CSX - Q1 2014

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the CSX Corporation first quarter 2014 earnings call. As a reminder, today's call is being recorded. During this call, all participants will be in a listen-only mode. For opening remarks and introduction, would I turn the floor to Mr. David Baggs, Vice President of Capital Markets and Investor Relations for CSX Corporation? You may begin, sir.

David Baggs (VP of Capital Markets and Investor Relations)

Thank you, and good morning, everyone, and welcome again to CSX Corporation's first quarter 2014 earnings presentation. Presentation material that we'll be reviewing this morning, along with our quarterly financial report and our safety and service measurements, are available on our website at csx.com under the Investors section. In addition, following the presentation, a webcast and podcast replay will be available on that same website. Here representing CSX this morning are Michael Ward, the company's Chairman, President, and Chief Executive Officer, Clarence Gooden, Chief Sales and Marketing Officer, Oscar Munoz, Chief Operating Officer, and Fredrik Eliasson, Chief Financial Officer. Now, before we begin the formal part of our program, let me remind everyone that the presentation and other statements made by the company contain forward-looking statements. You are encouraged to review the company's disclosure in the accompanying presentation on slide two.

This disclosure identifies forward-looking statements as well as the uncertainties and risks that could cause actual performance to differ materially from the results anticipated by these statements. In addition, let me also remind everyone that at the end of the presentation, we will conduct a question-and-answer session with the research analysts. That said, with nearly 30 analysts covering CSX today, I would ask as a courtesy for everyone to please limit your inquiries to one primary and one follow-up question. With that, let me turn the presentation over to CSX Corporation's Chairman, President, and Chief Executive Officer Michael Ward. Michael?

Michael Ward (Chairman, President, and CEO)

Thank you, David. Good morning, everyone. Last evening, CSX reported first quarter earnings per share of $0.40, down from $0.45 in the same period last year. These results reflect the challenging winter conditions faced by CSX and the broader transportation industry this quarter. In that regard, I would like to offer my sincere thanks to the talented and dedicated men and women of CSX who worked tirelessly through one of the worst winters on record to keep the network running as fluidly as possible. I would also like to thank our customers for their patience and support as we work through the service impacts to meet their needs. Looking at the quarterly results, revenue increased 2% to $3 billion on a 3% volume increase. The underlying economy remains strong, supports continued gain in CSX's intermodal and merchandise markets, which more than offset the decline in coal business.

At the same time, as Oscar will discuss in more detail later, we took many steps during the quarter to keep service levels as high as possible in a challenging environment. Dealing with those challenges also had the effect of increasing costs. As a result, operating income decreased 16% to $739 million, and the operating ratio increased 520 basis points to 75.5%. As we look forward, we have the resources in place to support a gradual service recovery while also capitalizing on market opportunities created by broad economic strength. We see the first quarter headwinds transitioning the longer-term positive momentum of the back half of the year as the economy drives additional growth in our merchandise and intermodal business, coupled with an improving environment for domestic coal this year based on increased electrical demand, higher natural gas prices, and reduced stockpiles across much of CSX's service territory.

Given these opportunities, we will more than offset the challenges of this quarter. For that reason, our earnings picture remains intact, with modest growth expected for full year 2014. Now I'll turn the presentation over to Clarence, who will take us through the top-line results in more detail. Clarence?

Clarence Gooden (Chief Sales Officer and CMO)

Thank you, Michael, and good morning. This was a challenging quarter with the impact of the severe winter masking the underlying strength of the economy and the strong demand for our service. As you can see on the left side of the chart, total volume grew 3%, has surpassed 1.6 million loads in the quarter, with growth in merchandise and intermodal more than offsetting the decline in coal. As a result, merchandise and intermodal now combine for 82% of CSX's total volume. Moving to the right, total revenue increased $49 million to over $3 billion in the quarter, reflecting overall volume growth and increased pricing across most markets. Here, merchandise and intermodal now account for over three-quarters of CSX's overall revenue. Next, the average revenue per unit was down slightly.

The impact of core pricing gains and liquidated damages was offset by the unfavorable mix impact related to growth in intermodal versus the decline in coal. Finally, core pricing on a same-store sale basis remains solid across nearly all markets. Recall that same-store sales are defined as shipments with the same customer, commodity and car type, and the same origin and destination. These shipments represented 75% of CSX's traffic base for the quarter. On this basis, all-in prices was 0.5% in the quarter, primarily reflecting continued rate pressure in the export coal market.

Since we continue to have greater variability in both our export and domestic coal business, reflecting global market conditions and our fixed variable contract structure, and since our merchandise and intermodal markets are becoming a larger portion of our business, we have again provided you with the same-store sales pricing for these two markets on a combined basis. At the bottom of this panel, you can see pricing for merchandise and intermodal averaged 2.6% for the quarter. This increase is less on a year-over-year basis but still represents a solid spread over rail inflation. That said, we remain confident that the value created by our service product for our customers provides a solid foundation for growth and pricing above rail inflation over the long term. Now let's look at the individual markets in more detail, starting with merchandise. Overall, merchandise revenue increased 4% to nearly $1.8 billion in the quarter.

Volume in the agricultural sector was up 4%. Feed grain shipments, both domestic and export, increased sharply due to a strong 2013 harvest. In addition, ethanol shipments grew as lower corn prices resulted in higher ethanol production levels. The construction sector declined 2% overall as weather-related challenges more than offset the continued recovery of the residential housing market. Finally, the industrial sector was up 3%. Strength in energy-related commodities, including crude oil and liquefied petroleum gas, more than offset lower shipments in the metals and automotive markets impacted by the severe winter weather. Moving to the next slide, let's review the intermodal business. Intermodal revenue increased 4% to $421 million. Total intermodal volume grew 5%, setting a new first-quarter record. Domestic volume was up 7%, also setting a new first-quarter record driven by continued highway-to-rail conversions. International volume was up 3% year-over-year, reflecting continued economic growth.

Total intermodal revenue per unit declined 1% as continued core pricing gains and higher fuel recoveries were offset by unfavorable mix. Volume associated with our domestic door-to-door product, which has a higher revenue per unit, was more severely impacted by the weather. Finally, we continued to focus on the intermodal product by adding new service offerings and making strategic investments. These investments include the new terminal in Winter Haven, Florida, which opened early this month. The Montreal terminal, which will open later in the year. And the ongoing expansion of the Northwest Ohio facility. Moving to the next slide, let's review the coal business. Coal revenue declined 9% in the quarter to $662 million. Export coal tonnage declined 15% as global market conditions for both thermal and metallurgical coals continue to soften. The API 2 benchmark for thermal coal recently fell to $75 per ton, a level where U.S. coals are more challenged to compete.

The Queensland Metallurgical Coal benchmark has also fallen to low levels of $120 per ton. Domestic coal tonnage increased 8% driven by increased northern utility shipments, including a competitive gain. Finally, total revenue per unit was down 8% with lower export pricing and unfavorable domestic mix, negatively impacting RPU. Moving on to the next slide, let's take a look at the macroeconomic environment. The underlying macroeconomy remains constructive for growth. The Purchasing Managers' Index increased to 53.7 in March. A reading above 50 indicates the manufacturing economy is expanding. This is the 10th consecutive month the PMI Index has signaled expansion. Meanwhile, the Customer Inventories Index declined to 42 in March. A reading below 50 indicates customers' inventories are low. This is the lowest reading since May of 2011, when the Customer Inventory Index registered 39.5.

On the right side of the page, both the GDP and IDP projections remain strong and show continued growth throughout 2014. This is consistent with what we see in the marketplace and what we hear from our diverse customer base. Now let me wrap up with the outlook for the second quarter. Looking forward, we expect the overall volume outlook for the second quarter to be positive, with favorable conditions for 83% of our markets and stable conditions for the remaining 17%. Looking at some of the key markets, agriculture is favorable, with higher year-over-year crop yields supporting continued growth in grain shipments. We expect growth in chemicals as we continue to capture opportunities created by the expanding domestic oil and gas industry. The continued expansion of the U.S. housing and construction markets will drive growth in forest products and mineral markets.

Strong intermodal growth will continue as our strategic network investments and service reliability support highway-to-rail conversions. We expect domestic coal volume will grow in the second quarter as inventory levels have normalized and gas prices have increased to levels where most coals are a more competitive fuel source. Export coal volume is expected to be neutral in the second quarter, and our best estimate of 2014 volume remains in the mid-30 million ton range, reflecting soft global market conditions, particularly in the thermal market. At the same time, rail pricing will likely continue to reflect the weak global market conditions. The automotive market is stable, with North American light vehicle production expected to grow 1% in the second quarter. The U.S. economic expansion is expected to continue in 2014, with projected GDP and IDP growth of 2.9% and 3.2% respectively, producing a macroeconomic environment that supports growth.

The value of the service we provide supports not only growth but also pricing above rail inflation over the long term. Thank you, and now I'll turn the presentation over to Oscar to review our operating results.

Oscar Munoz (COO)

Thank you, Clarence, and good morning, everyone. Well, as most of you know or have heard by now, this past winter season was one of near-historic proportions in terms of the duration, the cold, the snow and ice, and the corresponding impact on not only rail but truck and airline transportation systems, their supply chain, and frankly, the overall economy was pretty significant. We at CSX certainly felt the impact of the severe weather, and despite the best efforts of our operating employees, who often worked around the clock to ensure we were able to deliver freight even in the worst of conditions, CSX's operating performance this quarter was not at the high levels we've all come to expect. We assure you that the team is fully engaged to support both a gradual recovery and the strong demand that Clarence just discussed.

Now, looking at the operating results in the first quarter and beginning with safety, while CSX still remains a leader amongst the Class I railroads, we did experience an increase in both personal injuries and in train accidents. The personal injury rate was up to 0.96, and the train accident rate rose to 2.35, both up from near-record low levels in the first quarter of last year. Adverse operating conditions were a factor in these results, but we remained focused on prevention with a specific emphasis on avoiding catastrophic injuries. Let me now turn to the company's service performance on the next slide. Our operating measures echo the challenges that the North American transportation industry faced in the first quarter. Originations, arrivals, velocity and dwell are all well off the record levels of the last few years.

But as you'll see later on in the presentation, service measures are stabilizing and beginning to improve. Turn to slide 15, I will highlight some of the specific challenges we faced from the severe weather in the quarter. While the impact on CSX's network was most keenly felt in the Midwest and Northeast, this is a network business, and as you can see on the map on the left of the chart, on-time originations were negatively impacted as far south as the state of Georgia. Of course, our northern region clearly faced the worst of the storms, resulting in on-time performance for the quarter of just above 50%.

On the right side of the chart, you can see heating degree days, an indicator of the severity of cold temperatures, were up over 17% on a year-over-year basis, and snowfall was more than double prior year levels in most of our northern service territory. Now, in a normal winter, when a storm approaches, we make adjustments to the operating plan, move the relevant resources to the area to accommodate the disruption, and then usually have a little time to return to normal operating plans after the weather has passed. This year, 25 storms came back to back over several months, which meant the operating plan had to be constantly adjusted to serve customer needs. These adjustments require more resources and can also stress our line of road and yard capacity.

Now, as the worst of the weather seems to be behind us and we're beginning to see fluidity recover, however, given the duration of the storm season and the backlog of freight it created, along with the increased demand we are seeing, our complete service recovery will be gradual. Now, let me turn to the next slide, and I'll discuss the effects on the operating costs of the business. Now, while Fredrik will provide more specifics on where these impacts were in the quarter and what to expect going forward, let me give you some details on the key operational impacts. If you look at the chart and on the left, the number of relief starts doubled year over year, and overtime across the entire operating department was up nearly 50%.

We positioned maintenance of way and signal employees around the clock along our critical routes to ensure traffic could move safely and efficiently through these affected areas. Mechanical employees worked extra shifts to ensure locomotives and freight cars were available to help catch up and meet customer demand, and the transportation department labored to ensure terminals remained fluid and trains ran as close to schedule as possible. Moving down the chart, average freight car cycle days were up 9%, reflecting the additional time it took to move cars to and from customer facilities. We also placed additional locomotives into service. The result was a 7% increase in the average locomotive count. With this many additional locomotives and the harsh conditions, fuel efficiency was impacted.

I'm encouraged, however, that we only saw a 2% setback in this measure as the underlying technology and processes we have in place to drive fuel savings are still yielding results. Finally, our active T&E group count was flat on a year-over-year basis. Crews worked extra hard to run the network through this harsh winter, and I am pleased to say that crew availability remained high, and the team was able to support solid volume growth even through the operating challenges. So recapping, maintaining network fluidity in these extreme conditions drove a significant short-term cost impact that was necessary to serve our customers. Now, let me turn to slide 17 and discuss our recent service trends. CSX has stabilized and is beginning to recover.

The last of the significant storm systems came through about a month ago, and as you see depicted on the chart on the left of the slide, on-time originations are trending up and dwell is declining since that time, both positive signs. As Clarence reviewed, traffic levels are also increasing. In support of this growth, we expect our current high-level locomotives to remain in service for the foreseeable future, and we have new crew members in training to meet this rising demand. The recovery in Chicago specifically will likely take longer due to the amount of interchange traffic with other railroads and the complexity of the rail network there. Nevertheless, the rails are in close coordination, and we're beginning to see some headway.

As we look forward, we remain confident in our progress, though it is clear the recovery and the related additional costs will extend through the second quarter with more meaningful improvement in the second half of the year. Now, let me wrap up on the last slide. As I've discussed, the effects from the winter storms were wide and significant, driving an increase in cost and impacting service levels. Nevertheless, CSX is confident in the ability of this operating team to steadily return service to the levels our customers have come to expect. We're adequately resourced for recovery, and our operating measures are headed in the right direction.

From a productivity perspective, while it's too early to give you an updated estimate for the full year, it's pretty clear we're not going to be able to deliver our normal $130 million savings, but we'll update you on that later on in the year. So at this point, let me echo Michael's comments and thank each of our employees for their skill and dedication in safely and efficiently serving our customers through this challenging winter. With that, let me now turn the presentation over to Fred to review the financials.

Fredrik Eliasson (CFO)

Thank you, Oscar, and good morning, everyone. As Clarence mentioned earlier, revenue increased 2% in the first quarter, as declines in coal revenue were more than offset by gains in merchandise, intermodal, and other revenue. In the quarter, other revenue included $55 million of liquidated damages, an increase of $22 million versus the prior year. Looking at the remainder of 2014, we expect liquidated damages to be about $10 million for each of the remaining quarters. Expenses increased 9% versus last year, driven primarily by the adverse impact of winter weather that Oscar mentioned and the cycling of real estate gains, both of which I will discuss in more detail in the coming slides. Operating income was $739 million, down 16% or $141 million versus the prior year.

Looking below the line, interest expense was down $7 million versus last year, driven by favorable interest rates on debt that was refinanced in 2013 and modestly lower debt levels. Other income was $7 million, and income taxes were $208 million in the quarter for an effective tax rate of approximately 34%. This included the state legislative tax change, which benefited earnings by $0.02 per share. Without this change, the effective tax rate would have been 37.6%. Overall, net earnings were $398 million, and EPS was $0.40 per share, down from $462 million and $0.45, respectively, from the prior year period. Now, before we move on, let me take a moment to summarize the total impact that weather had on our first quarter financial results. We estimate that weather impact on the first quarter expense was around $90 million or $0.06 per share.

The revenue impact is more challenging to quantify, but we estimate there was about 2-3 cents per share in revenue contribution that we were not able to recover in the first quarter due to weather disruptions. With that, let's turn to the next slide and briefly discuss how fuel lag impacted the quarter. On a year-over-year basis, the effect of the lag in our fuel surcharge program was $4 million unfavorable. This reflects $9 million of negative in-quarter lag during the first quarter of 2014 versus $5 million of negative in-quarter lag for the same period in the prior year. Based on the current forward curve, we expect the year-over-year fuel lag impact to be negative in the second quarter, similar to what we saw in the first quarter. Turn to the next slide. Let's review our expenses. Overall expenses increased 9% in the quarter.

I'll talk about the top three expense items in more detail on the next slide, but let me first briefly speak to the bottom two on this chart. Depreciation was up 5% to $283 million due to the increase in the net asset base. Going forward, we expect depreciation to increase sequentially a few million dollars per quarter, reflecting the ongoing investment in our business. Equipment rent was up 6% to $101 million due to the weather's impact on the network and higher locomotive lease expense as active fleet was increased to minimize service disruption. Now, turning to the next slide, let's discuss our other expenses. First, let me highlight the impacts that we have attributed to weather disruption across each of these expense categories. As I previously mentioned, we estimate the first quarter weather impact on expense was $90 million.

Of that, $35 million is attributable to labor and fringe, driven primarily by overtime and relief crew starts. $35 million in MS&O due to an increase in active locomotives and higher utility expense. $15 million is in fuel, driven by loss of efficiency and an increase in non-locomotive heating fuel. And finally, there was $5 million of weather impact in equipment and rent expense, which I covered on the previous slide. Looking ahead at the second quarter, we expect to incur additional costs associated with recovering from the weather disruptions, although not to the same degree as seen in the first quarter. That summarizes the weather impact on our first quarter expenses. Now, let me discuss the other drivers for each of the expense categories, beginning on the left with labor and fringe. Total labor and fringe increased 6% or $47 million versus last year and included $14 million of inflation.

Going forward, we expect labor inflation to be around $15 million on a year-over-year basis for the remaining quarters in 2014. At the same time, we expect headcount to remain roughly flat to our first quarter level, although, as we have consistently demonstrated, we will continue to adjust resources to reflect current volume levels and drive efficiency. Moving to the right on the slide, MS&O expense increased 24% or $122 million versus last year. This included a cycling of $49 million of real estate gain, a $12 million increase in expenses related to train accidents, and $9 million of inflation. In addition, there was a $17 million increase in other MS&O, spanning multiple items, none of them of which were significantly by themselves.

Looking ahead, MS&O expense will continue to be impacted by the cycling of real estate gains, which, as a reminder, totaled $36 million in the second quarter of 2013. However, there are no further gains to be cycled in the second half. In addition, we continue to expect higher year-over-year expenses in the remaining quarters related to inflation and volume growth. Finally, fuel expense was essentially flat to last year as favorable price, driven by a 5% decline in our fuel cost per gallon, was offset by volume and weather headwinds. That concludes the expense review for the first quarter. Turning to the next slide, I'm pleased to announce that we'll be increasing our dividend. CSX will pay a dividend of $0.16 per share starting in the second quarter, which reflects a 7% increase versus the prior year.

While this results in a dividend payout ratio slightly above our target range of 30%-35%, it is important to note that weather-related headwinds we experienced in the first quarter are not indicative of the core earnings power of the business. We expect our full-year EPS to better reflect the true earnings power and to support a 30%-35% dividend payout range in 2014. Our second quarter dividend increase builds on the 11 increases we have made over the last eight years, representing a 20% CAGR in the dividend over that period. Now, let me wrap it up on the next slide. First, the core earnings power of our business remains strong. Despite the very challenging operating conditions that we faced, we delivered top-line revenue growth of 2% and grew volume by 3% in this first quarter.

Across the portfolio, we generally have a positive outlook on the growth trajectory for our merchandise and intermodal markets. In addition, we expect 2013 was a low point for domestic coal and that volume will grow this year, whereas the export coal market continues to be volatile. Our near-term focus is to restore superior service levels across the network as quickly as possible. We experienced significant incremental operating expense in the first quarter from weather disruptions and expect some of these costs to continue into the second quarter. While we plan to recover a portion of this lost productivity during the remainder of the year, our first priority is to restore higher service levels. For the full year 2014, we expect to see modest earnings growth despite first-half headwinds from weather and the cycling of real estate gains.

We have visibility into 7 million new tons of utility coal as a result of the cold winter and higher natural gas prices, which were more than offsetting intermodal costs incurred in the first quarter. Looking at 2015, it is still not clear whether our projected 2015 growth rate will be strong enough to deliver a two-year EPS CAGR of 10%-15% across 2014 and 2015, given the modest growth expectations we have for this year. That said, we feel confident that CSX can sustain double-digit EPS growth as we get through this year. That earnings growth, which will be more balanced between volume, price, and efficiency, will also contribute to an improving operating ratio, which we expect to be in the mid-60s longer term. With that, let me turn the presentation back to Michael for his closing remarks.

Michael Ward (Chairman, President, and CEO)

Thank you, Fredrik. As you've heard this morning, this first quarter was certainly more challenging than most. Again, I thank our employees and customers for their perseverance and patience over these past few months. As I look ahead, we have the right people and resources in place, and we're working hard to return our network to the high levels of service and reliability that we have consistently produced for our customers while remaining a leader in one of the nation's safest industries. With that as a foundation, I am confident in the company's ability to deliver modest growth for the full year 2014 and become more effective serving broad markets that will put the company in a position to sustain positive earnings momentum over the long haul. In that regard, we are particularly optimistic about the opportunities and plans to support increases in the intermodal and merchandise markets.

Put another way, the underlying strength of our network and team, coupled with a more stable domestic coal environment and a growing economy, gives us confidence that in 2015 and beyond, CSX should, again, sustain margin expansion and double-digit earnings growth. With that, we're pleased to take your questions.

Operator (participant)

We will now begin the question and answer session. If you would like to ask a question, please press star one. You will be prompted to report your name. To withdraw your question, you may press star two. Again, press star one to ask a question. One moment, please, for our first question. Our first question comes from Bill Greene with Morgan Stanley. You may ask your question.

Fredrik Eliasson (CFO)

Morning, Bill.

Bill Greene (Managing Director)

Yes. Hi. Good morning. Fredrik, can I ask you for a little bit of clarification on your guidance commentary, particularly as it relates to 2015? Because I think most of us recognize there are some extraordinary events so far this year, and so we don't have the same kind of expectations for this year. But in 2015, when you think about that double-digit growth rate, what kind of gives you confidence in it? Can you kind of maybe walk us through a little bit of the assumptions behind it, maybe? Because obviously, there's still concerns about how long export coal could be weak and this sort of thing. So I think it'd be helpful to know kind of what goes into that comment.

Fredrik Eliasson (CFO)

Sure. So just take a different year. So first of all, we said modest earnings growth in 2014. And while we feel strong and have good confidence in what we see for 2015 as the year by itself, we're pretty bullish about the macro factors that we're seeing. We're pretty bullish about the fact that once we get the network running better again, that 2015 by itself will be a very strong year. The question is, will it be strong enough to make up for the fact that we're only making modest gains this year? And that's left to be seen. Clearly, the domestic market on the coal side has gotten stronger over the last few months. But at the same time, we're continuing to see the export coal market deteriorate. So it's a little hard at this point to be too bullish about that part of the market.

And so instead of getting into individual components, what I've said throughout the quarter has been, from what we're seeing things right now for 2015, we're going to need some help as we think about this thing from a bottom-up perspective. And that help can come in different forms. It could come in terms of export market firming up, a little bit more domestic coal with a little bit better pricing, more productivity. We just don't know. But overall, 2015 by itself will be a very strong year. It is just not sure it's going to be strong enough to make up for the modest earnings growth we're seeing here in 2014.

Bill Greene (Managing Director)

Yeah. One point of clarification there. Another comment you've made in the past, I think, on 2015 has been the sub-70 OR, so high-60s OR in 2015. Are you walking away from that?

Fredrik Eliasson (CFO)

I think the same thing holds true there. In order to get to that sub-70 operating ratio, we're going to also need some help from what we're seeing things today. It doesn't mean we can't get there. We're certainly going to target it. We're trying to get there. But we're going to need some help from what we're seeing things today.

Bill Greene (Managing Director)

Does the change to fixed variable costs do anything to pricing there? If domestic coal comes back, does this make pricing sort of weaker? And does that affect the view?

Fredrik Eliasson (CFO)

No. It doesn't really impact the overall trajectory.

Bill Greene (Managing Director)

Okay. All right. Thank you for the time.

Operator (participant)

Thank you. This question comes from Ken Hoexter with Merrill Lynch. You may ask your question.

Oscar Munoz (COO)

Morning, Ken.

Ken Hoexter (Managing Director)

Good morning. Michael, you mentioned a couple of times that you're prepared for a gradual recovery. Oscar mentioned a little bit about maybe not hitting the $130 million recovery this year because some costs are coming in. I mean, we've seen volumes already up 11% quarter to date. What if we get a little bit of a sharper recovery in terms of volumes? What does that do in order to flex the network and stress-test what your infrastructure is?

Oscar Munoz (COO)

Ken, so that was a couple of questions. Specifically, restate your question a little bit if you could.

Ken Hoexter (Managing Director)

Well, I'm just wondering because Michael mentioned a couple of times, and I think as did you, in terms of a gradual recovery, you're prepared for that. What if we see, I mean, you've already seen volumes up 11% starting off the second quarter, pretty robust. How are you prepared if the recovery is a little bit stronger than that? Does that mean you're fearful that if we get too much volume, it's going to stress the network too much? And you wouldn't be prepared just because you mentioned the word gradual recovery so many times.

Oscar Munoz (COO)

Yeah. Thank you, Ken. I appreciate that. So the gradual recovery is based upon exactly the volume that we are seeing, so both backlog as well as the increased demand. And again, our balance between productivity and ensuring superior service levels. And so what we're making sure that everyone understands is that our balance is geared towards our customer. And the volume that we're seeing today is, if you think of our sort of annual peak periods, weeks 9 through week 23 is kind of at the peak of it. Right now, we're probably in the highest point of workload we're going to have in the course of the year. And we're slightly improving. So we feel pretty confident around that. Now, given that fact, we are bringing on some more locomotives. We continue to bring crews out of training and, of course, doing the hiring that's required.

But no, the volume is a very welcome event for us after a couple of years of being relatively dry.

Michael Ward (Chairman, President, and CEO)

Ken, the only thing I'd add to that is, obviously, with that demand, which I think we're doing a reasonable job of handling, it does slow your ability to recover. I think the other thing I would point out is Chicago is a key interchange. I think all the major carriers have issues around Chicago. Those will take time to work through. It does have a cascading impact on the rest of the network. So we will continue to improve. I think the reason we use gradual several times is we don't think this is going to snap back immediately. I'm just trying to make people understand that.

Ken Hoexter (Managing Director)

But I guess if we see a little bit stronger, is that something that you need to then re-engage that the One Plan from years ago? Is it evolutionary? I'm just trying to understand, is that something that could make this look even worse if you get a little bit faster growth?

Michael Ward (Chairman, President, and CEO)

Well, you used the term re-engage the One Plan. We still use the One Plan to run our railroad. But I'm not overly concerned. I think the demand levels we're seeing out there, we can handle. We will work through. So I don't see that as a major risk. I think it really, as Oscar said, it's an opportunity for us to help regain some of that lost earnings in the first quarter.

Ken Hoexter (Managing Director)

Wonderful. And then just a follow-up on kind of Bill's question there on the coal RPU. If you exclude the liquidated damages, how should we think about coal yields for the rest of the year, Fred? Is that something we're going to see accelerate on the declines given the change in contract structures? Or maybe you could just walk us through your thoughts a little bit on that.

Clarence Gooden (Chief Sales Officer and CMO)

Ken, this is Clarence. I think you'll see the coal RPUs will be very similar to what you saw in the first quarter. Our utility north business was up about 22% in the first quarter, and that tends to carry a lower RPU. Our southern utility was down about 6% in the first quarter. And our rates on our export coal, as we mentioned, were slightly down. And so that particular mix will tend to carry through here in the second quarter. So you'll see something very similar on the RPU going forward.

Ken Hoexter (Managing Director)

Great. Appreciate the insight and time. Thank you.

Operator (participant)

Thank you. This question comes from Brandon Oglenski with Barclays. You may ask your question.

Michael Ward (Chairman, President, and CEO)

Morning, Brandon.

Brandon Oglenski (Director and Senior Equity Analyst)

Yeah. Good morning, everyone. And it's still snowing in New Jersey, by the way. So it's a pretty tough spring as well.

Fredrik Eliasson (CFO)

Never-ending.

Brandon Oglenski (Director and Senior Equity Analyst)

Well, listen, I just want to ask a longer-term question, Michael. I mean, coal revenue used to be 30+% of your mix. It's down to close to 23%, 22% this quarter. We've seen your non-coal volume expand 3%-4% for the last few years. What are some of the impediments that keep that non-coal growth from driving better operational margins? And I'm not even talking about the quarter, but just thinking longer term, how do you get that base of revenue to drive better margins and better earnings growth looking forward?

Michael Ward (Chairman, President, and CEO)

Well, as Fredrik alluded to, one, obviously, the coal is a high-margin business, and our portfolio has changed. But we're very optimistic. If we look at our intermodal and merchandise growth, it is good-margin business. And we think as we go forward, if you look at our value creation we drove in the decade prior to this, it was about two-thirds price and one-third productivity. As we look at the company going forward, we still see strong value creation opportunities, but it'll be more balanced. Not exactly a third, a third, a third, but it's going to be continued productivity, continued pricing above rail inflation, and adding the element of growth. The intermodal margins are very nice now that we have basically double-stack economics and the density of lanes.

The other businesses we're growing, the crude by rail, the growth in our other merchandise businesses are all good-margin businesses that will help drive us to that mid-60s operating ratio long term.

Brandon Oglenski (Director and Senior Equity Analyst)

Okay. I mean, at what point, though, do you need still coal revenue stabilization in order to just overall expand margins for the business? Is that what we're hearing today?

Michael Ward (Chairman, President, and CEO)

Well, we do need the coal to stabilize. And we think we're getting fairly close to that point now. The only blessing of this cold winter is it did draw down those stockpiles. Actually, as Clarence alluded to, the demand in the north is very strong. And actually, the stockpiles are below where they ideally would like to have them. And the overhang we've been living with in the south for the last couple of years, about three-quarters of that was eliminated here. So we really do see that domestic as very strong.

Fredrik Eliasson (CFO)

Yeah. Just to add that to Brandon also, in terms of the underlying core earnings power of our company over the last two years, it's been pretty strong. I mean, we're still thinking of double-digit earnings range. The issue has been $800 million of coal revenue that has gone away. And in this year, we're still seeing some headwinds in coal, which is why we only feel that we're going to have modest earnings growth. But we're pretty confident, as I said, once we get through this transition, that we're going to return to that more normalized earnings growth going forward.

Brandon Oglenski (Director and Senior Equity Analyst)

Okay. Appreciate it, guys. Thank you.

Operator (participant)

Thank you. This question comes from Chris Wetherbee with Citi. You may ask your question.

Clarence Gooden (Chief Sales Officer and CMO)

Morning, Chris.

Chris Wetherbee (Senior Research Analyst)

Hey. Good morning, guys. Clarence, could I just ask for a little bit of clarification on your comments around the export coal market? I think you included it in the neutral category in the outlook. I just want to get a rough sense of how you think about that relative to the sort of full-year target. I think you still said in the mid-30 million-ton range. Should we expect a bit of an absolute tonnage step up in the second quarter, which I guess would be a little bit more neutral? Or is that still going to be a little bit under pressure on a year-over-year basis?

Clarence Gooden (Chief Sales Officer and CMO)

Well, it's a little too soon, Chris, to sort of see what this export coal business is going to do. Frankly, it's a lot stronger than this first quarter, and I anticipated that it would be. So we're sticking with sort of mid-30s throughout the year. We've got, in the second quarter right now, about 80% of what we project for the quarter is tied up under contracts. And that's obviously subject to market conditions. We think we've hit pretty much the bottom in where the global price of coal is going to be. The thermal is very low right now in Europe. The metallurgical prices are very low over in Queensland right now. So as we move toward the middle of the year, we expect to see more firming in the rate structure.

We can tell you a little bit more toward the middle of the year what it looks like. Right now, we're sticking pretty much to the mid-$30/ton, mid-30s in the export market.

Chris Wetherbee (Senior Research Analyst)

Okay. That's helpful. I appreciate that. And then, Fred, I think three months ago, you sort of mentioned that the first half of the year, when we thought about 2014, was going to be the one where you were lapping some of the real estate gains and other stuff that you had in 2013. When you look at the second quarter, with the volumes bouncing back but still some costs lingering, is that still the right way to think about it? The first half is going to sort of be a bit sort of flat to downish on a year-over-year basis, and then maybe you get a little bit of upside. Is that sort of how your plan is building as you think about 2014 showing modest growth?

Fredrik Eliasson (CFO)

Yeah. I would say that probably flattish is a good way to think about the second quarter. I think we feel very good about the top line. I think that you have still those things, the cycle that you talked about, real estate gains. Based on what I said earlier, liquidated damage is probably down a little bit in the second quarter as well. And then we will have some lingering costs here for a period of time because of the fact that our network is not running as well. But offsetting that is a more vibrant top line, especially on the coal side. And we expect it. So I think flattish is probably a good place in the second quarter and then from there be able to produce earnings growth for the rest of the year to get into that modest earnings growth for the year.

Chris Wetherbee (Senior Research Analyst)

Do you think you're mostly caught up on volume by the end of the second quarter? Is that how the plan would sort of trend?

Fredrik Eliasson (CFO)

I would think that based on what you've seen here over the last few weeks where volumes are up double digits, that that would be a good assumption.

Chris Wetherbee (Senior Research Analyst)

Okay. Thanks very much for the time. I appreciate it.

Operator (participant)

Thank you. And this question comes from Allison Landry with Credit Suisse. You may ask your question.

Clarence Gooden (Chief Sales Officer and CMO)

Good morning, Allison.

Allison Landry (Senior Equity Research Analyst)

Good morning. Thank you for taking my question. I wanted to ask a question about core operating margins. And if I'm adjusting both this quarter and the prior year for all the unusual items, including weather, liquidated damages, real estate gains, a fuel lag, etc., it doesn't appear that there was very much operating leverage on the 3% volume growth during the quarter. I wanted to ask how we should think about contribution margins for the balance of the year, considering both the rate cuts on the export coal side and the fact that you plan to bring on additional locomotives and people.

Fredrik Eliasson (CFO)

Yeah. So obviously, it was a noisy quarter in terms of the ins and outs. But I think you're right. If you do adjust for the real estate gains in both years, you adjust for the fact that you did have weather impact here, and you will see that you have modest earnings growth year-over-year. And now, that doesn't even factor in also the fact that we had taken our export rates down quite significantly. So once you adjust for all these things, as I said in my previous answers, the core earnings growth of our company and margin expansion is still very healthy. We're just dealing with a lot of factors right now that we have to cycle through. And as we get through this, real estate gains will be behind us here as we get through the second quarter.

We're at the tail end, I think, of what we reasonably can do on the export side. The rest of the business is doing good. Coal on the domestic side is coming back. We feel we're going to return back to normal incremental margins going forward. But it's just a lot of noise right now that prevents that from coming down to the bottom line.

Allison Landry (Senior Equity Research Analyst)

Okay. A follow-up question on the tax rate benefit during the quarter. I did notice that there was a comment in the earnings review that the future corporate tax rate would be reduced. I mean, should we expect sort of a similar tax rate as we saw in 1Q? Or was there any sort of prior period catch-up?

Fredrik Eliasson (CFO)

No. This is a state legislative tax change that impacted our earnings by $0.02 here in this quarter that made the effective tax rate 34%. If you adjust out for that, we were right at 37.6%. So our guide has always been somewhere around 38% is a conservative place to be. And we think that should be the place going forward as well.

Allison Landry (Senior Equity Research Analyst)

Okay. So I guess in terms of the comments that said that this will reduce the future corporate income tax rate, is that?

Fredrik Eliasson (CFO)

I don't know about that comment. So maybe David can talk about it later on. But there's nothing that's changed in terms of our overall tax rate. We would like to, of course, have a lower tax rate, but nothing is imminent around that.

Allison Landry (Senior Equity Research Analyst)

Perfect. Okay. Thank you so much.

Operator (participant)

Thank you. And this question comes from Rob Salmon with Deutsche Bank. You may ask your question.

Clarence Gooden (Chief Sales Officer and CMO)

Morning, Rob.

Rob Salmon (Senior Analyst)

Hey. Good morning, guys. Thanks for taking my question. Fred, you had called out about 7 million incremental utility coal tons. Do you guys are going to be taking on that you've got now line of sight into the back half of the year? How should we think about this as we look out to 2015 as well? Does this give you guys conviction that we're going to see utility coal volume at least stabilize to growth as we look out, even in spite of some of the, I think it's the 4 million tons that you're expecting to go away in 2014 and 2015 from some plant closures?

Fredrik Eliasson (CFO)

Well, a couple of things there in your question just to clarify. So first of all, we do see several million tons of incremental demand here this year because of the cold winter. Then, I think your question was around 2015 and beyond the impact of MATS. And what we have said is that as we look at the movements of coal for 2013 into plants that we expect to be closed because of MATS, we have identified 7 million tons that we think is going to come out between 2014 through 2018, essentially. 4 million of those tons, we think, is going to come out in 2014 and 2015 and the remaining 3 in the years beyond that, between 2016, 2017, and 2018. Does that answer your question?

Rob Salmon (Senior Analyst)

That answers the question with regard to the several million tons that are coming out in the back half of the year. Will we have continued? Are you expecting that? Do you have line of sight in terms of that traffic looking out 2015 as well, where you've got a lot of conviction that utility coal volumes have at least stabilized and are growing as we look out over the next several years?

Clarence Gooden (Chief Sales Officer and CMO)

Well, Rob, this is Clarence. We expect that our growth in coal continues in through 2015. In fact, the growth for the rest of this year in utility coal will be in the mid to the high single digits. And a lot of those plants that Fredrik is talking about that'll be closed in those years in terms of tons, the other plants that'll remain open will simply run harder to absorb those tonnage.

Rob Salmon (Senior Analyst)

Thanks. Appreciate the call.

Operator (participant)

Thank you. This question comes from Bascome Majors with Susquehanna. You may ask your question.

Fredrik Eliasson (CFO)

Morning.

Bascome Majors (Senior Equity Research Analyst of Industrials)

Good morning, guys. One for Clarence here. We've talked pretty extensively about export coal pricing pressure over the last couple of years. And you've said again today that you're kind of at the end of what you can do to help incentivize your customers' competitiveness in that market. If my math is right, it looks like the yields have come down a bit on the domestic side of the business over the last few quarters as well. And I know you called out mix earlier, but can you directionally kind of walk us through what's driving that drop in domestic yields between mix and any pricing or fuel that's in there as well?

Clarence Gooden (Chief Sales Officer and CMO)

Well, as I said earlier, on the mix side, it's present plainly preponderantly in the mix. The northern utility coal, which carries a much lower rate than the southern utility coal, is up about 22% this year. The southern utility coal, which carries a considerably higher rate due to the much longer length of haul, was down about 6%. Then when you put in the export coal, which we said has been slightly down in terms of rate, those three combinations have put down, have led to the lower RPU. Very little of that has been driven at all by the fixed and variable charges in our coal rate. So that's the principal and preponderant driver.

Bascome Majors (Senior Equity Research Analyst of Industrials)

Okay. And a bit more broadly on the similar theme, you talked about competitive gains helping your domestic coal volumes this quarter. What's the competitive dynamic like in that business today? And has the volatility we've seen over the last couple of years given you more opportunities to go after your competitors' business and vice versa than after yours?

Clarence Gooden (Chief Sales Officer and CMO)

Not really. It was a single account in the north that the customer had put up for competitive bid. And it did involve a one-time issue. So we really haven't had many opportunities in that area at all.

Bascome Majors (Senior Equity Research Analyst of Industrials)

Is there any way to quantify how much of that is driving your domestic gain that you talked about in the previous question?

Clarence Gooden (Chief Sales Officer and CMO)

Very little is driving our domestic gain in that area. Most of it has been a result of a burn in the northern utilities and their stockpile depletion.

Bascome Majors (Senior Equity Research Analyst of Industrials)

All right. Thanks for the time this morning.

Operator (participant)

Thanks. This question comes from Jeff Kauffman with Buckingham. You may ask your question.

Michael Ward (Chairman, President, and CEO)

Morning, Jeff.

Jeff Kauffman (Director of Transport, Logistics, and Machinery)

Hey. Good morning, everybody. Thank you very much. I think the point on the weather has been well made. But I have a question concerning some of the noise we've been hearing on the regulatory side. And I don't know if you're prepared to comment, but there recently were hearings on the competitive switching. They've put out some requests for recommendations on the revenue adequacy questions. How do you view the regulatory environment right now? And what are your thoughts out there on some of the discussions?

Michael Ward (Chairman, President, and CEO)

Yeah, Jeff. This is Michael. So on the Ex Parte 711, which is the NIT League proposal, as you're well aware, we did testify at the March 26th hearing opposing that proposal because it basically provides no public benefit at all. The only possible beneficiaries and you may recall there was a study commissioned by the STB a number of years ago by the Christensen Group is that very few shippers would benefit to the detriment of everyone else. And we think that's still true. It would degrade service. It would introduce uncertainty in the marketplace, disrupt our plans for growth and capital investments, strand prior investments. And if you think about it, our witness, Cressie Brown, at the hearing did say that you could introduce a perpetual winter like we've just seen because you'll be putting unnatural moves in there.

So we're hopeful that the STB, in its wisdom, will not do anything to disrupt what is working quite well today for our customers. On the side of the revenue adequacy piece, we actually welcome that examination. As you know, that's an issue that's, I think, ripe for examination in that no time in the past have the railroads even been anywhere close to revenue adequacy. Some of us are approaching that. But there's issues around what is sustained revenue adequacy? How many years do you have to be doing it through a business cycle? What is the appropriate criteria? And we really welcome that examination to try to bring better clarity to what will happen as the railroads continue to grow in their financial health. And we'd like to bring the question of replacement costs into that equation because we do have to replace old assets with new dollars.

We think that's really a ripe one. We're glad that they've called for it.

Jeff Kauffman (Director of Transport, Logistics, and Machinery)

Okay. Well, thank you very much. And congratulations.

Michael Ward (Chairman, President, and CEO)

Thank you.

Operator (participant)

Thank you. This question comes from Scott Group with Wolfe Research. You may ask your question.

Michael Ward (Chairman, President, and CEO)

Morning, Scott.

Scott Group (Managing Director and Senior Analyst)

Hey. Thanks. Morning, guys. I want to clarify one thing, Clarence. Did you guys have to take the export rates down further in 2Q as the new benchmark kicked in?

Clarence Gooden (Chief Sales Officer and CMO)

Scott, we did in a couple of lanes with a couple of customers to make them competitive. Yes.

Scott Group (Managing Director and Senior Analyst)

Okay. On the intermodal side, so nice volume growth but still some pressure on the yields. And wondering if that's a pricing thing, is that mix? I wouldn't think it's mix just with domestic growing faster than international. But maybe it's mix. And then with the truckload pricing that's really starting to get better, should we start to think about your intermodal pricing getting better going forward?

Clarence Gooden (Chief Sales Officer and CMO)

Two answers. It was definitely and specifically weather-related. It was definitely in mix. It was in our door-to-door product. It had almost a 2.5% impact. It was in the spot market where we couldn't price because of the weather-related issues this quarter. The other pricing in the other areas was positive. Yes, we are seeing affirming in the spot market with truck capacity tightening up in the U.S. and just about every regional area that we serve. So you are seeing more firming in truck pricing.

Scott Group (Managing Director and Senior Analyst)

Okay. Great. And then just last thing maybe for Oscar or Michael. You guys have done just such a great job taking resources out of the network following 2008, 2009. After a winter like this and maybe with volumes getting better, are there longer-term implications of do you need to spend more capital or bring back on a more sustainable basis more people or equipment?

Oscar Munoz (COO)

Yeah, Scott, it's Oscar. Being that operations are no longer the financial guy, you can always use a little more capital here and there. But generally, we had adequate level of resources. It's just that the winter conditions were harsher than in a long, long period of time, which created a little bit of a logjam. I think there's a high level of learnings we've had operationally that will obviously include. But we went into the year into the start of the year with more locomotives. We've done a lot of the work on the line of road over the course of time. And so from a long-term perspective, there are places that we will strategically sort of review over the coming things. But nothing immediately evident that would have been that helpful.

Chicagoland Terminal, which is the interchange between all the different railroads, that's where the CREATE project is really making a lot of that investment. I think continuing that is probably the biggest investment the industry can make to make that fluidity in that location better.

Scott Group (Managing Director and Senior Analyst)

Any implications on capital? It sounds like not really.

Oscar Munoz (COO)

Not from a CSX perspective.

Scott Group (Managing Director and Senior Analyst)

Okay. All right. Thanks for the time, guys.

Operator (participant)

Thank you. This question comes from Jason Seidl with Cowen & Company. You may ask your question.

Clarence Gooden (Chief Sales Officer and CMO)

Morning, Jason.

Jason Seidl (Managing Director)

Good morning, guys. Two quick questions here. One for Oscar. I'm sorry. One's for Clarence. Clarence, you mentioned you guys had to bring down some of the export rates due to the benchmark weakening a bit. If the benchmark starts recovering, how quickly can you bring those rates back up?

Clarence Gooden (Chief Sales Officer and CMO)

Within a quarter.

Jason Seidl (Managing Director)

Within a quarter. Okay. And the last question is from Michael. Michael has done this a while. And Chicago's always been a major interchange issue for the rail industry. It should have improved, I guess, over the last 10 years with the CN taking EJ&E and taking some pressure off of sort of that downtown area. What's needed going forward in terms of capital investments by the railroads maybe jointly or with some help from the government because it's pretty much still a sore point after all these years?

Michael Ward (Chairman, President, and CEO)

Well, two things. One, you're certainly correct that we need to put some better infrastructure in. And that is the CREATE project, which we're in the process of working. And there's money from the railroads, from the state of Illinois, and federal money to improve the fluidity in Chicago. But I will remind you, though it's funny. We looked at the statistics in Chicago going back to, I think it was 1871. They kept records from then. Normally, you can have a cold winter or you can have a snowy winter. You rarely have both. This was the third snowiest winter in Chicago, the third coldest winter in Chicago. I think they had 32 snow days. They closed schools in Chicago, which is really rare. So this was an extraordinarily tough winter that exacerbated some of the natural challenges in Chicago.

So yes, as an industry, we are putting more capital in there. But I think we do need to put the context of how severe this winter was when we think of what happened this year.

Jason Seidl (Managing Director)

Does what happened this year maybe accelerate some of the industry's plans to fix Chicago?

Michael Ward (Chairman, President, and CEO)

Well, quite frankly, the railroad piece, the money for the railroad elements of it because CREATE not only helps the rail freight infrastructure, it also helps the commuters. It also helps the interface at grade crossings and those sorts of things. The money related to the rail freight infrastructure is being provided by the rails today. The federal and state money for the other aspects, the commuter and the interface crossings, etc., is coming a little bit slower just because of some of the budget challenges, both state and federally. So that's moving at a slower pace. But the freight piece is moving forward faster.

Jason Seidl (Managing Director)

Okay. Gentlemen, thank you for the time.

Operator (participant)

Thank you. This question comes from Ben Hartford with Robert W. Baird. You may ask your question.

Ben Hartford (Senior Equity Research Analyst)

Morning, guys. Just want to circle back. Fredrik, I know we addressed this earlier in the Q&A. But in terms of kind of abandoning that sub-70 OR target for 2015, I want to understand the reasons. I believe it's on the export coal side, specifically on the pricing side. But Clarence, I think you as well had made a comment about volumes, frankly, in the first quarter being slightly stronger than even you guys had anticipated. And we know that the settlement prices are lower here on the margin in the second quarter. So Fredrik, maybe you could provide just some context into really what is driving the lack of confidence there for 2015 in terms of that line of sight to the sub-70 OR. And when you say that you will need some help, is it simply on the export coal pricing front?

Or are there other opportunities even at current pricing levels in the export market that would allow you that would provide for that help to get back into that sub-70 OR risk in 2015?

Fredrik Eliasson (CFO)

Sure. Sure. And so I wouldn't say we abandoned it. What we said is that, "Hey, we need some help from what we see things today." As we do a bottom-up view of things, we're going to need some help. And that help can come from different places. It doesn't have to be from export coal. But particular to that, while Clarence is absolutely right, our export coal market has done better than we thought from a volume perspective. As you also heard, we will continue to make adjustments on the rate side to make sure we optimize our bottom line and, of course, try to do what we can to keep the U.S. producers in the business.

At these low levels in terms of the underlying commodity prices, it is unknown to us or it's difficult for us to predict how long this will be able to sustain, how long will the producers be able to be competitive in the marketplace? So until we see some sort of an uptick there, it's hard to be too bullish on 2015 in terms of what overall volumes will do. But it's not confined to that. As I said earlier, we get help from other places as well in terms of more price, more productivity. The economy is doing well. And so we continue to target it. We continue to think that that's where we want to be. At the same time, one of the things that we try to do as a company is to be very transparent about how we see things.

That's really, I think, pretty consistent with the two public appearances I had in the quarter in terms of saying what we need in order to be able to get there. We certainly haven't given up on it. We certainly haven't abandoned it.

Ben Hartford (Senior Equity Research Analyst)

Of course. Okay. And then if I can ask a follow-on in terms of the mid-60s OR target longer term, do you have comfort that at current global settlement prices on the export coal market that this mid-30 million tons run rate is an appropriate run rate going forward and that with the components of productivity gains and volume growth and coal pricing growth, you have visibility over time to be able to get to that mid-60s OR? Is that how we should look at that longer-term target?

Fredrik Eliasson (CFO)

Yes. We think about pulling the three levers that we have: price, volume, productivity. As we do our long-term modeling, we still feel comfortable that we will be able to get to that mid-60s level. Obviously, it's taken longer than we had expected because of the fact that we've lost $800 million of coal revenue in two years alone here. And we still have some headwinds we're facing this year. But even at the current levels, as we model things out, we'll get there over time. It's just a little bit longer than we had anticipated originally.

Ben Hartford (Senior Equity Research Analyst)

Perfect. Thank you.

Operator (participant)

Thank you. This question comes from Cherilyn Radbourne with TD Securities. You may ask your question.

Clarence Gooden (Chief Sales Officer and CMO)

Morning, Scott.

Cherilyn Radbourne (Managing Director of Equity Research)

Thanks very much. Good morning. In her testimony before the STB last week, I think I heard Cressie Brown indicate that you'd recently acquired a new route through Chicago. Just given all of the focus on Chicago currently, I just wondered if you could give a bit of color on that and how it might be strategic to you going forward.

Michael Ward (Chairman, President, and CEO)

Yeah, Cherilyn. This is Michael. We acquired the Elsdon Sub of the Canadian National in a swap last year. When they acquired the J, the EJ&E, they didn't need that route anymore. So we acquired that from them. And we're currently, once this weather's broken, we're making improvements to that route to allow additional fluidity in the Chicago area.

Cherilyn Radbourne (Managing Director of Equity Research)

How long would you expect those investments to take before you start seeing some benefits?

Michael Ward (Chairman, President, and CEO)

No, Sean, this is Oscar. By mid-year, let's say July, we should be fully operational.

Cherilyn Radbourne (Managing Director of Equity Research)

Okay. And then just one last quick question. In terms of the double-digit volume growth that we've seen over the last couple of weeks in your carloads, do you have any feel for how much of that is pent-up demand versus real organic traffic growth?

Fredrik Eliasson (CFO)

I think a lot of that is pent-up demand. But at the same time, though, we still feel that the economy, as we said in prepared remarks, continues to be very vibrant. And we're also seeing our coal business now finally picking up. So the underlying volume trend is also very positive. But there's no doubt that there's a fair amount of that double-digit volume growth that is related to just catching up with things we didn't move in the first quarter.

Michael Ward (Chairman, President, and CEO)

But I would add to that. The economy is forecast to grow, let's call it, roughly 3%. We think our merchandise and intermodal business, we can grow faster than that rate, which we did last year. We will do this year as well. So we will be some amount above what that economy is doing with the great service product we've been providing. So we do need to temper that a little bit because it is pent-up demand, but it's also strong demand in the base business.

Cherilyn Radbourne (Managing Director of Equity Research)

Great. Thank you. That's all from me.

Operator (participant)

Thank you. This question comes from David Vernon with Bernstein. You may ask your question.

David Vernon (Managing Director and Senior Analyst)

Hey, good morning.

Michael Ward (Chairman, President, and CEO)

David, you heard who this was?

David Vernon (Managing Director and Senior Analyst)

It's David Vernon with Bernstein.

Michael Ward (Chairman, President, and CEO)

Oh, David.

David Vernon (Managing Director and Senior Analyst)

Hey, good morning. Just maybe a higher-level question. As you think about the slower rate of operating margin development and keeping CapEx as high as it is, is there a point where you need to start thinking about the capital budget a little bit differently just to ensure overall returns are kind of getting to an upward trajectory?

Michael Ward (Chairman, President, and CEO)

This is Michael. One, when I think of the slower operating margin growth, I don't know that I necessarily agree with that base premise. I mean, if we look at our business and strip out the effect of the loss of that coal business over the last couple of years, we are in the high single- to low double-digit growth on the other businesses. And once we get through this transition, we will produce that kind of growth. Now, to do that, we have to make the investments necessary to support it. So that 16%-17% of revenues that we've held with the last few years, we still think that is the appropriate level. We do need to make strategic investments in our intermodal as we're doing to capture that growth opportunity. We think there are 9 million truckloads out there that we can go after.

We have to make the investments necessary to do so. We still think the 16-17 is the appropriate level. It will produce value for our shareholders as we grow the business and the margins.

David Vernon (Managing Director and Senior Analyst)

You don't get concerned at all about the asset turns created by that mixed headwind towards lower revenue intermodal?

Michael Ward (Chairman, President, and CEO)

No, because while it's lower revenue, it doesn't mean it's a lower margin. So if we look at the margins on the intermodal business, it's as good as our other margins for our merchandise businesses. So it's good margin business. It's lower RPU. But what we get paid for doing is producing margin, not necessarily revenue per unit. So we think it's good business. It will lower the overall RPU, but will increase our profitability, which is what we really need to do.

David Vernon (Managing Director and Senior Analyst)

All right. Appreciate the time.

Operator (participant)

Thank you. And this question comes from Walter Spracklin with RBC. You may ask your question.

Oscar Munoz (COO)

Morning, Walter.

Walter Spracklin (Managing Director and Equity Research Analyst)

Good morning. Thanks for taking my call here. I just have two follow-up questions, really. One is for Clarence on the export coal side and the guidance that you provided with regards to the neutral on the second quarter. I know Chris kind of asked this. But just to clarify, if we reflect, you did 11.5 million tons last year. You did 10.5 million tons last quarter. Even if we just say 10.5 million tons this quarter, it would imply a step down of over 20% in the back half of the year to get to about 36 million tons. So is that what you're guiding? Or are we just giving a little bit more room for upside in the case that the back half turns out to be better than we were expecting?

Clarence Gooden (Chief Sales Officer and CMO)

Walter, I guess if somebody was to hem me up in a corner and say, "What are you really guiding?" I'm guiding that this market is very volatile, that at $120 a ton in Queensland, your guess is as good as mine. It is extremely volatile. With thermal coal selling in Europe between $75 and $79 a ton, some of the things that we've seen in the first quarter really defy what have been historical norms. It's highly speculative. We've worked with our producers to try to stay in the marketplace right now. And it's just too soon for us to bet on. So we've got a fairly clear line of sight of what the next two, three months look like. But to tell you what the third and fourth quarter looks like is just going way out on a limb.

Walter Spracklin (Managing Director and Equity Research Analyst)

Okay. All right. That makes a lot of sense. Okay. I appreciate that color. Staying with you, Clarence, here on intermodal pricing. Again, a clarification question. A lot of moving parts in the last few quarters with regards to fuel recapture or quite the opposite, a lower fuel surcharge, firming truckload market or trucking market. If we strip all that out now, on a base level going forward, would you see average RPU in intermodal flat or up going forward?

Clarence Gooden (Chief Sales Officer and CMO)

Up.

Walter Spracklin (Managing Director and Equity Research Analyst)

Okay. Okay. That's all my questions. Thanks very much.

Operator (participant)

Thank you. This question comes from Justin Long with Stephens. You may ask your question.

Clarence Gooden (Chief Sales Officer and CMO)

Good morning.

Justin Long (SVP of Equity Research)

Good morning. Thanks for taking my questions. First one I had was on core pricing. You talked about overall core pricing being up about 50 basis points year-over-year. But could you talk about the headwind this number saw from a lower level of rail inflation? I'm just trying to understand the overall core pricing environment, absent any changes in inflationary mechanisms. Would you describe it as stable? Or are you seeing some type of moderation?

Michael Ward (Chairman, President, and CEO)

Well, if you saw core inflation was around 1.4% from Global Insight, when you took coal out of the mix, we were at about 2.6%. That was down from what it was a year ago, which was around 3.3% in the merchandise and the intermodal markets. So we're pricing above rail inflation in our basic markets. The coal markets are being mainly impacted and influenced by what's happening in the global coal markets. So I would tell you that we're seeing stability in our general freight and our general merchandise markets as we're seeing capacity demands, as was just witnessed by the previous questions. We think that'll firm up through the years as we go forward from where we are today. Depending on what happens in these coal markets, we think we've seen the near bottom start to approach in global markets in coal.

The trend should be upward in the future in there. That's helpful.

Justin Long (SVP of Equity Research)

Okay. Thank you. That's helpful. And as a follow-up, I was wondering if you could talk about the industrial development opportunity and your current pipeline of projects. It seems to be pretty robust. Is there any possible way to quantify how much this could contribute to volume growth in 2014?

Michael Ward (Chairman, President, and CEO)

I don't have that number right off the top of my head. I'm sorry.

Justin Long (SVP of Equity Research)

Okay. That's fine. Maybe you could just provide some color on some of the opportunities as far as industrial development and what you're seeing and just kind of how that pipeline looks in general.

Michael Ward (Chairman, President, and CEO)

Well, one of the things that we are seeing as a result of the expansion in the oil and the gas industry is a lot of development is happening in the Marcellus area with fractionators either located on CSX or on short lines that feed into CSX. We have 5 new fractionating facilities located on us. Each one of those are producing between 15 and 20 cars a day of byproducts of the gas industry that are coming on to CSX. That's positive for us. We have 2 new ethylene crackers that have been announced on CSX as a result of that. So those tend to be, for lack of a better phrase, annuities going forward for us on CSX. So you're seeing a lot of developments in those areas.

In the last, I guess, 18 months and all, we've seen a lot of activity in general in industrial development as economies begin to expand with new industries on CSX. I think last year, we announced almost $1.5 billion-$2 billion worth of new industries that are located on CSX. So you're seeing a lot of economic activity now as economies beginning to expand.

Justin Long (SVP of Equity Research)

Okay. Great. That's helpful. I'll leave it at that. I appreciate the time.

Michael Ward (Chairman, President, and CEO)

Thank you.

Operator (participant)

Thank you. This question comes from Keith Schoonmaker with Morningstar. You may ask your question.

Michael Ward (Chairman, President, and CEO)

Morning, Keith.

Keith Schoonmaker (Director of Industrial Equity Research)

Yeah. Thanks. I'm in Chicago. I'm actually calling you from an igloo this morning. I appreciate those comments on uncertainty of export coal demand. I wanted to turn to domestic with a couple of quick questions. Fredrik mentioned expectations that 2013 was probably the nadir in domestic coal volumes. I know there's no crystal ball, but I just want to clarify if you're thinking that, based on current information, you expect domestic coal to be flat or up from here on, say, indefinitely, next 3-5 years?

Michael Ward (Chairman, President, and CEO)

No, no. We expect growth in the mid to high single digits for the rest of this year in 2014 in domestic coal.

Keith Schoonmaker (Director of Industrial Equity Research)

And then beyond the current year?

Michael Ward (Chairman, President, and CEO)

Well, I expect 2015 to also be up. I don't see much beyond 2015 right now at this point.

Keith Schoonmaker (Director of Industrial Equity Research)

Okay. And then, if I recall correctly, Illinois and Powder River Basins constitute about half of your recent utility carloads. And I'd like to ask about your expectations for mix, same time period, 2-3 years from now.

Michael Ward (Chairman, President, and CEO)

Well, 2-3 years right now, you're right. It's running just slightly above 50% in both those markets. We expect to see growth continue in both of them, particularly in the Illinois Basin coals. We're actually making capital investments on that line near the Illinois Basin to allow us to muster those unit trains more efficiently. And when's that expected to be done, Oscar?

Oscar Munoz (COO)

Again, probably third quarter of this year.

Michael Ward (Chairman, President, and CEO)

So we're putting infrastructure in because we do think that Illinois Basin is going to be a continual growing market for us.

Keith Schoonmaker (Director of Industrial Equity Research)

That infrastructure is track?

Michael Ward (Chairman, President, and CEO)

It's putting in a yard. It's a yard to be able to assemble unit trains and move them more efficiently.

Keith Schoonmaker (Director of Industrial Equity Research)

Thank you.

Operator (participant)

Thank you. Our final question comes from Cleo Zagrean with Macquarie Capital. You may ask your question.

Cleo Zagrean (Equity Research Analyst)

Good morning. Thank you for your patience. My first question relates to, again, the outlook for the export coal market. Could you help us understand your leverage to recovery in met coal across your book of business, contracted and spot, and also what your assumptions are with regards to this market in your guidance for double-digit EPS growth for next year?

Michael Ward (Chairman, President, and CEO)

Our leverage in met coal, is that your question?

Clarence Gooden (Chief Sales Officer and CMO)

The rebounds. What kind of leverage?

Cleo Zagrean (Equity Research Analyst)

Yes. How fast can you benefit from a recovery in pricing and demand in volumes given that you have a mix of contracted and spot business? And if you could also clarify how much of your contracted business is up for renewal this year, that would also help.

Michael Ward (Chairman, President, and CEO)

Okay. Our export coal business is priced on a quarterly basis. So our ability to leverage and to respond to the marketplace would be able to we'd be able to do so on a quarterly basis. But that upticks, we can move with it. We can respond within the quarter.

Cleo Zagrean (Equity Research Analyst)

All right. And with regards to your guidance for 2015, what kind of outlook do you have embedded for export coal?

Fredrik Eliasson (CFO)

I think what we've said is that that is one market that we're concerned about in terms of how long we can see this sort of positive volume despite having the underlying commodity markets as weak as they are. But we haven't given a specific number in terms of what we're assuming for 2015. Thank you. My follow-up is with regards to the path to your mid-60s operating ratio long term. Can you help shed some light into what you mean by long term and the main drivers, especially from the hurdle put by this hard winter? Well, in terms of the mid-60s, we talked about it earlier on the call today. Because of the fact that we've lost so much momentum in the $800 million of coal revenue that's gone away, it has been pushed out longer than we originally anticipated.

And we're going to have to get there a little differently than our original plans. But we're still confident that as we look at our long-term modeling, as we look at our pricing, productivity, and volume opportunities, that we'll get there. We're not going to put a time frame on it today. But clearly, that's where we need to be long term in order to be able to reinvest in the business the way we want to be able to do.

Cleo Zagrean (Equity Research Analyst)

So it could be three years or five, I guess?

Fredrik Eliasson (CFO)

We have not put a time frame on that.

Cleo Zagrean (Equity Research Analyst)

Thank you very much.

David Baggs (VP of Capital Markets and Investor Relations)

Well, everyone, thank you for your attendance, interest in the company. And we'll talk to you again next quarter.

Operator (participant)

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