CSX Corp (CSX) 2018 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the CSX Corporation Second Quarter 2018 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. Kevin Boone, Chief Investor Relations Officer for CSX Corporation.

Thank you, Amber, and good afternoon, everyone. Today -- with me on today's call is Jim Foote, Chief Executive Officer; and Frank Lonegro, Chief Financial Officer.

On Slide 2 is our forward-looking disclosure, followed by our non-GAAP disclosure on Slide 3.

With that, it is my pleasure to introduce President and Chief Executive Officer, Jim Foote.

Thank you, Kevin. Well, it's great to be with you this afternoon. Thank you all for joining our call.

In order to get started, I guess, the first way to kick it off is the press release that we put out says it all: record financial results. These results are due to the hard work of all CSX employees who I could tell you are really excited about what has been accomplished. We will all celebrate a little bit tonight and then it's back to work tomorrow to continue to drive change to fully realize the potential of this company.

Before I turn to the slides, let me comment on a couple of key initiatives. First, safety. We intend to be the safest railroad. In May, our new Chief Safety Officer, Jim Schwichtenberg, joined the company. [Schwich] comes to us with 20 years of railroad experience including almost 10 years with the FRA. I'm confident that he can bring new approaches that will drive improvement in our safety performance.

Also in May, we engaged DEKRA, a highly regarded expert in helping companies improve their safety performance. A comprehensive safety assessment is underway, and I expect positive changes to materialize as a result. The entire organization is committed to being the best in safety.

Second, we recently announced the appointment of Mark Wallace as Executive Vice President, Sales and Marketing. I've known Mark for a long time, and his ability to lead combined with more than 20 years of scheduled railroading experience will allow our sales and marketing team to work more effectively with our customers and drive profitable growth.

Diana Sorfleet will take over most of Mark's former portfolio, assuming increased responsibility as Executive Vice President and Chief Administrative Officer.

Diana, in her role as CSX's Chief Human Resources Officer, has built a big -- has been a big part of our transformation by driving a more productive and engaged workforce. Her new responsibilities, which will now include technology and labor relations, provide a significant opportunity to drive a more full-focused organization.

Now to get to the slides, let's turn to Slide 5 and start with our results. Two words, I think, sum up everything: great performance. Just like the first quarter, there's nothing unusual in these numbers. They are very straightforward. EPS increased 58% to $1.01 versus last year's adjusted EPS of $0.64. The new lower tax rate and lower share count, down 6%, contributed to the significant year-over-year increase.

Our operating ratio improved 490 basis points to a record 58.6% compared to last year's adjusted OR of 63.5%, clearly, the lowest ever for CSX and, I believe, the lowest ever by a U.S. railroad. The significant year-over-year improvement on our results was driven by 6% top line growth, combined with price and lower costs, pretty much across the board with the exception of fuel.

Revenue increased 6% as price, fuel surcharge, supplemental revenues and a 2% increase in volume, all contributed to positive growth this quarter.

Similar to recent trends, we did see slight improvement in pricing this quarter, excluding coal.

Quick look at the -- on the next slide, on the business segments, each were -- which were positively impacted by higher fuel and price. In chemicals, strength in industrial product, plastics and crude-by-rail was partially offset by our fly ash losses, which we discussed last quarter. Auto saw strength based on North American U.S. light truck production, which was up 5%. In forest products, lumber, panels, wall board and paper products, all increased in the quarter. In metals, shipments of sheet steel and construction-related steel products drove increases. Fertilizers' revenues, as I have mentioned previously, were mainly lower due to the Plant City facility closure last year. And in the coal markets, export coal remained very good during the quarter and showed healthy gains. Utility coal continued to weaken.

On the intermodal side of the business, growth continued to come from the international markets, with domestic relatively flat on a year-over-year basis because of the line rationalizations that we -- went through in the fall of 2017.

Other revenue declined $58 million -- declined due to a $58 million liquidated damages, which was in last year's results, which did not repeat this year. Excluding that item, we saw gains in supplemental revenue including demurrage.

We continue to work with customers to create a more fluid network, especially as we approach the fall peak season.

On Slide 7, let's take a quick look at some of the key operating metrics that this team is focused on. Train velocity increased year-over-year and on a sequential basis. Terminal dwell saw an 11% year-over-year and 7% sequential improvement. While we drove improved velocity in dwell, train length increased on both a year-over-year basis 13% and, sequentially, 5%. Let me tell you, improving all 3 of these metrics at the same time is no easy task.

Finally, car miles per day showed low double-digit improvement on both a year-over-year and sequential basis. This is a good measure of asset efficiency and our ability to effectively turn our assets. The improvements we saw on these metrics clearly translated into our financial results.

Now let me hand it off to Frank, who'll go through the financials in more detail as well as the benefits of these operating improvements.

Thank you, Jim, and good afternoon, everyone.

Turning to Slide 9, I'll walk you through the summary income statement. Reported revenue was up 6% in the second quarter, driven by 2% more volume, higher fuel recoveries and solid core pricing gains across all major markets. Same-store sales pricing, which reflects year-over-year increases for stable traffic, improved sequentially in the second quarter. Pricing for merchandise and intermodal contracts that renewed in the second quarter were strong, exceeding same-store sales pricing growth.

Other revenue was down year-over-year, though the benefit of higher demurrage and storage charges mostly offset the cycling of $58 million in liquidated damages from the prior year. Note that we now expect other revenue to remain in the $130 million to $140 million per quarter range for the remainder of the year.

Moving to expenses. Total operating expenses were 8% lower in the second quarter or 2% lower after normalizing for last year's restructuring charge. Overall, labor and fringe savings of $82 million or 11% year-over-year were driven by an 11% reduction in average headcount. This smaller labor footprint spans both the operating and G&A departments.

On the operating side, year-over-year improvements of 7% in velocity and 13% in train length drove more efficient use of our train crews and rolling stock. Even with 2% volume growth, train and engine employee road starts were down 9%, while yard and local starts also fell 9%. And the level of recruits, a signal of network fluidity, dropped by 15%.

Shifting to mechanical. The active locomotive count was down 13%, reflecting our ability to keep over 600 locomotives in storage despite higher volumes. The smaller fleet, along with freight car repair efficiencies helped drive an 18% decrease in our mechanical craft workforce.

We recently aligned the engineering function to the regional structure we have for mechanical and transportation, which will also yield headcount and other efficiencies moving forward.

Our G&A headcount continues to decline as we look for every opportunity to absorb attrition.

Over the past year, we have eliminated unnecessary layers of management, yielding a structure that is cost-effective and enables rapid communication and decision-making across our network. MS&O expense was down 5% against the prior year. As you look at the year-over-year comparisons in MS&O, recall that we are cycling a $55 million gain from a favorable legal judgment in the second quarter of 2017.

This year, results benefited from $37 million of real estate gains as we continue to make headway in monetizing our surplus real estate portfolio. These gains are consistent with our guidance to achieve $300 million of cumulative real estate sales through 2020.

From an operational perspective, many of the key drivers of labor expense favorability also yielded savings in MS&O in the quarter as lower asset and resource levels helped drive down MS&O expense.

Material savings attributed to the smaller locomotive fleet are complemented by our decision to store units that are less reliable. The decisions we've made around storage combined with additional fleet reliability efforts drove a 33% year-over-year improvement in our locomotive out-of-service measure and further reduced costs related to materials and contracted services.

Looking at nonlabor costs associated with our train crews, the reduction in road crew starts combined with better network fluidity yielded lower hotel and taxi costs. Additionally, MS&O continues to benefit from our efforts to streamline contractors and consultants, particularly in our technology department.

Consistent with our prior guidance, we remain on track to reduce our total workforce by 2,000 resources by the end of 2018.

Looking at the other expense items. Depreciation increased slightly as the benefit of asset sales mostly offset the impact of capital investments. Yield expense was up primarily due to a 36% increase in the per-gallon price, though we were pleased to achieve record fuel efficiency in the quarter.

We will continue to drive further fuel savings through continued improvement in network fluidity, train length increases and the use of fuel optimization technologies.

Higher equipment rent expense is mainly attributed to volume growth. These volume-related increases were partially offset by improving car cycle times across most markets.

Equity earnings were favorable due to improved performance at our affiliates in addition to a nonrecurring benefit from an affiliate's property sale in the quarter. Given the recent strong performance, we now expect core equity earnings of affiliates up $20 million to $25 million in Q3 and Q4.

Lastly, just as a reminder, we are cycling 2017's restructuring charges. Looking below the line, interest expense increased, primarily due to the additional debt we issued earlier this year, partially offset by a lower weighted average coupon rate. Tax expense was lower year-over-year, even with higher pretax earnings given the benefits of the new lower corporate tax rate.

Our effective tax rate was 23.3% in the quarter, slightly lower than our prior guidance, mainly due to a onetime benefit from state legislative changes. Going forward, absent onetime events, we expect our effective rate to be around 24.5% for the back half of the year.

Closing out the P&L, as Jim highlighted in his opening remarks, CSX delivered record operating income of nearly $1.3 billion and a record operating ratio of 58.6%.

Turning to the cash side of the equation on Slide 10. Year-to-date capital investments are lower by 14% and keep us on track for our 3-year $4.8 billion capital target. The reduced capital intensity of the scheduled railroading model, the substantial core earnings progress detailed on the prior slide and the benefits of tax reform helped drive a nearly $600 million increase in year-to-date adjusted free cash flow.

Significant improvements in free cash flow generation combined with higher leverage enabled us to nearly double our shareholder returns compared to the first half of 2017. We have now completed approximately $2 billion of the current $5 billion buyback authority and remain on pace to complete the program by the end of Q1 2019.

As we stated at our investor conference, CSX will continue to evaluate cash deployment and shareholder returns on an annual basis.

In closing, I will reiterate the 3 key priorities that drive this management team on a daily basis: ensuring the safety of our employees and communities, delivering great service for our customers and appropriately rewarding our shareholders.

With that, let met turn it back to Jim for his closing remarks.

Great. Thanks a lot, Frank.

Turning to the last slide, #12. While we've achieved a lot in a very short period of time, we are far from where I believe we can go. As many of you know, we just rolled out our trip plan compliance a few months ago. We're in the early stages of driving improvement in this metric, and there is significant opportunity there to get better.

Trip plans are so important as we think about delivering even better customer service and asset efficiency. It allows us to track every car and container on our network and identify at a very discrete level where we may have a problem. This allows us to know why something happened so we can react and, more importantly, fix any problems so it does not repeat.

I mentioned velocity and dwell earlier. Clearly, to be the best, we have more room to improve. On train speeds specifically, we have significant opportunity to improve as we remain below the industry leaders. Our dwell is better than the industry average, but again, there is significant runway for opportunity before we can call ourselves the best.

Cars online continue to be a focus of this team. We are in the business of moving cars, and the more efficient we get, the less cars we need to move with the same -- to move the same volume. But turning cars faster, it also frees up capacity for us to take on additional business.

Finally, fuel efficiency. Diesel prices are up, so this becomes even more important. There are many ways to drive improvement in this area. Fuel alone this quarter was $270 million in cost, so we are in the $1 billion run rate range for the full year. These are big dollars. From Trip Optimizer to distributed power, we will use all of these to drive improvement and lower cost.

Now on revenue. We are raising our full year guidance from up slightly to up mid-single digits. At some investor conferences, I said we were trending to be a little better than where we thought we would be at that time of the year. This slightly higher outlook is a reflection of a number of factors, including our belief that export coal strength will continue, higher fuel prices will remain and a healthy economic backdrop.

Obviously, there are factors we cannot control, mainly the economy, that can provide some variability as we get into the back half and fourth quarter specifically. But this is how we see it today.

In closing, we have shown a relentless focus on executing our business model. But let me assure you we have an eye on the horizon to develop long-term sustainable growth. Our business practices are new to CSX employees but are becoming part of our DNA as we work hard every day with the goal of becoming the best-run railroad in North America.

Thank you, and I'll turn it back to Kevin.

All right. Thank you, Jim. (Operator Instructions) Operator, we'll take the questions.

(Operator Instructions) Our first question comes from Amit Mehrotra.

Congrats on the great results. Jim, the OR, obviously, in the second quarter is below the target that you set for 2020. Fully understand the nuances and seasonality and the risks around the macro, but would it be fair to characterize the 2020 target as conservative based on what the team has achieved so far? And if so, what do you feel maybe is the structural limit of where you can take that OR over that time period?

Well, over the time period, what we laid out just 3 months ago when I stood up there and said we had a target of 60% in 3 years, and I think everybody in that room kind of thought I was crazy that we'd never be able to get there. So -- and it's only -- we're only 2 quarters in. So we're not -- clearly, not changing our guidance here and what we think is achievable. And as I said, we have a lot, a lot of work to do. And we got a lot of help this quarter from coal. So if things continue to align, I continue to say I have confidence that we can hit a number, 60%, which everybody, I think, thinks is extremely, extremely impressive. So there's no change in the short period of time from what we laid out just a quarter ago.

Right. Okay. And just kind of related to that as my follow-up. Your comments at the end there with respect to where you are in implementing PSR and just a lot more room to go in terms of low-hanging fruit on the cost side, in particular, I would imagine. Can you just talk about where PSR is not represented in the network today? I guess, some of the new initiatives that you're taking on, specifically on the intermodal franchise in terms of implementing scheduled railroading, that strategy on that particular business, if you can talk about some of the places where it's not represented and the opportunity there more concretely in terms of reductions in dwell time or things like that, that would be great.

One answer: intermodal. Our intermodal network needs a ton of work in order to become -- to be an efficient part of our system that it needs to be. And we are just really beginning to get in there and start to figure out how to rationalize that big part of our business so we can become much more efficient and have a much better product for our customers.

And is that -- should we be watching origin dwell time yields in that business? I mean, how should we monitor, looking outside, in terms of your progress there?

I mean, all of our -- yes, it'll be reflected in all of our metrics. Again, our terminal dwells are pretty good, but we have a network franchise here that, to a large degree, is dysfunctional. And it is the product of, for many, many, many, many years, CSX having a standalone intermodal entity. So we need to kind of go forward and reconfigure the franchise and make sure that it is properly and appropriately integrated into the rail company so we can achieve the benefits of operating more effectively and efficiently. So we are at the very, very early stages, a lot of work to do in that area and in every other area. As I said, yes, we had some great results, and we did that -- we're not -- we don't have the highest velocity. We don't have the lowest dwells. So we have a lot of opportunity ahead of us to get even better.

Yes. It makes it seem just that fixed OR is so conservative. But I will -- those are my 2, so I'll leave it there.

Our next question comes from Ken Hoexter with Merrill Lynch.

Congrats, that's a phenomenal job on the operating ratio so quickly. But Jim, I guess, on the on-time originations and arrivals, both are down year-over-year, but you noted the calculation has changed in the details, but the results were restated to conform. Why are they down given the network improvement and how everything's accelerated on the network?

We're pretty comfortable -- obviously, we'd like to be better on the originations. We depart our trains pretty close to on schedule. We don't get them across the network as effectively as we should. We depart -- if we give ourselves, which we don't, but if you did, from an accounting standpoint, give yourself a couple hours of flexibility on either end, we depart in the high 90% our trains to schedule. And we get to destination, again, with that 2-hour cushion over a 3-day operating period in the 80% range. That's not acceptable. And a lot -- that always comes up with -- for a number of different reasons. And so we need to just continue to be able to work to eliminate the causes of failures. And that's why our trip plan compliance is in the kind of 60% range. We need to get that up to 100%.

And when the trains fail to arrive on time, they miss their connections and then, therefore, we're off the trip plan. So all of those things need to improve, and a lot of it has to do with culture, when people recognize that there's going to be a failure and they go above and beyond the call of duty to make sure that we get the box to make the connection on the next train, as I've said many times. What does a UPS employee do when he sees that a box is not going to get in the truck? He runs behind the truck down the road to make sure that he gets the box on the truck. Our guys kind of wave to the train, "See you later," and the car runs a day later. So it's culture, and it's all kinds of changes that we need to take place in order to get better.

Wonderful. And if I can get the follow-up on pricing. Frank, you mentioned that pricing accelerated on a pure pricing basis. Are there levels you can talk to, especially given how tight the truck market is? Can be any more specific in terms of are you seeing it growing, going 100 basis, 200 basis points up, on a sequential or year-over-year basis from where you were?

Yes, Ken, I think, you probably know the answer to that question. I think what we're trying to help you understand is that the environment's a strong environment, and that's why we're seeing the contract renewals come in higher than the same-store sales pricing. I think the last public number we have out there is in the Q3 of 2017 at 2.2%. For merchandise and intermodal, what we can say is that we have seen sequential improvement every quarter since then in same-store sales and that the discretionary renewals in Q1 were better than that and the discretionary renewals in Q2 were better than that.

Our next question comes from Brandon Oglenski from Barclays Capital.

I don't know if Mark is on the call, but I guess, for Jim or Mark, it seems the improvement here is coming maybe a bit faster as the first 2 questions kind of alluded to. I mean, does this in any way change your philosophy on the revenue outlook? I think, at the Analyst Day, you were saying, "Look, maybe we'll get a little bit of growth in '18," but obviously, you're seeing a bit more now. So is that because of the changes you've made in the network, is the market that much stronger and, now with the lower-cost basis, that changes the dynamic on focusing between price and volume at all?

As I said at the Investor Day and as I've said, basically, ever since I've been here, number one, I don't differentiate in the implementation of scheduled railroading that you ignore your customer and don't focus on growing the top line as you implement your operational changes. You do that at the same time. So -- and we have been working to improve the quality of our service and work with our customers to grow our business throughout the last 6 months and with, I would say, pretty favorable results and responses from our customers. They went from, when I showed up here, to hating me to now on occasion even buying me a drink. So we made great improvements in our customer relationships.

And so -- but I don't see a differentiation here. I also don't look at this as, "Oh, you're a price leader or a price taker." We're focused on volume. We're focused on price. We're focused on growing our business with long-term sustainable, profitable business that people recognize that we have differentiated ourselves in the marketplace, we have a better product to sell to our customers. And our customers recognize that by working with us and paying us more because we're a better-quality product, they can save money in their business. That's our strategy. That's our strategy to grow the business, and that has been our strategy since day 1 and will continue into the future.

And next, we'll go to Tom Wadewitz with UBS.

Great results. I'm sure everybody is going to refer to that but they are obviously very impressive. What do you think about OR in the second half? I mean, your sub-60% in second quarter probably implies numbers ought to go up in the second half. Is it pretty reasonable to think you'd be sub-60% in the second half as well? Or is there anything in terms of maybe, you know, incentive comp is a tailwind, there would be a headwind or anything else we ought to consider when we think about second-half OR relative to the really strong result in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacation, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase -- around 3% wage increase in the second half of the year. So those are headwinds that we have planned for and have expected all along.

And then the most reliable variable is the weather here in the fourth quarter, which is a new phenomena for me and Mark, where you've got a hurricane in Florida and the Gulf while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth -- I mean, fourth quarter. So those are the kind of things that we look at and say it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they'll be lower than they were last year. How about that?

Okay. Sure, that's fair. I appreciate the color on that. Let me ask you, also, you made a comment on the intermodal network. Seems to imply you might simplify it further. I don't know if that's accurate or not. But how do you think about the potential changes to get the intermodal network right? Is that simplifying the flow, fewer touches? Is -- and what might be the timing for that? Is that something that you can do pretty quickly? Or is that something you need to kind of plan and execute over multiple quarters and maybe you see that result in 2019?

I think, as I said earlier, Tom, we're just starting to really peel this back and understand what changes we need to make. Obviously, last year, I mean, it was well talked about when Hunter closed that -- changed the philosophy and got rid of the hub-and-spoke. That was about 7% of the volume that was taken off the revenue -- sorry, taken off the railroad. And at that point in time, it was my belief that a large part of that rationalization of intermodal had been accomplished. Well, that's not the case.

So -- but we're going to take it very methodically. We are going to have very good and open communication with our customers about what it is we're trying to accomplish. And it involves train design changes. It involves terminals and terminal -- potential terminal consolidations. And we will do this very methodically and logically and appropriately and do it being fully aware of the fact that we are looking at a peak season this year, which everybody is indicating us is going to be very strong. So we're not to do anything that's going to screw up the railroads. So if it takes a little longer than a quarter or 2, I'm fine with that.

Our next question comes from Chris Wetherbee of Citigroup.

Wanted to touch a little bit on sort of the revenue and volume outlooks. You're taking the revenue numbers up, I think some of that is driven by what you're saying on the other line. But how do you think about the sort of volume outlook and maybe sort of queuing up the competitive environment? You brought the OR down, arguably, a lot faster than most of us had expected. Does that open up new opportunities? Do you see some of that in the second half? How do you kind of think about those opportunities going forward?

I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio so that we can be the price leader in the marketplace. So I think, as I said last time, we don't get stickers and bonus points for volume. And therefore, to the extent that we can sell our products as a superior product in the marketplace, we fully intend to do that.

Clearly, we have as much flexibility as we want to if there are unique opportunities in the marketplace where a customer to us is not interested in quality of service but is only interested in price and it makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So we have all the flexibility in the world to pursue whatever business segments we want.

Our principal objective here is to be a better-run network that has a differentiated service product in the marketplace that demands a higher price for that and we can grow business at the extent of truck, which we already know the customer is paying 15% to 20% more for, so why discount your better quality product when you know you can go save the customer money by having a service that's more truck-like?

Okay, okay. So it sounds like there might be opportunity there on the volume side. That's helpful. And then getting a little bit more specific, when you think about export coal as we look out into the back half of the year, and I know this is a tough commodity to predict, but you've given us some help in the past as to what you expect. Any changes to sort of that high 30-million-ton number that we've talked about for 2018 as we look out to the second half?

Yes. In the second half, I mean, clearly, one of the reasons that we have talked now about higher volumes is because export coal has been better in the first half of the year and appears that it will be better in the second -- slightly better in the second half of the year than what we originally expected. Frank, maybe you have some further comments on that.

Yes. So we were at about 22 million tons in the first half if the framework holds, as Jim mentioned in his opening remarks and we see the indices hold at the 200 and 100 or higher on the met and the thermal index. You could see that same run rate prevail in the second half. So early to mid-40s would be probably a decent range for you.

And next, we'll go to Scott Group of Wolfe Research.

So I wanted to follow up on intermodal and what you've been talking about. Jim, maybe give us some perspective. Where is this OR relative to the rest of the business? Are we 1,000 basis points behind, maybe 2,000 basis points behind? If you can maybe directionally give us some color there. And once you've got it all optimized the way you want to, how close do you think intermodal margins can be to the rest of the business?

Well, as I think I tried to portray, we have a lot of areas in intermodal where we can make improvements. And we don't ascribe the various -- the business segments in great detail in terms of what's more profitable than the other. You've been around this business long enough. You know which ones are. I can tell you, when we did this -- when I did this at CN and we got involved in -- did the same thing at CN. We fixed the merchandise business and then we went over and started fixing intermodal. And intermodal at CN was a basket case.

When we were done fixing it over a couple-year period, the average profitability of our intermodal business there was better than the corporate average. So we have -- we got a ton of work to do, and I couldn't be happier that Mark is here to do it. So -- and we'll just keep updating you. But it's going to be slow. It's going to be gradual, and it's going to be a good process that works for our customers as well.

Okay. That makes sense. And then just real quick, some number questions. The raise in the other revenue guidance, is that because customers are not changing behavior or you're rolling it out to more customers? And then do you have any way to -- $70 million of real estate in the first half, any way to put a range on what you think is realistic for second half?

Scott, on the other revenue, I'd say it's 2 things: one, the behavioral changes that we're looking for, obviously, through the increases in the rates and the reduction of 3 days, it just isn't happening as quickly as maybe we thought it was 3 months ago -- was going to 3 months ago. So that's, I think, the answer on that one. We did roll out some additional policies effective July 1, so that then bleeds into the run rate there.

On the real estate side, yes, you're right, we had about $70 million in the first half, so we had a good first quarter, a good second quarter. You all probably saw a line sale that was announced with Omnitrax a couple of weeks ago. That combined with some smaller transactions that we may close in the third quarter, I'd say we'll have a good third quarter, not unlike what we saw in Q1 and Q2.

And we will go to Brian Ossenbeck of JPMorgan.

Just wanted to talk about the domestic coal side first. Obviously, the volumes are challenged this quarter, remain challenged for the first half of the year. Are you seeing anything from structural competition from new gas-fired power plants, gas pipelines going further down south, especially into Florida? And do you still have the confidence that there's going to be no material retirements of coal-fired plants this year or through the next couple of years through 2020?

Brian, Frank. I think the utility story has largely stayed the same. Nat gas is $2.75-ish, which isn't all that helpful to the environment, though stockpiles in the South have come down pretty significantly. The cooling degree days are up year-over-year. We're just not seeing the burn rates go up in coal quite yet, but a lengthy hot summer and a cold winter would certainly help those. In terms of your structural competition, again, we don't know of any plant closures that are going to impact us significantly in the next couple of years that are new. Clearly, we have a couple that are going to roll off. We knew about those. We've adjusted our outlooks for those, but nothing new.

Okay. If you can give us a quick update on the leased and licensed, I guess, the wires and pipes, the other ancillary revenues, are those things that you're starting to be able to monetize yet? Or is that something that will start to pick up in the back half or 2019?

Brian, both. We've had an ongoing business of licenses and leases that utilize -- or cross over the quarter. Mark and his team have been increasing those over time and will continue to deliver and are on track to deliver the $300 million guidance that we gave you at the investor conference, over 3 years.

Our next question comes from Matt Reustle of Goldman Sachs.

You're obviously ahead of schedule on the network improvement, and that's boosted the 2018 revenue outlook. Does that also raise the potential for revenue in '19 and '20? And I guess, the real question is, does your 4% revenue CAGR target increase beyond the 2018 bump that you're guiding to now?

I would say, at this point in time, no, for the 2 principal reasons that I talked about. One is one of the most significant reasons that we're looking at higher -- have looked at higher volume and revenue in the first half of the year was export coal, and one of the principal reasons we're talking about being more optimistic for the second half is because of export coal. And I don't know at this point in time if anybody could tell you what the future is beyond December 31 of '18 what export coal is going to do. So it's a little premature for us to start saying that that's going on.

And at the second time, I'm -- because we are in the early stages of this network reconfiguration in intermodal, I don't know what implications that might have on revenue growth in intermodal at this time. So I'll just have to stick with, "Hey, here's what we -- where we are today, what we think the rest of this year looks like," in terms of being mid-single digits. And for now, we're in the same mode looking at '19 and '20, about where we were 3 months ago.

Got it. That's --

(multiple speakers) 3 years ago, but it was only 3 months ago.

That makes a lot of sense, makes a lot of sense. And second question, just still early days on trade and tariffs, but can you talk about, high level, where you see you're business sensitive? Are you hearing or seeing anything with -- from your customers in terms of talking about adjustments relative to the tariffs? Any color on that is helpful.

Well, again, there's so much noise swirling around about tariffs. In terms of the specific impacts on CSX today from any kind of tariff activity, clearly, first was steel. And from a steel standpoint, both finished steel out and ore business in, we have seen some positive as a result of the U.S. steel manufacturers kicking up production. The second area where there have been some real activities involve export soybeans. Our export grain business in total is around $30 million. About 1/3 of that is soybean. And so in the grand scheme of things, in terms of soybeans going to China, it's really not a factor at all for us.

And then the third area, which, again, has not had any real activity, but again, a lot of noise about it, is both NAFTA and Europe in terms of tariffs on imported autos. We are not impacted in terms of imported autos from Mexico. We would clearly watch carefully if anything were to be put on imported vehicles from Canada, but nothing has happened there yet. And in terms of European imports coming in through the East Coast ports, normally, they don't touch rail anyway. So not much of an impact at all right now. And our customers continue -- despite the fact, again, that there's much discussion that this could lead to an economic downturn, our customers seem to be -- continue to be very optimistic about the future.

Our next question comes from Allison Landry of Crédit Suisse.

Maybe that was a good segue into my somewhat pessimistic question. But how are you thinking about CSX's ability to turn what have historically been fixed costs into variable costs in a downturn? And is the network at a point where if volumes dried up tomorrow, you'd still be able to generate significant OR improvement?

Wow, that is pessimistic, and on such a happy occasion for us here. But I'll try to deal with that, and it's not something that Frank and I don't talk about on a regular basis here, having myself been through it a couple of times, when all of a sudden, yes, your volumes just go away. And again, because of all the speculation just in the media about tariffs and trade wars and what could that -- so we're always doing recession scenarios here about what if this and what if that.

Clearly, as we get better and as we get a better handle on our operations, we will be able to more quickly respond and make appropriate adjustments to our variable costs in the event of volume decline. And you always have to -- you always have the wherewithal at your fingertips to reduce your fixed cost to a degree, meaning fixed labor. It's just how much you need to do in order to do that.

Depending upon what kind of an economic decline scenario you came up with, I guess, my thoughts are if we, again, assuming a severe decline, if we were able to maintain our plan and at least are the status quo, we would be able to -- we'd be doing a very good job. If it's a minor thing, then it's probably a minor thing, and we continue to stick with the program and see what we could do to make our numbers.

Okay. That was helpful. And then as my follow-up, if you think about the disparity between your service metrics and your competitor, and within the context of your earlier comments about pricing for a better service product, do you expect to pull the growth lever perhaps earlier than what we saw at CP and/or CN?

Again, we never push the growth lever in the other direction. We're always in the growth mode. It was -- and again, through a lot of this, I wasn't present here, but many of the people that were work -- that worked here and Frank were, it was tough to grow when your railroad wasn't running. And products that -- cars that should have been across your network in 3 to 4 days were taking 3 to 4 weeks. So that's difficult to say, "I'm in a growth mode," at that period of time. Once the service has improved and where the service is today, we are always looking to get business from -- more business from current customers, the business back from the former customers and all of that. And -- but it is -- again, it is our philosophy that we want to be the premium service provider in the marketplace and get paid for it.

Our next question comes from David Vernon of Sanford Bernstein.

Jim or Frank, could you help us -- you mentioned earlier in the call that coal helped you out a little bit here in the quarter. Is there any way you can help us dimension how much coal has contributed to the year-over-year sort of profit development of the company in the first half of this year? What I'm just wondering is how much of the very, very aggressive improvement in operating income you'd chalk up to kind of PSR versus how much of it would you chalk up to help from the commodity markets.

Obviously, it's help from a lot of different areas. Precision Railroading is clearly one. When you look at the levels of efficiency that you're seeing, the headcount reductions that you're seeing, the asset reductions that you're seeing, I mean, those produce real dollars and significant dollars. If you look at the point that Jim made around export coal, just to dimensionalize it, we moved a little over 11 million tons in the second quarter of this year, and last year, we moved a little over 8 million tons. So you can get a feel for the uptick in export coal. At the same time, we saw some reduction in utility coal. So you've got to net those 2 things out. They're both good pieces of business for us. We want to move them both. But there's a whole lot more that's happening in our company other than coal. But coal is...

I totally agree with that, and -- but I guess, I was just wondering if there were maybe an indication you can give us for directionally how much export coal rates have moved up on a year-over-year basis in relation to domestic coal rates.

Well, we generally follow the indices. We don't follow them 1:1. So when you see them -- you see the forward curves move up, generally speaking, our pricing is going to follow that, again, not 1:1. The highs on the benchmarks are going be higher than our price, and the lows on the benchmark are going to be lower than our price, but we generally are going to follow those.

When you look at it on an RPU basis, you can get a feel for what the export RPU is and what the domestic RPU is. There are times when the export's higher. There are times when the domestic's higher, but it's really going to depend on what those external benchmarks are. But again, there's a lot more happening here, and I don't want you to lose sight of that by focusing on coal.

Yes, absolutely not losing sight on it. I'm just trying to get you to tell us what happened to the export coal RPU, which we're not going to get to. So maybe just...

No. You're not going to get that from me and I'm not going to get that from Frank.

Well, we can always get it from the guys at Parker Host. But let me ask you a quick follow-up question, Frank. When you think about the gains you had in the MS&O from idling some of the spare locomotives, is there a chunk of that that maybe snaps back as you start to run a little bit hotter and leaner? Or is it all just pure kind of run -- you should run rate these levels on the cost side going forward?

Well, remember, you've got real estate in that line item. So be careful about run rating real estate on a [per-head] basis. I tried to give you some intel on Q3. But when you look at what we're doing, the smaller locomotive fleet's clearly a driver. You've got contractor and consultant eliminations which are rolling through that line. You've got, as I mentioned in my opening remarks, less hotel and taxi costs. You've got, G&A, fewer people, obviously, spend less money on the MS&O line. So as long as you're seeing those things stay the same, excluding the real estate piece, I think you can run rate those.

Our next question comes from Justin Long of Stephens.

Congrats on the quarter. Wanted to start and ask about headcount. Do you have any updated thoughts on where headcount will end this year? Just curious if your expectations have changed. And based on how the network has performed during the first half of 2018 and what seemed to be a better-than-expected start as it relates to volumes, is there any change in the expectation for headcount that you're targeting in 2020 as well?

No. In terms of this year, we're right on -- again, we're slightly ahead of where we -- the run rate to get to the 2,000 reduction, but that was planned for, as I said earlier, because of vacations and other purposes, that we would have an accelerated pace in the first half of the year. So we're right on target to hit the number for this year, and nothing has changed in terms of the number for the 3-year plan.

Okay. That's helpful. And maybe to circle back on the increased revenue guidance for 2018 as well. Is there a way to help us think about how you would allocate this increase between, one, a better outlook for export coal and, two, a better outlook for everything else? I'm just curious if that split is 75%-25%? Or how would -- you would quantify that?

Without getting into the specific volume details by the various commodity groups, I'm trying to come up with a more simplistic way to answer that. I think, if you look at our coal business in the second quarter, and I think that's a relatively good run rate. Again, we had a great -- we just got done telling you we had a great second quarter with strong export demand and weak utility demand. That's kind of a norm for us for this year, but we expect that kind of run rate to continue in the second half of the year. So that will give you some guidance in terms of volume from coal, and the rest of it is going to come primarily from merchandise, which is, again, across the board.

All of these various commodities that I talked about, metals, forest products, blah, blah, blah, blah were all relatively strong in the second quarter. That's just a reflection of good markets and customers recognizing that we've got a good service product. And so that's kind of a, I would say that that will give you a better run rate view of what we think the top line is going to do. And then, as both Frank and I mentioned, you'd layer in continued reasonable pricing environment, continued recognition of supplemental revenues from the demurrage policies that we are now -- policies that were in existence for many, many years but now we're collecting on.

And then thirdly, a little bit more fuel surcharge because price on fuel is going to get up. And I think the second quarter will give you a pretty good understanding of why we think that the second half of the year is going to be a little bit better than what we originally expected. Second quarter was a little bit better than we expected. I kind of started talking about that early in the quarter when I said we're going to be a titch better. And then now we came in with a 6% growth. And so if things stay the way they are right now, I think that leads us down the road of giving you a pretty good way to get to a general view of how you get to mid-single-digit top line growth for the year.

And our next question comes from Walter Spracklin of RBC Capital.

I want to come back, Jim, to your answer to a previous question with regards to exactly that you're -- the trends you've been noting in the back half of the year have picked up. And I think what you said in the last -- just now is that it wasn't all just due to coal. There was other factors due to better pricing and better volume in other areas.

I'm just curious as to why that wouldn't change your view into 2019. Why would it all stop as of December 31? Wouldn't there be a carryover in the first half of next year even if commissions remain that will lap easier comps that would give you a bit of better lift into next year? Just curious as to why you wouldn't expect it to continue more than just 6 months.

For the 2 reasons I said, one, I don't have a clue what coal is going to be like in '19 and '20, and I don't know what the implications are to our intermodal franchise by some of the work we have to do there. So those -- the uncertainties surrounding those 2 big components of my business give me pause to say that, "Oh, this is the new norm for '19 and '20." I need to get a little bit further down the road this year to have a better -- more -- a clearer view of year after.

Okay. And just on the pricing environment, can you talk to us a bit about kind of the cadence in the negotiations you have now versus 1 month ago, versus 3 months ago, versus 6 months ago, particularly where trucking comes into play on your intermodal franchise or where you come head-to-head with your competitor? Are you finding that -- is there anything capacity constraints that are allowing for the movement of price to come in a little bit, well, not easy but easier that it might have 1, 3 or 6 months ago?

Well, 6 months ago, we had our hat in our hand telling everybody how sorry we were for not running a very good railroad. So the environment for us right now compared to where we were at the end of last year is dramatically different. In terms of the pricing environment and the capacity environment, it's a good time to be in the railroad business. It's a good time to be in the transportation business. Price, it's no secret that the pricing environment is strong for everybody. As I said -- and again, but as I said earlier, we are in this to grow the top line through long-term sustainable, profitable growth. Our plan in the spot market. I'm not worried about volume. I'm not worried about highway-to-rail awards, that kind of stuff. Long-term sustainable, profitable growth where we provide value to our customers and our channel partners and everybody in the marketplace is our strategy, and that is what's going to make CSX the best.

If I could sneak one last one here. In terms of when you sit down with Mark now in his new role, what do you guys talk about as your kind of objective #1? I think you alluded is that the intermodal franchise, or is there something else that you want to kind of zero in on as his #1 objective as he starts the role?

Mark is -- one of Mark's strengths and one the reasons I'm so excited about Mark taking over the job besides the fact he's a really bright guy is he's got great relationship skills, and we need to develop long-term solid relationships, again, with our customers. There's been a lot of turnover here at senior management of this company. And we hear this all the time: We don't know who to call. We don't know who you guys are. We got a whole new team there. What I'm supposed to do? Who do I call if something goes wrong? So number one, fix intermodal, but two, start build back the long-term relationships that CSX should have. And I'm totally confident that Mark's going to do an exceptional job in that area. Not to say that the guy that runs our merchandise group, Michael Rutherford, and his team aren't doing a phenomenal job in that area. But again, I know Mark, and I've been around him for a long time, and I think that's where he can do some great work for us.

And next, we'll go to Ravi Shanker, Morgan Stanley.

A couple of follow-ups here. Just on the intermodal and your comments on the tons of work you still need there and eventually getting that up to an above-average margin profile. Can you just help us understand how much of that is fairly basic blocking and tackling that can be achieved pretty easily versus maybe bigger, longer term like yard automation or something?

Oh, this is blocking and tackling. This is just running a good railroad. I'd like to be in a position where we were running so well that we could start to look at ways to adopt the new technologies to help us run things better. We're a long way from that. This is just basic core fixing a bunch of broken windows.

All right. Understood. And just a follow-up on IM. When you think of auto as an end market, is that primarily in your autos' volumes, or do you also have smaller auto components or something running through intermodal?

We have auto parts. We have auto parts in our intermodal, especially imported parts. And we have auto parts in boxcars and merchandise service, racks, frames, et cetera. But the primary volumes are in finished vehicles that are moving in trilevels and bilevels.

Got it. Is there any way to quantify your overall autos exposure in terms of volumes kind of combined across segments?

We could -- not off the top of my head. But if you get back with Kevin, we can see if we can try to come up with some way for you to help -- some percentage for every vehicle, how much moves and kind of a general percentage, for every finished vehicle, how -- what's the percentage of a car kind of a thing. We might be able to come up with something that can give you guidance on that.

Our next question comes from Benjamin Hartford of Robert W. Baird.

Real quick, Jim, what are -- in the context of intermodal and the work that needs to be done there as you think about the back half of '18 and through '19, whatever the plan may end up being in terms of volume growth, what do you think the box count needs within UMAX specifically are going to be to support growth? Will it grow in line with volumes? Or is there enough opportunity as you work through that network and improve velocity that perhaps that fleet size does not need to grow to be able to satisfy volume growth targets?

Yes. Under the current scenario, I don't anticipate us making any investments in boxes for UMAX.

Our next question comes from of Bascome Majors of Susquehanna International.

Frank, years ago in the prior regime, you guys used to make some directional comments around the profitability of different commodity groups. I know putting hard numbers to that was declined earlier on this call. But I am curious, with the overall profitability of the franchise moving up in 12, 13 points in less than 2 years here, has the directional sort of contribution of the various revenue groups that you do, has that changed dramatically? I'm just curious if we're kind of in a new game as to -- versus the historic playbook of what's the best business for you and what's not.

So back of the -- a rising tide lifts all boats clearly. In a good pricing environment and a good efficiency environment, you're going to expand your margins. When we look at the rack and stack of profitability, I could show you intermodal moves that are at the top and I could show you coal moves that are more toward the bottom, and merchandise runs in the same spectrum. So we've got a good portfolio of business. Obviously, when you say a 58.6% operating ratio across, that portfolio must be pretty good, and we're going to continue to optimize and drive that long-term profitable growth that Jim mentioned.

And next question comes from Cherilyn Radbourne of TD Securities.

Just wondering if you could speak to some of the mix dynamics in the quarter. RTMs up 7% versus 2% carload growth would suggest a pretty big shift. So maybe you could just give us some color there.

Ton miles up 7%, Frank?

So I think what you're seeing is what we did at some of the network changes last year. As we closed terminals, et cetera, we probably introduced some out-of-route miles, and we're now pulling those down pretty significantly. Ed and his team are working on that. I think you'll see that continue to come down in that disparity that you mentioned, I think, will get a lot closer as we go forward.

Okay. And then maybe just a quick follow-up on the whole intermodal discussion. As you continue to reposition that network, do you continue to be able to leverage the benefits of a hot trucking market from a volume enterprising standpoint?

A good time to be in the railroad business, and it's even a better time to be in the railroad intermodal business. So yes. Just take a look, as I said earlier, we took 7% of our business off in the network last year, and we're flat today. So people are looking for capacity. We want to be able to provide that service and capacity to our customers. We just want to make sure that we have a rational footprint of an intermodal network when we are going into the marketplace and selling a product to our customers. And that's just going to take us some time to straighten that out, and then we are going to be back there doing whatever we can help out the -- again, our channel partners, principally, who work with us, to who want to use intermodal to reduce their costs as well as the growth that's coming with some of our other partners as their volumes grow enormously with the growth of e-commerce. So this is a good time for us to be here. We just need to make sure we fix it, and that's what we're embarking upon doing. And look at what we've done already with the company in terms of making improvements. And this is just one more area where we're going to take all of our efforts and initiatives and tap into the brainpower of guys like Wallace and Harris and make intermodal a huge franchise.

Amber, I think that wraps up the queue. And I would like to thank everybody for joining the call, and I'm available for calls afterwards. Thanks.

Thank you very much.

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