target in the first six months that had originally been established for the entire year?

John, I think what we have been able to do is put a series of initiatives together, mostly structural with the closure of facilities late last year in the coal network and moving forward into this year where we also closed Russell Yard and also consolidated our Huntington division headquarters. But it's not just in the coal space. We've also announced publicly and you probably read it where we've consolidated facilities in Central Florida with Winston Yard in Tampa, a consolidation actually in Tampa and also streamlining some of our mechanical facilities and shops that are aligned more with our outer triangle in the core network that we have.

Our job is to really become less resource intensive. So between train length and the density of the train as well as the density of the route that we route the train has also allowed us significant savings across the board. So I think there's really no one thing that we have accelerated that would really answer your question.

But we are able -- as we are able to put initiatives in place we are doing so and continually looking for more. We have great momentum here. Everyone is overdelivering and I think technology is a big help for us and also some of our -- working with our labor organization is also a big help for us.

Thank you for that very detailed answer. And then maybe has a follow-on, I understand there's a fairly big initiative internally given that intermodal is going to be a bigger part of the puzzle going forward to make intermodal more consistently profitable going forward. And it occurs to me that some of the initiatives to achieve that goal come from the marketing side.

And I was wondering if Fredrik could talk about some of the initiatives that perhaps sales and marketing has underway within intermodal to normalize the volume so that you are running full trains every day of the week every week of the year. That's an obviously very difficult mountain to climb, but can you talk a little bit about what you are doing there perhaps in working with third parties to fill all the trains up every day to really leverage that productivity?

Yes, there's a variety of things there that we are working on, that's absolutely right, John. And some of them are I think at this point ready for public consumption, some of them are not. But overall you are absolutely right.

In the environment where the RPU is so much lower, one of the key things that you can do to drive up margins is to make sure that you have a much more leveled workload and the team is certainly working on that and thinking through how we can do that longer term. That is a pretty significant structural change.

In the meantime what we are trying to do is work on terminal productivity. We have a variety of initiatives in place there that has yielded a lot of results here. We continue to work on train length in an intermodal space to make sure just as we do elsewhere in our business to allow for the levers that occurs there.

Of course, double stack clearance is as important and you know where we are with the Virginia Avenue Tunnel. By the end of this year we should be able to be double stack clear there, as well.

And then the hub and spoke strategy that we've lined out for all of you for a long time has allowed for a significant amount of efficiency being able to penetrate some of these smaller markets with a lot more density than we otherwise could. And of course, overall speed up the network itself which I alluded to before which has been a priority as we think about the service improvements here in 2016 because the turn time on the equipment is critical.

And then to your point, and this is a little bit more longer term, how do you structurally ensure that the day of the week balancing is a little bit better than what it is today. But that is I think a little bit longer-term initiative from our perspective.

Got it, thanks very much.

Bascome Majors, Susquehanna.

We talk a lot about rising competition and its impact on intermodal but I wanted to focus on how it's hit your carload merchandise business. Do you have a sense of how much share loss to truck has been a drag on overall volumes and I guess, more importantly, when you begin to cycle the worst of that drag on let's call it a year-over-year basis?

One of the key things that we are focused on right now within our sales and marketing team is to sell through this cycle of excess capacity. And there is excess capacity in the truck market and that is probably impacting our volume to some degree.

But one of the key things for us is to continue to be able to reinvest in our business and not necessarily chase that down too much when we see these temporary changes because we do have to be able to be there for our customers day in and day out. And that's one of the things we sell with our customers that we've got to work through the downturn that we are seeing right now and we want to be able to be there for you not just today but also tomorrow when capacity is tighter.

So we are seeing in certain other markets beyond intermodal where there has been probably some share loss to truck. We look at that each and every deal has the marketplace and we always try to estimate what the second best alternative is and try to match that.

And in certain places where that is below what we think is long-term reinvestable for us, and at that point we probably don't participate because we don't want to do anything artificially. The pricing lever is critical. With the service improvements that we've gotten here we've been able to sustain and allow customers to see the long-term value that access to our network provides, but in certain places we have seen some traffic go way back to truck.

Understood. And I just had a quick housekeeping one on one of your expense guidance items.

On MS&O, it implies what you guided that it could be up as much as 10% sequentially from the second quarter in 3Q. Looking back it's been eight or nine years since we've seen a magnitude of that rise from Q2 to 3Q. Can you just give us a little color on what's driving that expectation, that big increase?

Not commenting on the numbers that you threw out there. As you know MS&O is awfully difficult to predict in any given year in any given quarter. I think what we said was that it would be down moderately versus the prior year which does have some implication sequentially.

I think what you are going to see is we had the timing item on the $10 billion casualty reserve, so that's generally what we do in the second quarter and the fourth quarter of each year. We re-look at the probability and severity of casualty. And we had a favorable one-time item, you shouldn't think about that on a sequential basis in the third quarter.

And then in any given quarter, again, you have timing items and small one-time items that are going to impact the sequential comparisons. So I think you are directionally accurate, although again not commenting on your numbers specifically.

Thank you for the time this morning.

Justin Long, Stephens.

So I wanted to start by asking about the point-to-point pricing initiative in coal. Could you provide an update on how far along you are in that process and do you think this will be a tailwind or a headwind to the core price numbers you are putting out today?

So we have implemented the point-to-point pricing across our coal network and overall I would say the process has gone very well. The reason for doing that is to make sure we better match the true cost of service, some of the locations that are further away from so-called our core routes to reflect the maintenance costs and operating costs that is associated with moving that.

I don't think that that will be material in any way shape or form to our same-store sales measure. And as I said it really is more about ensuring that as we try to rationalize the infrastructure in the coal fields that we from a sales and marketing perspective help operations to do that by truly reflecting what it costs to move some coal from certain other mines that are further away from some of our core routes.

That's really all it's about. It's not so much about the same-store sales changing because of it, even though I think overall I would say probably it's slightly helpful.

So you've put it in place on the tariffs. It will take some time to go through all the contracts (multiple speakers)

That is correct, as well. We've put it in place in terms of the tariffs. We have adjusted one or two contracts, but it will probably take one or two or three years, frankly, to get it completely implemented across our whole book of business.

That's helpful and maybe as a quick follow-up, so the 4% increase in core price excluding coal is a pretty strong number in this environment. It's also above what we've seen from some of the other rails here to date. Do you think this level of price increases is sustainable as we get into the back half of the year or is there risk we see some moderation given truckload capacity is pretty loose right now?

So first of all great testament to both what our sales and marketing team have done in this tough environment to your point about the strong results and also clearly a critical part of this has been the service improvements that we have seen. We don't really forecast what pricing will do over time.

We will obviously disclose it each and every quarter in terms of our quarterly flash. But I think you know from our statements before, on one hand we know value creation for CSX pricing is a critical component of that but I've also alluded to the fact that I think short term, meaning for the next 12 months or so, we see a period Of excess capacity out there that certainly is impacting things. But overall you'll have a chance to see it where it comes each and every quarter.

Okay. I will leave it at that. Thanks so much for the time.

Donald Broughton, Avondale Partners.

Help me think about this strategically or help me understand how you think. I understand how the strength of the US dollar is affecting, negatively affecting ag exports and exports of other commodities. I understand why crude being under 70 is affecting negatively chemical volume and everything related to fracking and nat gas obviously under 4 is going to continue to be a headwind for coal.

So what's your crystal ball? Not that your crystal ball is any better than anyone else's but you have to have a plan, what do you plan?

Do you expect the dollar to stay strong, crude to stay above under 70 and nat gas to stay under 4 for the foreseeable future? Is that your expectation or are you planning for the dollar to get weaker, for crude to go back up and nat gas to go back up?

That's where the flexibility I think in our resource planning is critical because to your point earlier there's a lot of crystal balls out there but I'm not sure which crystal ball is better than the other. What we do, as I said earlier, we do go out to our customers in the fall to try to get a sense of what they are saying in the different markets that we serve and then from there we take their best input and triangulate with other things to put together our perspective on 2017. And it's a very volatile marketplace right now where it's very hard to predict.

We have laid out that overall from a coal perspective we do think there's a secular decline that we are heading towards. And certainly we've seen the vast majority of that already. The US dollar, it is impossible for me to sit here and predict what the US dollar.

It's probably much better to look at a forward curve than me speculating on that. But the key thing for us is that we continue to have flexibility in our resource planning and right now the best predictor of tomorrow is today. The dollar is strong and the low commodity prices are there. So that's how we approach it.

Donald, what does your crystal ball say?

My crystal ball says is that crude is going to stay under 70 and nat gas is going to stay under 4 for the foreseeable future and that there's nothing to indicate that the dollar is going to get weaker anytime soon. But, again, whose crystal ball is better than the other? I just wondered what you are planning against.

What is your best guess? Because obviously I understand you're triangulating your expectations to your customers but you have to have your own internal gauge as to where you are going, as well.

I think that goes back to the point of flexibility. It is so hard to plan these days and I think Cindy and team has done a fabulous job of really variablizing our cost structure.

We talked about that for a long time. And then we do whatever we can to forecast, even on a monthly basis, and try to flow that around the network so we can make very timely changes to our network based on the best information we have. But it's hard to see much beyond a month to three months at this point.

Very good, very fair. Thank you, gentlemen.

John Barnes, RBC Capital.

Two things. One, you indicated that you saw more spot-load activity on coal volumes in the quarter.

Fredrik, I think you alluded to a few more phone calls. Do you have a sense for how much volume moved in the quarter, was it on a spot basis versus on a normal contractual basis?

On the export side? Or overall?

Overall.

Overall? As you well know, on the export side, pretty much everything is spot these days. So also that's a great example in a previous question around things change very fast in terms of how much we move.

And we did see a pickup on the export side in the second quarter beyond what we had originally anticipated, which is why we increase the guidance on the export side to about 20 million tons for the year. On the domestic side, really the calls that we have received has really come in here over the last I would say three to four weeks. And so we really haven't had a chance to move a lot of that yet.

But we do expect a little bit of a sequential uptick on the domestic coal which it is embedded in the guidance as we expect export coal to be weaker in the second half. We expect that domestic coal to be slightly stronger within that 22 million to 23 million tons for the quarter.

Okay, all right. And then my second question, and this is a little bit longer term more strategic in nature. I recognize both of these things have only occurred since July 1, but you have got be expanded Panama Canal is now open, the bookings are pretty solid thus far and then you had the SOLAS rules go into effect on July 1, as well.

Have you seen any impact of either and what do you think are the longer-term impacts? What do you think it means? Is there a stairstep in volume as a result of one or both or is this just moving, this is just changing where the freight, how the freight gets to you but no real stairstep?

On the SOLAS first of all we really haven't seen any impact at all. And we have spoken to our international customers and it seems like the capabilities have been there either by the court or some other freight orders or somebody else providing that information that is required.

So we have not heard anything and we don't anticipate any impact on our international volumes because of SOLAS. In terms of Panama Canal, obviously, it is very recent. It is a little too early to tell.

We have said this for a while that there are so many different drivers that comes into play here that it's very difficult to predict exactly what's going to happen. The good news is that we have a flexible network. We will be able to handle additional volume coming into the East Coast if that happens, and we are working very closely both with international customers and with a porch to make sure we have the capability that we need if it is a bigger shift than what we are currently anticipating.

Very good. Are the ports, how far behind are the ports in being prepared for this?

I don't think that is my place to comment, John. I think overall we work very well with the ports.

Certain of the ports have better infrastructure than others, of course. But overall it's a great relationship and I think the East Coast ports are certainly seeing this as an opportunity and have spent a fair amount of capital over the last decade to prepare for this.

All right, thanks for the time. I appreciate it.

Keith Schoonmaker, Morningstar.

This is probably a question for Fredrik related to your last answer. Could you comment on the possibility that significant potential Panama Canal diversions from the historical land bridge road route could be simply truckable when they arrive by ship?

Yes, so our view of this has been is that as you -- if you do see a major shift over to the East Coast ports what we might lose some traffic that goes into the coastal regions that would be trucked to those markets. However we also see then the opportunity to pick up some traffic into the Ohio Valley, into more of the Southeast that is further away from the ports including potentially also going all the way back up to Chicago.

We have seen a fair amount of shift already as the Suez Canal has taken up a bigger shift. We have seen as production in Asia has moved more to the Southeast that we see additional volume coming in through the ports. So we have the capability and there could be a little bit of a mix change, but overall we feel that we are very well-positioned to capture whatever happens.

Okay, thanks. Maybe just one more on truck competition. In the commentary I think that was issued last night, if I am remembering correctly, there was a remark about forest products experiencing some competition from trucking and yet you managed to grow domestic intermodal an impressive 5%.

It's sort of a contrast there, losing in one area. Is this just pretty route specific with the forestry?

And the reason why the intermodal domestic has been as strong as it's been has been the fact that we boarded a significant amount of new traffic from one specific customer last fall and we are starting to lap here as we get to the third quarter. Hence the guidance for not the same sort of growth and probably close to flat on the domestic side as we get to the third quarter.

Obviously long term we think we can grow the domestic intermodal business 5% to 10%. But we are in a period here on the domestic side and on some of the merchandise side where we see some temporal weakness because of excess capacity. But we fully expect that to be worked out over time and allow us to get back to more normalized growth rate as we move into hopefully the second half of 2017 or so.

Okay, great. Thank you, Fredrik.

Scott Schneeberger, Oppenheimer.

I was going to ask on a couple smaller segments since we are at the end here. But with regard to metals, could you give us an update on what you are seeing there, in particular the steel? And is there a chance that it could swim to positive volume growth within a matter of quarters?

I think steel production year to date is relatively flat year over year. And part of what has helped that has been that the countervailing tariffs and so forth has been very helpful to stem the flow of imports into the United States.

Our volumes are down a little bit more than that and the reason for that is on one hand mill closures that has affected us specifically. We have one mill that we both have inbound and outbound to that has closed down as really a big driver for our volume decline. And we also are seeing the impact to the metal side from a little bit more truck competition that we've seen before.

So as we think about the second half I think it's a little too early. I think we are going to have some of these specific CSX-related issues that is going to hurt us as we get into the second half of the year. So I think the second half will be pretty challenging still.

But the key thing for us is to continue to work with our customers on the steel side, provide a better service product and continue to make sure we can reinvest in the business. And that's where we are focusing on.

Great, thanks. Just as a follow-up, and again a small segment, but waste & equipment, nice lift from revenue per unit in the quarter. Is that something that's going to persist or was that a one-time event?

There's a lot of changes depending on what you move in there because a lot of that equipment are some high wides that have very high revenue per unit because it's a very specific service, specific unit trains. And so that varies quite a lot from quarter to quarter. But overall positive pricing continues, but you will probably see more volatility in that line item than any other of the line items.

Okay, thanks again and congratulations.

Thank you. And thank everyone for joining us and we will talk to you again next quarter. Thank you.

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