CSX (CSX) Q1 2017 Earnings Call Transcript

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the CSX Corporation First Quarter 2017 Earnings Call. As a reminder, today's call is being recorded. During this call, all participants will be on a listen-only mode. For opening remarks and introduction, I'd like to turn the call over to Mr. David Baggs, Vice President, Treasurer, and Investor Relations Officer for CSX Corporation.

David Baggs (VP, Treasurer and Investor Relations Officer)

Thank you, Shirley, and good morning, everyone. On behalf of the management team, I'd like to welcome you to our first quarter earnings call, and also thank you for your interest in CSX Corporation. This morning, we're being represented by our Chief Executive Officer, Hunter Harrison, our Chief Marketing Officer, Fredrik Eliasson, our Chief Financial Officer, Frank Lonegro, and our Chief Operating Officer, Cindy Sanborn. Now, before we begin the formal part of our presentation this morning, let me remind everyone that the presentation materials, our safety and service measures, our quarterly financial report, and our press release announcing our new guidance press and, dividend and share repurchase, are all found on our website at csx.com under the Investors section. In addition, following this presentation, later today, our webcast replay and the 10-Q will be filed.

And so now let me turn your attention to Slide 2 of our presentation. Here, our forward-looking disclosure statement outlines the risks and uncertainties of forward-looking statement. There will be a number of them this morning, during our presentation, and I imagine quite a few during our question and answer session. So I would encourage you to take those forward-looking statements in the full context of this disclosure statement. On Slide 3 is our non-GAAP disclosure statement. While CSX does file all of its financials in accordance with the U.S. GAAP, we are providing some non-GAAP financial measures in addition to the GAAP financial measures to help you better understand the business, but these measures are not a substitute for GAAP.

Finally, I would say that we have close to 30 analysts this morning, and so I would encourage everyone to play nicely in the sandbox, so to speak. We'll have one primary and one follow-up question so that everyone can be heard, and we use everyone's time wisely. And before I turn the presentation over to the team, let me also remind you that the earnings call today is limited to discussions of the earnings and the business of CSX only, and we will not touch upon matters that are currently the subject of the company's annual meeting. And with that, it is my great pleasure and privilege to introduce our President and Chief Executive Officer, Hunter Harrison.

Hunter Harrison (President and CEO)

Thank you, David. And thanks to all of you for joining us this morning. I guess my first comment would be, I'm back. I didn't think that I didn't think this was gonna happen, but it's come together. Hopefully, well, not hopefully, I think it's actually my last leg on this journey that I've taken down this railroad career for now, a little in excess of 50 years, that I ever think that I would finish in Jacksonville with a group of railroaders with the talent that they possess and the franchise that's before us. And I'm very, very excited about the opportunities. I met yesterday with the first board meeting, formally with our board.

I think it's safe to say that all of us were pretty excited about the opportunities going forward. As I found here, like I've found before, and I thought there's a group of great railroaders. It might be a little shift in direction, but this company is gonna achieve things that sometimes you don't think could be achieved. I'm not gonna spend a lot of your time and mine on this, on the first quarter because I wasn't here. I was only here for 30 days, and the three leaders here that with their team produced those results are gonna spend some time going through there with you.

I certainly think it was a pretty outstanding quarter as an outsider, certainly looking in, and it builds a foundation for us to go forward on with our plans for the future. Yeah, I would say this, as I was reflecting this morning on what I might say here today, and I know if you look at the various constituencies that we deal with, certainly our investors are represented, certainly our employees are represented. The one group that's so important to us that's not represented directly, that I'm gonna become an advocate for, is our customers. And I'm extremely excited. If you look at our service offering as it is today, we do a I think there's a lot I've got to learn, but pretty good job in our bulk movement and cycles.

We do a good job in the intermodal area. I think all of us would say that in our "merchandise" category, we can make some significant improvements. Cindy and her team have already started that down that road. I think you'll see some, what I would characterize as some pretty dramatic changes in our cycles, and I think you'll see things like from Chicago to Florida markets, that we'll take 2 and 3 days out of that as a result of some of the strategies you're gonna hear about today. I think that's pretty exciting for the customer base. Without me taking up a lot additional time, let me turn it over to the team here and let Frank give us some observations on the results in the quarter.

Frank Lonegro (CFO)

... Thanks, Hunter, and good morning, everyone. Consistent with the transformation that we are undertaking to Precision Scheduled Railroading under Hunter's leadership, and knowing that you're eager to ask questions this morning, we're going to be very efficient in the way that we discuss the numbers. So with that as a backdrop, let's turn to slide 7. The safety of our employees and the communities that we serve will continue to be a top priority for CSX and for this leadership team. While the Personal Injury Frequency Index was 9% higher year-over-year, the absolute number of injuries was down slightly, and that's part of our continuing drive toward the ultimate goal of zero injuries. Our Train Accident Frequency Index was 25% improved on substantially fewer reportable incidents.

In terms of efficiency, we are continuing to drive both train length improvements and fuel efficiency gains, while our service levels remain stable on a year-over-year basis.

Cindy Sanborn (COO)

Thanks, Frank. Let me just add a little bit. First of all, very excited to be working with Hunter here, and as the operating leader, spend a lot of time with him. And so I'll talk a little bit about the quarter, but I will talk about going forward, how we're working on some of the items that Hunter has briefly alluded to this morning. First of all, as you would expect, and has always been the case at CSX, safety is our highest priority, and we will continue to focus on that, not only in employee performance, employee injury performance, but train accidents in order to improve or make sure that the communities that we operate through, we operate through safely.

Turning to productivity, in the first quarter, we delivered $123 million worth of savings. Significant resource productivity drove this, and continued train length opportunities and reduction in crew starts. Also, we saw some other support costs, particularly in engineering, and mechanical, labor, costs also affecting us positively in the quarter. But I think what we really want to hit on here is how we think about our business going forward to drive both productivity and service, as Hunter's alluded to. And in the past six weeks, we've done a couple of key things I'll just highlight this morning. One, we've adapted our operating plans to incorporate some of our unit train business into our merchandise business, in merchandise service. And this allows us to do a couple things.

As you think about our 28-hour train dispatch or variable train dispatch, we did that in order to improve our train length, and we've done that, been very successful with it. But I think what's helping us continue to move forward with train length and cycle time improvement is adding the batch network into the merchandise service. So now we can have a more balanced network with a more highly likely probability of seven-day-a-week service and still keeping the length of the trains where it is, is productive. This also serves our customers well as we're able to improve dwell time in our terminals as a result of these changes.

The second item that we've been working on is reduce or changing or converting our switching operations in some of our traditional hump yards into a flat yard model. We have 12 hump yards across the system. To date, we have converted 4 of those over into flat switching operations. This has allowed us to reduce support resource efficiencies, particularly in managing the infrastructure that's necessary to support in hump yards, in the humping process, reduce that, as well as, again, our plan has been focusing on improving the cycle time through those terminals. So we've been able to do both of those things. As we look forward, we expect to continue to reduce several hump yards. We don't have a hard and fast specific number.

We'll look at each one individually. We will make sure we're making the right decisions to improve both productivity and service. And I would also say that, as we look at our quarter one measurements, our network performance measurements, we are seeing, as we've implemented some of these changes I'm talking about, improved dwell time, improved velocity across the network, and we think that will compound, that compounds the effect of some of the changes that we're making to lead us to feel very comfortable moving forward, that we'll actually have record productivity in 2017, following our previous record productivity in 2016.

So overall, I think the team is doing very well coming together with some significant changes as we adjusted to the reductions in management headcount as part of our first quarter initiative. We saw a lot of change there, and we're continuing to see change. We're driving that effectively, I believe, and we'll continue to do so, incorporating that into our business model going forward.

Frank Lonegro (CFO)

Hey, thanks, Cindy. Those are great insights for the analysts and for the investors. Going forward, as we implement Precision Scheduled Railroading, you'll see what we believe is a powerful combination of improved safety, improved service, and improved efficiency that exemplifies a great railroad. We believe that that powerful combination will benefit employees, customers, and shareholders alike. Turning to slide 8, the GAAP view of our income statement highlights the 10% year-over-year top line improvement, which has been achieved through a combination of volume growth, higher fuel surcharge recoveries, favorable mix and value pricing. Volume is up 3%, with pricing on a same-store sales basis, increasing 3.9% all in, and 2.5%, excluding coal, driving revenue per unit up 7%.

Looking at the expenses at a high level, total costs were up $243 million, with the $173 million restructuring charge accounting for most of that year-over-year increase. After the charge, the combined impact of increased fuel prices, inflation, and volume were nearly offset by the $123 million of efficiency savings that you heard Cindy reference. The focus on cost control in a rising volume environment produced incremental margins of over 70%, excluding the charge. Bottom line, ex charge, CSX delivered record first quarter operating ratio of 69.2%, operating income of $885 million, and a record first quarter EPS of $0.51. Turning to Slide 9, these financial results drove over $1 billion in operating cash flow, a nearly $300 million year-over-year improvement.

This improvement carried through to free cash flow before dividends of $630 million. Earlier this morning, we announced a free cash flow target of around $1.5 billion for the year, which takes into consideration the combined impact of our earnings trajectory and a CapEx reduction of over $100 million. We continue to remain focused on returning capital to shareholders through a balanced deployment strategy. In the quarter, we distributed $166 million to shareholders in the form of dividends, while repurchasing $258 million of CSX shares. Having now completed the two-year, $2 billion program we commenced in April of 2015, we were pleased to announce a new one-year, $1 billion buyback program earlier this morning.

While ROIC was stable on a year-over-year basis, we fully expect that it will inflect more positively going forward as we continue to increase efficiency and reduce the asset intensity of our railroad. Debt to EBITDA was also relatively stable as we continue to appropriately utilize our balance sheet and remain committed to a BBB+, Baa1 credit rating. Turning to Slide 10, the volume outlook for the second quarter is largely positive, with nearly 70% of our markets in the favorable category and over 20% of our markets in the neutral category. Only domestic coal is expected to be unfavorable in the second quarter.

Fredrik Eliasson (CMO)

Yeah, so just to add a little color to that, if you, if you look at the macro environment, there are several indicators that seem to support continued growth. Obviously, the economy continues to grow at a modest pace, GDP in the 2-2.5 range for the full year, and probably similar pace in the second quarter itself. The consumer sentiment continues to be at high levels, which helps many of our markets, especially perhaps in the modal market. At the same time, though, the truck market right now is continues to see excess capacity. But as we move through the year, we do expect that to gradually improve in the second half and into 2018.

And then, of course, on the favorable side, export coal was very strong here in the first quarter, 8.7 million tons that we moved in the first quarter. We do expect that to taper off as we move through the year, but we still think that an upper 20 million range in terms of tons for the full year on the export side is a good estimate at this point. As we think about some of the headwinds, we think that auto production is clearly flattening out, and we think for the rest of the year, relatively flat is probably a good place to think about the auto business.

Then while the core chemical market continues to grow at a nice pace, we expect crude by rail to continue to decline, both year-over-year and sequentially as we move through the rest of 2017. Then, of course, on the unfavorable side, we see our domestic coal business. We talked about in the fourth quarter, we lost some short-haul business, and but we—despite that, we did about 50 million tons here in the first quarter on the domestic side, and we expect a similar pace in the second quarter. But as you saw in the first quarter, the quality of the revenue and the impact of the bottom line is still very strong, and we expect it to continue as we move through the year.

It's obviously reflected in our, in our RPU. So I, I would say overall, we feel good about the top line. We continue to expect our merchandise and intermodal business to grow at or above the economy as a whole, and it's nice to see coal revenue to be growing a little bit here this year as well. And echoing Cindy's comments earlier, we are very excited about what this operating model can do for CSX, not just in terms of the bottom line, but really what it can do for our customers. We're already seeing that, and but from a service perspective, both in terms of transit time, reliability, and recoverability. We feel very good about this change.

Frank Lonegro (CFO)

Thanks, Fredrik. A very helpful, again, commentary for the investors and for the analysts. Let's finish up on Slide 11. With our first quarter results, we're off to a very good start in 2017 and expect to accelerate the transformation to Precision Scheduled Railroading in the coming quarters. Earlier this morning, you saw that we issued full-year guidance, excluding the restructuring charges. To that end, in 2017, CSX expects to achieve a mid-60s operating ratio, record efficiency gains that you heard Cindy mention, EPS growth of around 25% off of 2016's reported EPS of $1.81, and free cash flow before dividends of around $1.5 billion. In issuing these expectations, we assume, of course, that the coal markets and the overall economy will remain stable.

This morning, we were also pleased to announce an 11% or $0.02 increase in the quarterly dividend.

... along with a new 1-year, $1 billion share buyback program. Finally, we look forward to sharing our longer-term plans with you in the second half of the year. With that, we'd be delighted to take your questions this morning.

Operator (participant)

Thank you. We will now begin conducting a question-and-answer session. If you would like to ask a question, please press star one. To withdraw your question, you may press star two. Again, press star one to ask a question, and one moment, please, for our first question. Our first question comes from Brian Ossenbeck with J.P. Morgan. Your line is open. Go ahead with your question.

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Okay, thank you. Good morning. Thanks for taking my call. Hunter, I guess the first one for you, I know we'll have a scheduled day later in the year, perhaps to hear more about the longer-term plan. But, you know, the initial impressions that were laid out on the slides, if you could just give us some context in terms of what do you think the significant opportunities are to further streamline the network? You've talked about monetizing real estate, which I know is a target at Canadian Pacific when you were there.

You know, just in general, if you think there's just, you know, too much, too much track with too few car loads going over there, is there just an ability to improve the network density and the design as you move forward over the next couple of years?

Hunter Harrison (President and CEO)

How long do you have, Brian? Listen to this response. Let me, you know, I don't think that this franchise is significantly different than others that we've overlaid this model with. You know, Cindy touched on a lot of these things, and as we've talked internally, you know, we don't have some ironclad numbers on what's the number, what's the headcount number got to be? What's the hub closures got to be? It's going to be what's smart to do. I do think that I spent a great deal of time with Cindy and her team. We are, I think step one was, we're cutting through a lot of bureaucracy.

We're shedding through where we had, I think nine divisions or so, we're going to be going down to maybe a couple, you know, lines in organizational charts just cost money, and I think we're trying to streamline that. We're trying to get the right leadership in the right spot. We've got nine dispatching offices. I don't think any railroad has nine dispatching offices, and we're going to make some efforts there. There's efforts going on now with the locomotive productivity. I would expect that before the summer's out, we'll have 550 or so locomotives stored. We'll probably have 25,000 freight cars put up and all the associated costs that go with them, the labor, material, and the locomotives, fuel productivity, velocity, and a lot of things.

Dwell time in terminals, I would say, will come down dramatically. Are some of our facilities... Historically, have they been overbuilt? Yes, like a lot of railroads. But this railroad has had a, had a special challenge. If you look back at the mergers, there was more companies involved with the mergers of what is now the CSX than any other major road. So if you go to a place like Atlanta and we have, you know, 4 or 5 yards, well, it's because everybody had a yard there, or if you go to some of these common points. So we're, we're doing some things. For example, Atlanta is a good example where I think we have 4 yards there.

Cindy's helping me here, and I think we'll be down to, you know, maybe there's one super operation there, but I know we have a tract of land there that's an operating property that doesn't need to be, that's worth a good deal of money. So there's going to be some monetization of assets. So this is going to be more the same at maybe a more rapid pace with the taking advantage of larger opportunities.

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Okay, great. Thanks, Hunter.

Hunter Harrison (President and CEO)

Sure.

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

So just one quick follow-up just on the coal side. Frank or Fredrik, if you could just give us a sense as, you know, the export market price in met really spiked and, you know, pretty much after the quarter ended. So I just wanted to see if you thought that the mix, the favorable benefit that you saw in the first quarter is something that you would also be able to capture in the second and third quarter. Thank you.

Fredrik Eliasson (CMO)

Well, thank you. You know, obviously, we don't forecast price, but we have said overall, over time, that we do have industry indexes on our contract on export side, that when things go well, we share in some of that economics, and when things aren't as well, we take some of that pain. Clearly, this quarter, it wasn't just the export pricing that helped. We also saw some pretty favorable mix, and a lot of that mix we do expect to continue, but it all, of course, depends on where we see the utility business, for example, go in terms of refill, replenishment of inventories through the year.

So I think there's a favorable mix story, and favorable story going forward, but I think it's unclear at this point how favorable it's going to be as we go through the year.

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Okay. Thank you.

Operator (participant)

Thank you. Our next question comes from Chris Wetherbee with Citigroup. You may ask your question.

Speaker 22

Great, thanks, and good morning. Wanted to touch on the volume side, Hunter. If you could just sort of give your initial impressions on what you think about sort of volume opportunities that are out there for CSX. Obviously, playing in the East, we automatically kind of think of the intermodal markets, and efficiency obviously plays big into being able to gain share, either both from truck as well as your rail competitors. Give us a sense of sort of what your initial impressions are about sort of the franchise there and how you think about that going forward?

Hunter Harrison (President and CEO)

...Well, you know, I'm obviously, in 30 days, I'm limited to my knowledge. I will say this, I think one of the exciting things going forward with this organization, as well as rail overall, is the opportunity that's before us to get business off the highway. And I think that we're set up in almost a perfect storm here to take advantage of that. If you look at that we had, we started with a strong base to begin with, with great markets that we serve up and down the East Coast and Chicago, Florida, and some really growth areas where, you know, there's congestion, the highway system is not going to be able to accommodate everything.

If you look at the advantages of rail with, from an environmental standpoint, from an energy standpoint, and if you look at an organization that is going to be able to take a combination of the dwell times and in terminals by eliminating terminals, which lowers costs, but at the same time, then takes the dwell times down from an average of effectively a day or 25-6 hours of dwell down to 18 or so. You say, we're going to skip some terminals, and you start to look at, really, what we used to talk about was truck competitive. Now, it's not truck competitive, it's better than truck. Now, the issue is the change, and it's trying to, to take that to the marketplace and, and to sell it and convert it and change it. But that's where, you know...

Look, the individual markets, you know, I mean, this company has had some, has some, we got some worthy competitors out there. We'll scratch and fight and win the business there. The real opportunity I see is on the, in the highway.

Speaker 22

Okay. Okay, that's very helpful. I appreciate that. And then, just to follow up, thinking about some of the guidance and, and maybe how to think about it a little bit beyond 2017. So, you know, mid-60s for, for this year, which I think pulls forward some of the benefits, but clearly, some of the things that you're going to be doing are going to be, you know, gaining traction as the year progresses. So presumably, you'll be entering 2018 at a better run rate. So obviously, I'm trying to jump the gun here a little bit and get some of the forward look before you might be ready to give it.

But when you think about 2018, am I thinking about it wrong in the respect that it is sort of natural that some of the benefits you're accruing in 2017 will be playing out in 2018, and maybe we're thinking about something like the low 60s or so OR in 2018?

Hunter Harrison (President and CEO)

Is that bait? Send me your model, Chris, and I'll fill it in. But I think you're, I think you're right on. Look, this is not the first time this movie's played out. We see opportunities. Not going to happen overnight. Is it going to be exactly linear? No. Will it be a stair-step approach? Yes. Do we have any barriers here, structural issues that we've dealt with before that says we can't do what's been done before and even go beyond that? No reason.

Speaker 22

Gotcha. That makes sense. Thank you very much. It was worth a shot. Appreciate it.

Hunter Harrison (President and CEO)

Yes.

Operator (participant)

Thank you. Our next question comes from Tom Wadewitz with UBS. You may ask your question.

Tom Wadewitz (Managing Director and Senior Equity Research Analyst)

Yeah, good morning.

Hunter Harrison (President and CEO)

Morning, Tom.

Hunter, I wanted, I wanted to see if you could offer some thoughts on the opportunity at CSX versus what you saw at CP. I think of your approach being one of the things you do is simplify the flow of traffic and reduce work event. If CSX has a greater complexity in the network to begin with versus CP, that would apply maybe greater opportunity, for cost takeout and OR as you take out that, that complexity, right, and simplify things. So I don't know if that's the right framework or not, but wanted to see if you could comment on that and maybe compare the opportunity you see so far, at CSX versus what you had at CP.

Well, I mean, Tom, as you know, they're totally different franchises. The makeup, the markets, as generally speaking, a lot of roads are in North America. So, you know, you look at the hand you're dealt, and you say: Look, what is the best way to operate and run this franchise? And I think that, you know, before I arrived, you know, there was a lot of talk about this is not, you know, a simple key operation, that it's got all the complexities and the density and the spaghetti bowls. Well, the way, you know, to handle that, eat the spaghetti and get rid of it.

So one of the things we're doing, you know, is that Cindy and her team are working diligently on, is being sure that we're not going through terminals and processing cars just because the terminal is there. So it's almost kind of the old term we've used before, the whiteboard approach. But let's start over with this franchise. The last, and I was in error yesterday when I talked to a group, but the last hump yard that was built in North America, the last two, was one at Waycross, Georgia, which is the heart of the CSX in my view. And the other one was, I believe, Galesburg, Illinois, which I had something to do with the construction of it for Burlington Northern in the mid-1980s. Markets have changed since the mid-1980s. The amount of traffic that's bulk, that is intermodal, that-...

Unit grain, unit coal, crude trains that don't have to be sorted and switched. So you adapt your operating strategies to the market. And I just think that there's much more of a natural fit to make some of the changes that we need to make here. That will present even more opportunities, because to your point, for the complexity, as said in the past, and the ability to simplify it, this franchise, if you apply from my career to some degree, has more potential than any one I've dealt with.

Tom Wadewitz (Managing Director and Senior Equity Research Analyst)

Okay, great. That's helpful. I appreciate it. Then the second question or the follow-up would be, CSX's approach to intermodal has been a bit different than I think what's typical. If you look at Norfolk, they have the Corridor strategy. I think that would be more characteristic maybe of the Canadian road, but CSX has this Baltimore and Ohio hub strategy, and has talked about one in the Southeast. Do you think that is the right approach to continue, or do you think on the intermodal network, is there opportunity to maybe simplify and go towards more of a kinda, you know, origin to destination, as opposed to sending it to the, you know, the hub and that you have in Baltimore and Ohio? Thank you.

Hunter Harrison (President and CEO)

Well, you know, Tom, I don't want to get ahead of myself. I'm sure the people here, you know, they've had potentially a different set of strategies, given what they had to work with. You know, the operating group's challenge is to present velocity and speed and customer requirements to the marketing sales group. And then given how well that service can apply to the market, then it spreads team's job then to design the service to take that to the market. And I think the better product, raw product, that Cindy and team can produce, the more successful and more latitude it will give Fred and company.

So I think that, you know, I think the competition, we're gonna get bigger in the rearview mirror, and they're gonna be looking at the rear, and we're gonna be passing them on the left.

Tom Wadewitz (Managing Director and Senior Equity Research Analyst)

Okay, great. Thank you for the time, Hunter. Appreciate it.

Hunter Harrison (President and CEO)

Yes.

Operator (participant)

Thank you. Our next question comes from Allison Landry with Credit Suisse. You may ask your question.

Speaker 23

Good morning. Thanks for taking my question. Hunter, you know, Chicago has always been at the forefront of your mind, and historically, you've made comments that CSX used the Chicago Belt and perhaps the Indiana Belt for switching more than any of the other rails. So now that you're, you know, in arguably a much better seat to affect change, do you, you know, do you have any plans to fix Chicago? And if so, could you provide some context surrounding that?

Hunter Harrison (President and CEO)

I don't know that I'm equipped to fix Chicago, and Chicago is a special, special issue. If you noticed in a lot of our, what we've discussed and talked about, it hadn't included Chicago, because Chicago, we have effectively carved out and are taking a different, special type of look at. Chicago has some real challenges to this old North American infrastructure. Chicago cannot survive as it's headed today. You've got, you've got lawsuits now with eminent domain, taking, wanting to take rail infrastructure up to replace it with tollway. You got it right beside O'Hare, okay? Everybody wants to grow, they want to grow in Chicago, and it's not gonna work. Now, the plus for us is this: we own a lot of assets in Chicago, and we can be a more significant player than in positions I've been in the past.

Yes.

Operator (participant)

Thank you. Our next question comes from Amit Mehrotra with Deutsche Bank. You may ask your question.

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Okay. Thank you. Good morning. Thanks for taking the question. The first one is just on the operating expectations for this year. It looks like the OR target of the mid-60s implies around, you know, $800 million of year-on-year profit improvement. It just seems, by our estimate at least, that only about $300 million of that will come from, you know, revenue growth and improved fixed cost absorption, which leaves about, call it somewhere close to $500 million of absolute reduction in the cost base. So first of all, is that the type of cost takeout that you, Hunter, and the team are targeting to realize this year?

Just for our own—my own edification, you know, how does one achieve sort of $500 million of cost takeout without maybe driving a significant amount of disruption, at least in the near term? Thank you.

Frank Lonegro (CFO)

Amit, let me... It's Frank. Let me take that one first and then turn it over to Hunter for additional commentary. In the targets that we gave you, one of the things that we mentioned was record productivity. Embedded within that is obviously, the prior record of $427 million in 2016. So clearly, you can have, your own estimate in terms of how much we will exceed that by. We're off to a very good start in terms of the $123 million, of efficiency. I think from just a line item perspective, other than fuel, you should expect us to continue to drive costs out across the board in terms of, you know, the various items there.

When you look at better service, you look at better productivity, you look at the ability to absorb volume with literally no additional cost associated with that, you get huge flow-through from whatever your expectations are on the revenue side. So we're kicking on all cylinders here in terms of the volume side, the pricing side, and the efficiency side. So that's what gave us the confidence to put out the targets that we did this morning. Hunter?

Hunter Harrison (President and CEO)

Yeah, I mean, I'd only add one example that, you know, if you want to look at hard numbers to see how you might achieve that. You know, prior to my arrival, this group had already taken on some initiatives to take 1,000 positions out of this organization. Now, those 1,000 positions were a lot of them were voluntary, and there was a severance program. And those were all, I think, if I'm accurate here, those were all management positions. That has not touched any of the people on the ground. We have put in place a hiring freeze. We're going to utilize the people internally we have. We're very sensitive to your comments of disruption and of morale, and we have attrition that is a little higher than normal.

And so I think, you know, if you had to kind of put a number on it, and I hadn't gotten to that kind of level yet, but I think the potential is there that sometime around the first of the year, by then, you know, there'll probably be a similar number taken out also. Now, it doesn't take many of those to take some real cost out without impacting the service or safety or anything else. These are just the different ways of doing things. We're bringing some jobs home. We have, I don't know, about 250 or 300 employees in India. Well, we're bringing those jobs back here. So there'll be some losses in jobs, but I'm really, to be honest with you, I can't worry about India right now.

I'm more worried about CSX and Jacksonville and made in America. So there's a lot of opportunity, and I don't think it's a stretch to say if we do the job that we have the ability to do, that we can achieve all these things that we've talked about.

Frank Lonegro (CFO)

I'll make one other point on the folks in India. They're contractors, not employees, but obviously, we're going to in-source that work and really look to absorb that with the existing workforce. I know Cindy also had some points she wanted to make here.

Cindy Sanborn (COO)

Yeah, I'll just put it in a couple of broad categories as I think about it. You know, Hunter mentioned the reduction in management that took place last month. I think as you think about the hump yard conversions and so forth, those types of actions I would call core operations, and we expect to do more of that. Volume absorption, we are seeing our outlook with a higher level of volume for us to move, and we think we can absorb that more efficiently than putting resources back one for one.

And then I would also say, you know, some of the looking back at some of the improvements that were made at other railroads as Hunter has arrived, I'd call it network efficiency, cars on line, velocity, dwell, those types of things, we think we'll see improvements there. So I would call that just network efficiencies going forward. And when you put all that together, that's what's given us our confidence, to move forward with a, with another record year.

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Right. Well, thanks for all that. Let me just ask one follow-up, if I could. Frank, on, on your, you know, comments about productivity, you know, maybe I'm thinking about it incorrectly, but I feel like productivity is different than absolute reduction in the cost structure. Because productivity is, in my view, the way I understand it, you're optimizing the cost structure to maximize the incrementals, maybe, minimize the decrementals, but it doesn't necessarily mean the, the cost structure is, is declining. So you guys achieved 72% incremental operating margins in the quarter, which is unbelievably great. Is there a way to understand or help us in terms of what, what, what was that with actually fixed cost absorption? What was that actually absolute reduction in the cost structure?

Frank Lonegro (CFO)

So when we think about productivity and how we, I'll say, keep score internally, you know, we do look for structural cost reduction. So a big part of that record productivity is structural cost reductions, meaning each line item in the expenses is going to get lower. Again, I'm excluding fuel, just given the price environment that we're in, but we are focused on fuel efficiency, as well. I think what you'll see from an incremental margin perspective, we're off to a very good start with about 72% incrementals, for the first quarter.

When you understand what we're trying to do on the cost side and you understand what the volume outlook looks like, I would estimate that the incremental margins will actually improve throughout the year, which is going to give you the bottom line flow through of the revenue that we're bringing on.

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

That's great. Hunter, one last one for me, if I could. Can you just comment on your relationship with the union so far? I mean, the company has over 20,000 union employees. Can you just talk about those initial meetings and conversations and, you know, just in the context of all the operational changes to come? That's it for me. Thank you.

Hunter Harrison (President and CEO)

Well, you know, I hope it's pretty good. I have, I, I've worked, you know, most of my career, the first four years, alongside of these various roads that now make up CSX. I know some of the leadership. I've had some... Let me be careful what I say here. I've had some, some very fascinating conversations, exploring opportunities with those, individuals. Now, look, it, it is, it's not real common for a new CEO to come in, and I don't care what your last name is, and the labor leaders to, to be bringing in a brass band and red carpet welcoming you to town. That's just not their style, and I recognize and understand that.

But at the same time, I think, for example, to be approached, unofficially at least, to conversations about potentially doing something like an hourly agreement that's, that's been extended and that is now part of the, U.S. system on the, now the Canadian National that we developed, is, is very encouraging to say that we would even enter a dialogue like that. And one of the things, the beauty of that would be a, a couple of things that, that, that people should think about. One, those agreements, guarantee people position. That's important today, people that, that can have a job and have a job guarantee. You know, that's, that's very important in people. And at the same time, for us, it lowers our, potentially our T&E, training and human costs.... 30%-35%.

So, you know, look, we're gonna have, we're gonna have some, some squabbles. You know, they don't like to see their people disrupted, nor do I, but you gotta do what you gotta do sometimes. And, and so there'll be some, I'm sure there'll be some negative comments, that all I care about is the bottom line or profit or what, but I hope that's not true. We're very sensitive to the employees and the part they play in this. And, so I think we'll do, I think we'll do fine with them at the end of the day.

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Okay. Thank you for answering my questions. Appreciate it.

Operator (participant)

Thank you. Our next question comes from Ravi Shanker with Morgan Stanley. You may ask your question.

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Thanks. Morning, everyone. Hunter, just to summarize or tie up everything you've said in the call so far, in terms of playbooks, the Precision Railroading playbook that you've so effectively deployed several times before at other railroads, do you think that's kind of directly applicable to CSX here? Or do you think the complexity of the network here involves changes to the way it's been done before? And also, CSX has, in recent years, had a playbook of de-emphasizing coal and becoming more of an intermodal rail. Do you agree with that, and do you think that kind of becomes part of your playbook as well?

Hunter Harrison (President and CEO)

Well, you know, number one, the question, yes, but, you know, look, I think one of the things that people miss is the more complexity there is to the network, the better model you can apply to it, you can take it more advantage of the opportunity. If you just got a linear straight line railroad that goes from A to B, a lot of people can design a model for that. So yeah, this has certainly those implications. Now, you know, strategically going down the line as so far as... Look, I think the, you know, if you're looking 3 years out or 5 years out or 10 years out, it's a lot different.

You know, look, we need to understand that the world is gonna continue to change up, and we need to be flexible and to have a plan that allows us to change with those changes, okay? And we got things going on as we speak, okay? From an energy standpoint, what's the future of fossil fuel? What's the future of crude? How, how much influence are the environmentalists are gonna have? What's the net gonna do with the waste freight? You go out here in Jacksonville, you drive by this huge warehouse of Amazon, and so the supply chain is gonna change. And we have to be. It's not gonna be some of the game that I've played before, the traditional intermodal, coal, merchandise. We have to be more flexible and more creative to be able to deal with those changes in the world.

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Yeah, and-

Operator (participant)

Go ahead, Hunter.

Fredrik Eliasson (CMO)

To echo on Hunter's point, I mean, we haven't de-emphasized coal at CSX. Coal has been de-emphasized by the utilities, and so we want as much business as we can, whether it's coal, intermodal, or anything else, but we will deploy our strategies where we can capture the growth and create bottom-line value for CSX through excellent service for our customers.

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Got it. And in your vision of intermodal, is this largely... I know you spoke about service initiatives a little earlier on the call, but is it largely a case of improving the service levels and getting to a point where it becomes super competitive versus truck, or are you looking for more demand improvement from macro or kind of being able to take price in segments? So between service and demand and price, kind of which do you think is the most important lever for intermodal?

Hunter Harrison (President and CEO)

I don't know that you're, look, the market would have you believe to begin with, that it's price, okay? We are not gonna sit here and let our precious service become a commodity. And so the better we create in service velocity, and, and I would hasten to add this: you know, when just in time and intermodal got real hot, if you look back and do a little history lesson, you'd see that Prime then was knocking on 20%. The interest rates aren't there today. You let interest rates, and they're going back up. I forget that, okay? I just can't tell you when, but they're going back up. And when they do, people that move merchandise will be rewarded because carrying costs are gonna go up. The beauty is this: the quicker we move it, the cheaper it is.

And so it grows on itself, and so we turn the equipment quicker, we give better service to the customer, and we got lower costs, and then we can be more competitive. And it all fits in this model.

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Very good. Thank you.

Operator (participant)

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

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Great, good morning. Hunter, you sound well. Look forward to your tenure at, at CSX. You noted you're gonna be an advocate, for customers in, in your intro remarks. Is, is that a change in, in how you're gonna attack the plan? I mean, after you've left, obviously, we heard Keith talk about fixing ruffled feathers and, and Claude launch a, a customer focus. So sounds like you may, may start this with a little bit of a different tack. Maybe you can just talk about that a bit.

Hunter Harrison (President and CEO)

Well, I'm gonna talk to Claude and Keith later on today, okay? We'll mentor them a little bit, okay? But look, I have my whole career, okay? In fact, one of the reasons why I'm sitting here was I happened to be an operating guy that thought we ought to provide good service to the customer, okay? I got a little bad reputation in Canada because I asked people to pay their bills, and that wasn't the thing to do in the Crown Corporation. But look, there's no one more sensitive than I am, and more appreciative than I am, of the business that our customers give. Okay?

I am the greatest advocate in the world, and I wish you could sit in some of our meetings when we talk about service and when we talk about car delays, because that's not just about car delays, it's about creating pain and suffering for a customer, which I don't want to see created, okay? And I can't get anybody to give me one example of a customer, except during a turnover period, just where we're going through a transition, that's had any problem or issues from a systemic standpoint that says we got service problems. Okay. It doesn't exist, okay? So I'm gonna do a little coaching to a couple of my former sidekicks and see what their comments are. And I can anticipate right now the response. Misquoted.

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Let me just revisit something you talked about on the unions, because the U.S., it seems like historically have been a little bit different, right, in terms of all the rails kind of negotiating in one team against kind of all the unions in one group. You've always had things maybe a little bit differently in Canada. Can you, is that something you think you need to shift how you address that as you move forward?

Hunter Harrison (President and CEO)

Well, I think it's something we're gonna look at. If you look back at, you know, the parts of when I was at the Canadian National, parts of the U.S. operation that we had and when we had the Illinois Central, we were not part of, quote, "national handling." So we negotiated our labor agreements on our own. And that's not to say that we're gonna do that now. It's we're gonna have some dialogue. It appears to me, and I hadn't had a chance to visit with some of my colleagues about this, but it appears to me that some of the Big Six, if you will, or seven Class Is, see the world a little differently.

If they start to see the world differently, and they're not all on one page, I'm not so sure that it makes a lot of sense to have this one big carriers conference negotiating force. You know, I would much prefer, I think, us to sit down with our employees and do what's the best for CSX organization and CSX employees. So I think that all those things that deal with policies and coalitions and all, we'll take a look at it and see how others see the world and how we see it going forward, and what's the most appropriate action for us to take.

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Thanks, Hunter. Look forward to your working with your team at CSX. Appreciate the insight.

Hunter Harrison (President and CEO)

Thanks, buddy.

Operator (participant)

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

Brandon Oglenski (Director and Senior Equity Analyst)

Yeah, good morning, and thanks for taking my question. And, Hunter, definitely welcome back. I know there's a lot of investors excited to see you back in the seat, too.

Hunter Harrison (President and CEO)

Thanks, bud.

Brandon Oglenski (Director and Senior Equity Analyst)

So, you know, surprisingly, though, it just keeps coming back. We hear it a lot, that length of haul and the shorter length of haul on the East Coast just means that the return on invested capital or the margin potential is not as high as some of your predecessor railroads or, or some of the stuff going out, out west in the U.S. Can you just talk to that dynamic and whether or not you think, you know, length of haul plays a lot of determination in the ultimate profitability of the network?

Hunter Harrison (President and CEO)

Well, you know, longer length of haul is better than short, but if you only have short, you gotta deal with short. The markets are the markets. You know, we don't get a chance to make the market. I know this: the more productive we are, the better we are at, quote, "controlling costs," not cutting and slashing. The operative word is controlling costs, okay? Will put us in a position that says... You know, people used to say, "If you weren't hauling intermodal 800 miles plus, you couldn't make a buck." Well, that's not true. If your operating ratio is 90%, it's true. If your operating ratio is 58%, it's wrong. So, you know, it's, you know, I don't really focus necessarily on the long and the short.

It's the bottom line margin that we can make out of all the business, you know, and I don't think we set the price out there. The market sets the price. We decide whether we want to play it or not. And if we keep ourselves competitive with the market, we'll do fine, both with long and short haul.

Brandon Oglenski (Director and Senior Equity Analyst)

And if I could follow up, kind of, off of that question, maybe, you know, what Ken was asking as well. Just, you know, there's some fear that as you go through these operational changes and focus more on service, that maybe some of your customers are disrupted from the way business was done in the past. Is there potential here that you see some share shift as you go through this transition period? Or do you think, as service improves, you could actually improve top line at the same time?

Hunter Harrison (President and CEO)

Yeah, that's the, that's the story. You know, that's why you provide good service selfishly, okay? You know, it starts with your product. If you don't have a product, you don't have anything. So we start with a product, and the better we make that product, the more we can extract in value out of it, both in market share and what I refer to as quality of revenue... So, you know, this is not a one side of the ledger game. This is revenue up and costs down, and investors get rewarded, and it's fun. Okay?

Brandon Oglenski (Director and Senior Equity Analyst)

Well, we look forward to it, Hunter. Thank you.

Hunter Harrison (President and CEO)

Thanks, buddy.

Operator (participant)

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

Scott Group (Managing Director and Senior Analyst)

Hey, thanks. Morning, everyone.

Hunter Harrison (President and CEO)

Morning, Scott.

Scott Group (Managing Director and Senior Analyst)

So maybe, Fredrik, can you isolate the strength in export pricing from the mixed benefit of losing the short-haul business? I'm just trying to understand which had a bigger impact on coal yields in the quarter. And then can you just kind of confirm if the guidance for the year assumes kind of export pricing stays where it is, or that it does come down in the back half of the year? And then bigger picture on coal, maybe for you, Hunter. I mean, we can see this quarter how profitable the coal franchise is. You know, if we kind of assume that coal resumes its secular decline in the next couple of years, do you think that maybe could impact the ability to get to a sub-60 OR in a couple of years?

Fredrik Eliasson (CMO)

So, so let me take your first part of your question first. I would say that the majority of the coal RPU change was favorable mix. We have favorable mix, on one hand, that some of that short-haul traffic obviously went away, which was, you know, short haul and, and marginal. But also we saw more replenishment of utilities in the South versus last year, where, if you recall, natural gas prices were tremendously low for a period of time. And then also on the export side, we saw additional traffic going into Virginia, which is generally a little bit of a for export pier there, that is a little bit longer length of haul. So we, we had a couple of things that was favorable from a, from a mix perspective, that certainly helped.

So that was the majority of the driver that we saw. Then I'll turn the question about the coal franchise to Hunter.

Hunter Harrison (President and CEO)

Look, my numbers, my analysis, as a short-timer, it doesn't include some big rebound with coal. If coal comes back stronger than anticipated, it's gravy. Will it change any of these numbers? I don't think so. If you look at the last story, we had the same thing, except it was crude oil. Then can you still get to the numbers? Well, I think that group has done an excellent job, and they continue to do it. They, I think they bounded through 60, and I don't know what their last quarter was, but it started with a five, and it was 58. So I... No, I don't think that, you know, I've said longer term, they almost ran me out of Western Canada, that, you know, that fossil fuels are dead in my view.

I said it, and I can't retract it. I just think longer term, coal is not something that, that rails should depend on. Now, it's going to take a while to transition out. It's not going to happen overnight. And, you know, we might see another 10, 15 years, but longer term, I don't think that fuel, I mean, coal, is going to be the, the energy source of the future.

Scott Group (Managing Director and Senior Analyst)

Okay. And just that, that part about coal pricing assumed in the guidance in the back half?

Fredrik Eliasson (CMO)

Well, overall, you know, we saw on the export side that we follow the indexes that are out there, a variety of them. And as you can see in the forward curve, currently, that is coming down as we move through the second half of the year, and that's certainly then our expectations as well. But we'll ultimately see where the market ends up.

Scott Group (Managing Director and Senior Analyst)

Okay, thanks. And then just, Hunter, since this is your first call, just a couple of things that want to address. You know, there's some people that presume that ultimately M&A is part of the strategy, and maybe you can talk about that. And then also in some of your past rails, you've brought some people on in terms of the team. Should we be expecting something similar here?

Hunter Harrison (President and CEO)

Well, look, I don't know what I can say, I'll, but I would emphasize and emphasize this, okay? M&A has nothing to do with the strategy of me being here at all, okay? And one thing I take great pride in is my integrity, okay? And I'm telling you, there's no such plan. Even if... I don't have time, you know? Look, I got four years. It's not going to happen in my tenure to have anything to do with me. Number two, my MO is, I like to play with the hand I'm dealt. Okay? And we got a good hand here. Now, do we have a couple of missing cards in a 52-card deck? Maybe.

But we're looking internally, and in fact, I was here late last night talking about some people and going through, and I'm not sure that we have, that we've taken advantage of all the internal talent, that we have here. But if we hit a void, that we have a void here that we need, then we can—we always have the ability to go externally. Is there anybody who wants to come to work for us? The list is long, okay? And we don't have any restrictions about who can leave, and you can't go here, you can't go there. You know, we're a free agent, okay? So if people don't want to work here, they can leave, okay? In fact, if they want to go to some other railroad, let them go, okay? But, but we've got-...

We will not have a shortage of talent or resources to be able to operate this railroad like we've described.

Scott Group (Managing Director and Senior Analyst)

Okay. Thank you.

Operator (participant)

Thank you. Our next question comes from Jeff Kauffman with Aegis Capital. Your line is open. Go ahead and ask your question.

Speaker 21

Thank you very much. Welcome back, Hunter. Good to have you back, Hunter. You know, my question's been asked six ways to Sunday, how CSX differs from some other rails you've been at. But what I'd like to know is, at CP, there needed to be a capital investment in sidings and some other portions of the rail to achieve the things you wanted to achieve. At CN, it was a different investment. Can you talk a little bit, not so much about multiple yards, 'cause we've been built through acquisition, but talk about the capital plan at CSX, and is there investment that needs to occur for what you need to do and kind of how we think about that strategically?

Hunter Harrison (President and CEO)

Well, you know, overall, just to look at it as, without starting to break it down, I think it's clear to me that the capital investment will come down over time. There's been a good deal spent, the last few years, if I look again at the graph. If you take a look at, just what's been spent the last few years on locomotives, and you say, we're not going to have to do that for a while. We've got 550-600 locomotives stored, and I can know one of our previous experiences there, that we went through similar numbers, and we said, "Well, maybe we can take a couple year holiday for locomotives." And we did, and I think they're on their fifth year holiday.

So if you say, "Well, we don't have to spend anything on locomotives generally, for 4 or 5 years," clearly, a lot of the replacements that were an issue with the hump yards are not there. Clearly, if we have sidings that are too short for the longer trains, we're certainly not going to leave those sitting in the ground and not being utilized. But we'll pick up one 6,500-foot siding and pull it 15 miles down the railroad and put it with another 6,500, and that'll... We got a 13,000-foot siding, and the only thing we've capitalized is effectively the labor. You don't have to capitalize the rail but once, and so there's some ways to save capital.

Another issue that people overlook is this: the better productivity you have with capital, the more you can put in. The higher productive you are, you take $100, and you put in more ties with $100 being productive. So there's a productivity factor to the capital. So I think, Jeff, overall, you know, I'm not... I'm a little embarrassed that the numbers don't jump, but I think my numbers were that over the 3- or 4-year period, we can see $500 million-$600 million reductions in the capital spend. And then there will be a point where it'll, you know, where it'll potentially trend back up, and if we don't have something else, like PTC, come along with all the brilliance in Washington to help us with our capital spend.

And I'm not a big, I'm not a big advocate of some percent of revenue. You know, I wish it worked that way. It doesn't. When ties wear out, ties wear out, whether whatever the revenue is. But I think overall, to answer your question, there will be some positives for free cash flow out of the reduction in capital.

Speaker 21

Okay. Well, Hunter, thank you for your answer, and best of luck to you all at CSX. Thank you.

Hunter Harrison (President and CEO)

Thanks, Jeff.

Operator (participant)

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

David Vernon (Managing Director and Senior Analyst)

Hey, good morning. Hunter, maybe just a quick question for you on the presence of the Shared Assets Areas, the old legacy of the Conrail acquisition. Does that sort of joint operations in some of those bigger eastern metros create any challenges or opportunities for you, when you think about implementing that Precision Railroading model into the CSX?

Hunter Harrison (President and CEO)

You know what? I'm going to have to defer to Cindy there. I don't, I have not spent, in my first 30 days, a lot of time in that area, and, and I'm limited on my knowledge there, and, I don't want to try to baffle you with a story that I don't know a lot about. So Cindy, if you've got any comments there?

Cindy Sanborn (COO)

Yeah, David, I think, we're always looking for efficiencies where we hand off cars, whether it's to the jointly owned facility known as Conrail or IHB in Chicago. There's nothing that really jumps off the page, but, you know, as we've said many, many times, you know, everything's on the table, and if we can find opportunities, we will certainly take advantage of them.

David Vernon (Managing Director and Senior Analyst)

But do you think there are any sort of constraints because you're tied to a schedule that maybe the Conrail is serving for that meets both your and CSX and Norfolk's needs, and it's harder to change, or is that something that's probably not an issue?

Cindy Sanborn (COO)

That's really not an issue. It's in all of our best interests to serve our customer better, and they just simply supply the last mile of service and do a very good job of it. We work very closely together on making sure that's efficient and effective for our customers.

David Vernon (Managing Director and Senior Analyst)

Okay. And Fredrik, maybe just as a quick follow-up, when we look at the same-store sales pricing, I hear your comments on mix in coal, and I think what I've heard is we should expect that to continue to happen. But I think in the intermodal and merchandise, the deceleration and the core price, is that something that we should also expect to kind of happen here, or are we starting to see some signs of improvement in that domestic intermodal market that would help kind of shore up that number?

Fredrik Eliasson (CMO)

Well, yeah, just to clarify also, and I'm not sure that's where you were going with your question. The mix is obviously out of the same-store sale number, which is why we're doing it. Second, once again, we don't forecast price, but I think it's clear that we've been in a place over the last few years where there's been a fair amount of excess capacity in the marketplace, and all our customers, as Hunter alluded to before, have alternatives, so we got to price to market.

The key thing is, as I look forward now, between what I think you guys write a lot about, which is that there's a structural change coming afoot in the truckload market with some of the ELD implementations and the shortage of drivers, and hopefully getting to better place from a capacity perspective. And a couple of that, we were doing with this operating model, where I already see a significantly improved service. I think there's an opportunity as we move into 2018 to really capitalize on that. So, we feel good about where we are. We re-price to market each and every day, and as we move forward, we will do the same.

David Vernon (Managing Director and Senior Analyst)

But then as we think about where we are right now, are we starting to see things kind of improve sequentially, or are we still kind of in a soft patch on the domestic market?

Fredrik Eliasson (CMO)

You know, I see some opportunities on the spot market side that I follow closely, where things seems to be moving in the right direction. I do think that obviously, if you see some of the and you follow this more than I do, on the trucking side, that there's some challenges out there. But I see that, you know, the light is coming closer at the end of the tunnel, and supply and demand should be getting to better place as we move through the second half of the year and into 2018.

David Vernon (Managing Director and Senior Analyst)

All right. Thanks very much for the time, guys.

Fredrik Eliasson (CMO)

Thanks.

Operator (participant)

Thank you. This question comes from Bascome Majors with Susquehanna Financial Group. Your line is open, you may ask your question.

Bascome Majors (Managing Director and Senior Industrials Equity Research Analyst)

Yeah, thanks for fitting me in here. Just real quickly on the attrition rate, can you guys help quantify that for us, whether in percentage terms or, or the number of people per year?

Hunter Harrison (President and CEO)

You know, I think they were working on some numbers for me. Let me clarify something that I'm trying to... We all have kind of semantically different type of explanations for. I'm talking about contractors, consultants, employees, all of the above, everybody that gets a check, okay? I think, and I'll correct this if I'm wrong, that the attrition is going to come in at about 9% level range, 8.5%-9%. So if you look at those numbers as opposed to where we are, gives you some kind of order of magnitude of what we can absorb without adversely affecting people.

Bascome Majors (Managing Director and Senior Industrials Equity Research Analyst)

Yep. Thank you for that. And Hunter, as we take a step back, if you look, you know, recently, at least, management incentives have been based in the short term on operating income and in the longer term on a mix of ROA. And as you and the reconstituted board look at the outcomes you want to drive over the next four years, you know, is there a change to that coming? You know, how do you want to incentivize the senior management team to accomplish what you want to accomplish?

Hunter Harrison (President and CEO)

Well, yeah, I think that clearly, look, we, I am not obsessed, for example, with operating ratio, okay? The more I try to get away from it, the more people push me back in the middle of it. I mean, clearly, there's some, there are issues that are returned on, you name it, capital, equity, debt, whatever. There are more mature ways over a longer time frame to... Look, the problem gets to be is to incorporate it into your yearly, daily operation and make the conversion, because there's a lag period that you go through. I think a lot of businesses, and I think we are a little bit, that we have to address, is this: we've got our compensation system so complex that employees don't understand it, then you've gone too far.

But I think that that's something that the board talked about this week. The compensation committee discussed it, and I think it's something that we want to be sure that we're motivating the right behavior with employees of, you know, return effectively on capital. You know, one of the rules of this model is this: don't spend one dollar in precious capital until you've looked and explored every operating alternative. And so I think there's going to be, you know, a push that way more and more for return numbers rather than just raw margins or operating ratios.

And to that point... I'm sorry.

Frank Lonegro (CFO)

For one second. On the, you had talked about the long term being ROA. ROA is half of it, and operating ratio is the other half. I just want to make sure you knew both of them.

Bascome Majors (Managing Director and Senior Industrials Equity Research Analyst)

Yeah, appreciate it. Is, is there a possibility for a free cash flow component? Is that something you guys are considering?

Fredrik Eliasson (CMO)

Yeah, free cash flow works. I mean, in all of the above, it's how you, you know, it's how you weigh those factors, you know, and if you do those things in a mature manner. Every one of them has got some downside to them. You know, you focus this year on free cash flow, and you make some immature decisions to make some artificial goal, which kills you next year. You know, so it really takes a mature approach from management, and sometimes that's hard to put together.

Certainly, a focus on cash is important, as you saw in the quarterly financial report we put out last night and the guidance we put out. I mean, we're certainly being transparent in terms of free cash flow and how we're calculating it and what the goals are for the year. That's a new thing for us.

Bascome Majors (Managing Director and Senior Industrials Equity Research Analyst)

Hunter and Frank, thank you for the color here.

Hunter Harrison (President and CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from Jason Seidl with Cowen and Company. You may ask your question.

Jason Seidl (Managing Director)

Thank you, operator. Hunter, welcome back. Everyone else, hello. A couple quick things. Hunter, when looking at intermodal, you know, clearly, it's an opportunity in the east. In your eyes, what's the most important piece of intermodal and how to get it more profitable for the railroad?

Hunter Harrison (President and CEO)

Well, I mean, clearly, you know, it's pretty simple formula. Cindy talked about it this morning. You know, the longer the train, the fewer the train starts, the lower the cost, the better we can be in the terminals, and the service factor, that's all you have to do. You know, get the trailer, get the container, get it on a train, get it to its destination, and get it on the ground and have it available for the customer. And, you know, it's not so much, you know, if you do the job right, and this organization is doing a pretty good job there.

I mean, I look at some of our numbers that I'm learning, and with our domestic business, we're like, up in the mid higher nineties, which is, you know, pretty admirable with pretty demanding customers, as they should be demanding, like UPS. I mean, UPS, just all they want you to do is right what we say in the model. Just do what you say you're going to do. You say you're going to be here third morning at by X, be here. And if you do that, okay, it's not - sometimes we make these things too complex. It's just simply get it, move it, and do what you say you're going to do, and be efficient with it.

And, you know, are we looking at some fine-tuning that we can do a little bit here, a little bit there, continually, but I think we're going to do fine there. We're going to get even better there, but... And then we'll, at the same time, take advantage of this merchandise network.

Jason Seidl (Managing Director)

Hunter, is the offering as big as it needs to be? Is there any investment beyond the typical investment that goes and needs to be made at intermodal?

Hunter Harrison (President and CEO)

Well, I mean, Frank can, I mean, Fred can probably and Frank can speak to that better than I can. I know that, look, I know this company is going to be in a much better position from a cash standpoint, that if we see the opportunities, we're ready to make whatever investments we need to take advantages of opportunities in the market out there.

Fredrik Eliasson (CMO)

Yeah, and we've talked about before that over time, in terms of the network itself, we're at, you know, 95% double stack clear, which is a critical component to driving efficiency. We are opening one new terminal in a white space that we that we felt was needed, which is in Pittsburgh, here, in July. And we are looking at longer-term terminals that we've announced out at the-- in Carolina, the CCX terminal we talked about. And we're also, to Hunter's point earlier, trying to see where there are opportunities to leverage existing facilities and perhaps combine things to create value that way. So, you know, Hunter's been a great supporter of our intermodal franchise and what we're trying to do.

The essence of Precision Railroading is about running a scheduled network at a high level of reliability, and that is what we have been doing, and we're going to do even more so going forward.

Jason Seidl (Managing Director)

All right, I'll get my follow-up. Hunter, I'd love to hear your opinions on CSX and the rest of the rail industry pushing towards one-man crews, and when do you see that as a viable option?

Hunter Harrison (President and CEO)

I'm not a one-man crew advocate. Now, there's special circumstances, there's different issues. I mean, clearly, if you're switching a rip track or you're switching a mine track, that's one track or something, there's applications that we have today for one person. But today, to take a 20,000-ton train on a line of road with one person, I don't think it's good business. Number one, I don't think that, and shame on us, but we don't have, in my view, the quality control to do it. So you got one person on the train, and you have an air hose failure or a drawbar, whatever, how is the one person going to deal with it? The delay to the customers, the domino effect and all that.

And then some of my cohorts tell me, "Well, you know, we're going to have people in trucks along the right of way with all these material with them, and they'll, they'll be dispatched to the train to help the engineer, the one-man crew." And I said, "Well, it's not one man, then. It's one point, whatever it is." Particularly today, with where rail is relative to safety issues and the whole issue of common carrier obligation, you know, I just don't think that it's something that we're focusing on. If you look at the payload, you know, and people will shudder when I say this from my peers with labor leaders.

If you look at the cost of the other person on that train that's got a revenue and a payload of X, it's relatively a drop in the bucket to the value that that person can bring as an additional eyes and ears. And you can't watch both sides of the train. I'm just we've got a lot of other things in the ABCs that we need to get better at before we start talking about one-man crews. And I guess before it's over with, that we'll have we'll be running an electric train with nobody up there, with somebody with a rheostat somewhere running it. I don't know how we're going to get to minus, but somebody will figure it out before we're told.

Well, listen, Hunter, I appreciate the thoughts as always. Thank you for your time.

Operator (participant)

Thank you. Our next question comes from Ben Hartford with Baird. You may ask your question.

Ben Hartford (Senior Equity Research Analyst)

Yeah, thanks for fitting me in. Hunter, I'm just curious about your—we've talked a lot about intermodal on the call, but curious about your go-to-market perspective on that. The focus has been on the operational side and improving service and efficiency for the customers. But as you think about being innovative and creative and flexible, as you see CSX's IMC partnerships, do you see opportunities to expand into new partnerships with new IMCs or even kind of go more direct-to-market on the intermodal side as you think about a marketing strategy? Do you have any perspective on that? Thanks.

Hunter Harrison (President and CEO)

You know, under certain circumstances, I think they all work. You know, I think there's a lot of things that we can do intermodally that, that for whatever reason, some have tried before and they've kind of gotten away from it. But I'm a big advocate of day-of-the-week pricing. One of the things that you have to do in our model, that you'll hear a lot about, is balance. And when you look at a graph, you know, of intermodal trains and it's down kind of to the bottom on Monday, and it peaks on Thursday night, and then it sinks down on Sunday, it's just money that's being wasted. And I, you know, I tried one experiment, you know, and you listen to the market and you listen and you hear service, service, service, service, service, service, service.

And so we said, "Well, you know, we, we're having to run 3 trains on Friday night, so maybe we can discount on Saturday and Sunday to move some of that business from Friday to Saturday and Sunday." And so we discounted 15% and 20%. Guess how many people came Friday? Nobody. Everybody went Saturday and Sunday. So you start to find out what the real market is out there. So there's a lot of creative things I can see today, you know, that we're going to have dispatchers sitting there at 2:00 P.M. selling the slots. Saying, "I got 8 slots left that, that are going to be open unless..." And they're going to, you know, discount. I, I see that my personal view is we'll see a day where, you know, there, there won't be quote, contracts, as such, as we think about it.

There'll be tariffs, but they'll be shorter, even in length. And so I think there's a lot of things to do, the way we compensate sales people, for example. And a lot of things that rail can do that we've kind of been a little stuck in the mud with, that we can be much more creative to supplement the standard intermodal product.

Well, Frank spent a lot of time this week with the board and the finance committee, and I have, believe it or not, tried to back up from that discussion and be a little more operating focused. So let me let Frank help you there.

Frank Lonegro (CFO)

Yeah, we had a great discussion this week, and obviously, you heard us reiterate the BBB+ Baa1 today. You saw the size of the program for the next 12 months. Obviously, as we get more and more months and quarters under our belt, and we get an understanding of, you know, the free cash flow numbers, both for coming quarters and coming years, we'll take a hard look at whether or not we're deploying capital in the correct way to shareholders and in the correct amounts.

And, you know, we always look at the balance sheet and try to determine what the appropriate place is, given really the cyclicality of the business on the merchandise and intermodal side, as well as the capital intensity of the business and making sure we preserve, you know, the access to the marketplace that we need in tougher times. So we wanna stress test the numbers that we have internally to make sure if there is, in fact, a coal decline or any decline, that we can stomach that. So we think we're in pretty good shape. We put good numbers out for you in the quarter and the forward guidance, as well as the buyback and the dividend. So, right now we feel like we're in pretty good shape.

Hunter Harrison (President and CEO)

Yeah. I don't think our policy, you know, is gonna be any different than what, you know, you've been familiar with in the past. If you look at allocation of capital, the first call is gonna be always reinvestment in this railroad, and hopefully, we've got opportunities to make the appropriate returns there. If those don't present themselves, then we're gonna look at other ways, the most efficient ways, as Frank described, to return that cash to the owners, whether it's through buyback, dividends, combinations thereof. You know, we'll always be a little debated about what your structure is and what kind of funds you're managing and which customers want which, and...

But, I think the board yesterday had, or this, well, for two days, had committee meetings and board meetings, had a thorough discussion of our policies there, and there was a great deal of common understanding of directionally which way we need to go.

Walter Spracklin (Head of Canadian Research and Co-Head of Global Industrials Research)

Okay. This is the second question here is on the competitive response to your initiatives, both from a service standpoint, but also from a operating standpoint, as you get lower cost, your ability to more efficiently and at higher profitability, service your customers. And I'm just interested in what the competitive response might be that might cause problems for you, Hunter, in terms of what you're trying to achieve. I know you've always had a great view on pricing. You know, the pricing is what the market dictates, but often we hear when market share shifts, you know, they want it on price.

So is there a risk that a competitive response might come in and put problems on how you can affect change or make them a lot longer to achieve at the end of the day? Do you have any views on that?

Hunter Harrison (President and CEO)

Well, yeah, I, you know, I'd say they ought to be careful. You know, if that's, you know, the response. Look, I think this is a pretty simple response. As long as we provide the service we've talked about today, and we become, and we're gonna get there, the low-cost carrier, okay? We got the world by the tail. I don't know what they're gonna do in, in the way of response that is smart, that they can do to hurt us. Now, if the competitor's doing things stupid, that's good. Sometimes it's short-term pain, but I don't think that I see anything out there that says they're gonna have some different response than they had six months ago than what they're gonna have in the future, that's gonna set this organization back.

You know, we've got an agenda, we've got a wonderful customer base. We're gonna see some organic growth. I'm convinced we're gonna see some market share growth. I got to be a little patient there, but this is gonna come together, and I don't think a lot of what takes place is gonna be negatively impacted by the competition.

Walter Spracklin (Head of Canadian Research and Co-Head of Global Industrials Research)

Is there a view out there that it can be emulated, that some of your initiatives can just be copied and the efficiency you achieve can be followed by your competitors? Anything you'd respond to that with regards to what you're doing and the unique way you're doing it that will make it more difficult for the competition to copy you?

Hunter Harrison (President and CEO)

Nothing to buy the book. It's on eBay for $1,000. I think it's a bargain. Okay. It's not—it, we can't get it recopied. Some of the competition, I used to work for one of those. They got the copyrights to it, and they're sensitive about it. It's no secret, okay? It's one thing to write a playbook, okay? A lot of coaches can sit down and give you X and O, okay? The key is you got to have players that can execute, okay? If you don't have the players that can execute, you know, you can steal every playbook you want, okay? So I hope they do copy it, because if they copy it, I think they might be more efficient.

I look at other rails, generally speaking, much more as our partners, as our newer competitor, because we have so much airline business together. So we don't have... If there's any secrets to this, I missed them.

Walter Spracklin (Head of Canadian Research and Co-Head of Global Industrials Research)

Fair enough. Thanks very much.

Operator (participant)

Thank you. Our next question comes from Scott Schneeberger with Oppenheimer. You may ask your question.

Scott Schneeberger (Managing Director and Senior Analyst)

Thanks. Good morning. Yeah.

Hunter Harrison (President and CEO)

Good morning.

Scott Schneeberger (Managing Director and Senior Analyst)

Hunter, I was curious, just, your comment on taking 2-3 days out of the Chicago-Jacksonville route. Curious, what type of time it would take to do such a thing? And is that unique because of Chicago, or should we expect that more broadly, thanks?

Hunter Harrison (President and CEO)

Well, I think you'll expect it broadly if you look at the overall velocity. You know, I just used Chicago for an example, and how quick can you see it? You can see it overnight. I mean, we're starting to, you know, reschedule the railroad. I know that Cindy and company has gotten, I think, effectively Florida, pretty well reworked and done. And I think then I've been doing some looking westward towards New Orleans, and so we're going to kind of go up the line. We'll have what you have been used to before, with every car is going to have its own trip plan. One plan, you don't fail and get re-tripped and re-tripped and re-tripped. You got one plan. We're going to tell the customer it's going to be 83 hours door to door, and we're going to do it.

And, you know, one of the ways to do it is this, look, I... You know, we've, we've got a lot of good things going. We got some things we got to fix. Our train speed is not where it ought to be. Our merchandise train speed between terminals is like 18 miles an hour. We've got the potential to be at 27, 28. And you start taking numbers like that, and then you avoid terminals, and rather than drive into a terminal, and dwell for 26 hours, you can drive by that one and skip that 26 and pick up a little here, and you do the math. It doesn't take long, you get to Florida 2 or 3 days quicker, depending on where in Florida you're going.

That's just an order of magnitude that impacts both service and cost and asset turns and all that stuff that's good.

Scott Schneeberger (Managing Director and Senior Analyst)

Great, thanks. And then just, separately, with regard to this year's operating ratio guidance, what is the one big, the one big bucket item that you think could, could, where you could outperform, and then maybe a bucket item where you're most nervous, where you may underperform? Thanks.

Hunter Harrison (President and CEO)

Hunter Harrison (President and CEO)

Operator (participant)

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

CSX - Q1 2017

Transcript

Operator (participant)

David Baggs (VP, Treasurer and Investor Relations Officer)

Hunter Harrison (President and CEO)

Frank Lonegro (CFO)

Cindy Sanborn (COO)

Frank Lonegro (CFO)

Fredrik Eliasson (CMO)

Frank Lonegro (CFO)

Operator (participant)

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Fredrik Eliasson (CMO)

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Operator (participant)

Speaker 22

Hunter Harrison (President and CEO)

Speaker 22

Hunter Harrison (President and CEO)

Speaker 22

Hunter Harrison (President and CEO)

Operator (participant)

Tom Wadewitz (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Tom Wadewitz (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Tom Wadewitz (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Operator (participant)

Speaker 23

Hunter Harrison (President and CEO)

Speaker 23

Hunter Harrison (President and CEO)

Speaker 23

Hunter Harrison (President and CEO)

Speaker 23

Hunter Harrison (President and CEO)

Operator (participant)

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Frank Lonegro (CFO)

Hunter Harrison (President and CEO)

Frank Lonegro (CFO)

Cindy Sanborn (COO)

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Frank Lonegro (CFO)

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Amit Mehrotra (Managing Director and Senior Equity Research Analyst)

Operator (participant)

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Operator (participant)

Fredrik Eliasson (CMO)

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Ravi Shanker (Managing Director and Senior Equity Research Analyst)

Operator (participant)

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Ken Hoexter (Managing Director and Senior Equity Research Analyst)

Hunter Harrison (President and CEO)

Operator (participant)

Brandon Oglenski (Director and Senior Equity Analyst)

Hunter Harrison (President and CEO)

Brandon Oglenski (Director and Senior Equity Analyst)

Hunter Harrison (President and CEO)

Brandon Oglenski (Director and Senior Equity Analyst)

Hunter Harrison (President and CEO)

Brandon Oglenski (Director and Senior Equity Analyst)

Hunter Harrison (President and CEO)

Operator (participant)

Scott Group (Managing Director and Senior Analyst)

Hunter Harrison (President and CEO)