CSX Corp (CSX) — Q2 2018 Earnings Call Transcript

Thank you, Amber, and good afternoon, everyone. Today, I am joined by Jim Foote, Chief Executive Officer, and Frank Lonegro, Chief Financial Officer. On slide 2, you will find our forward-looking disclosure, followed by our non-GAAP disclosure on slide 3. It is my pleasure to introduce President and Chief Executive Officer, Jim Foote.

Thank you, Kevin. It's a pleasure to be with you this afternoon, and I appreciate everyone joining our call. To begin, our press release highlights record financial results. These achievements are a testament to the dedication of all CSX employees, who are genuinely enthusiastic about what we've accomplished. We'll take a moment to celebrate tonight, but it's back to work tomorrow as we continue to drive change and fully realize the potential of this company. Before moving to the slides, I'd like to touch on a couple of key initiatives. First, safety. We aim to be the safest railroad. In May, our new Chief Safety Officer, Jim Schwichtenberg, joined us. Schwichtenberg brings 20 years of railroad experience, nearly a decade with the FRA, and I’m confident he will introduce new strategies to enhance our safety performance. Additionally, we engaged DEKRA, a respected expert in safety improvement, to conduct a comprehensive safety assessment, and I expect to see positive changes as a result. The entire organization is committed to achieving excellence in safety. Secondly, we recently appointed Mark Wallace as Executive Vice President of Sales and Marketing. I have a long-standing relationship with Mark, and his leadership skills, along with more than 20 years of experience in scheduled railroading, will help our sales and marketing team work more effectively with customers and drive profitable growth. Diana Sorfleet will take over much of Mark's previous responsibilities as Executive Vice President and Chief Administrative Officer. As Chief Human Resources Officer at CSX, Diana has been instrumental in our transformation by fostering a more productive and engaged workforce. Her new role now includes technology and labor relations, offering a significant opportunity for us to further streamline our organization. Now, let’s move to slide 5 and look at our results; in two words, great performance. Similar to the first quarter, the numbers are straightforward. EPS increased by 58% to $1.01, compared to last year's adjusted EPS of $0.64. The lower tax rate and a reduced share count, down 6%, contributed significantly to the year-over-year increase. Our operating ratio improved by 490 basis points to a record 58.6%, compared to last year's adjusted ratio of 63.5%, marking the lowest ever for CSX and possibly the lowest for a U.S. railroad. The substantial improvement in our results is attributed to 6% top line growth, alongside price increases and reduced costs, except for fuel. Revenue grew by 6%, driven by price, fuel surcharges, supplemental revenues, and a 2% increase in volume contributing to positive growth this quarter. Consistent with recent trends, we observed slight improvements in pricing this quarter, excluding coal. Looking at the next slide on business segments, all were positively influenced by higher fuel prices. In chemicals, we saw strength in industrial products, plastics, and crude by rail, although partially countered by losses in fly ash that we discussed last quarter. The auto sector benefited from a 5% increase in North American U.S. light truck production. In Forest Products, lumber, panels, wallboard, and paper products all increased during the quarter. In metals, shipments of sheet steel and construction-related products drove growth. Revenues in fertilizers were lower mainly due to the closure of the Plant City facility last year. In the coal markets, export coal performed well this quarter, with healthy gains, while utility coal saw a decline. On the intermodal front, international markets drove growth, although domestic performance remained relatively flat year-over-year due to line rationalizations we implemented in the fall of 2017. Other revenue decreased by $58 million, primarily due to liquidated damages recorded last year that did not recur this year. Excluding that item, we saw gains in supplemental revenue, including demurrage. We are continuously working with customers to foster a more fluid network, particularly as we approach the fall peak season. On slide 7, let’s take a quick look at some of the key operating metrics that this team is focused on. Train velocity increased year-over-year and on a sequential basis. Terminal dwell saw an 11% year-over-year and 7% sequential improvement. While we drove improved velocity in dwell, train length increased on both a year-over-year basis, 13% and sequentially, 5%. Let me tell you, improving all three of these metrics at the same time is no easy task. Finally, car miles per day showed low double-digit improvement on both a year-over-year and sequential basis. This is a good measure of asset efficiency and our ability to effectively turn our assets. The improvements we saw in these metrics clearly translated into our financial results. Now, let me hand it off to Frank who will go through the financials in more detail as well as the benefits of these operating improvements.

Thank you, Jim, and good afternoon, everyone. Turning to slide 9, I will walk you through the summary income statement. Reported revenue increased by 6% in the second quarter, driven by a 2% increase in volume, higher fuel recoveries, and solid core pricing gains across all major markets. Same store sales pricing, reflecting year-over-year increases for stable traffic, improved sequentially in the second quarter. The pricing for merchandising and intermodal contracts renewed in the second quarter was strong, exceeding same store sales pricing growth. Other revenue declined year-over-year, but the benefit of higher demurrage and storage charges mostly offset the cycling of $58 million in liquidated damages from the previous year. We now expect other revenue to stay in the $130 million to $140 million range per quarter for the rest of the year. Moving to expenses, total operating expenses were down 8% in the second quarter or 2% lower after normalizing for last year's restructuring charge. Overall, labor and fringe savings of $82 million, or 11% year-over-year, were driven by an 11% reduction in average headcount, impacting both operating and G&A departments. Year-over-year improvements of 7% in velocity and 13% in train length drove more efficient use of our train crews and rolling stock. Even with 2% volume growth, train and engine employee road starts were down 9%, as were yard and local starts. The number of recruits, signaling network fluidity, dropped by 15%. In mechanical, the active locomotive count declined by 13%, reflecting our ability to keep over 600 locomotives in storage despite higher volumes. The smaller fleet, along with great car repair efficiencies, contributed to an 18% reduction in our mechanical craft workforce. We recently aligned the engineering function to match the regional structure we have for mechanical and transportation, which will yield further headcount and efficiency improvements. Our G&A headcount continues to decline, as we seek every opportunity to absorb attrition. Over the past year, we have removed unnecessary layers of management, leading to a structure that is cost-effective and facilitates rapid communication and decision-making. MS&O expenses were down 5% year-over-year. When comparing MS&O year-over-year, remember that we are cycling a $55 million gain from a favorable legal judgment in the second quarter of 2017. This year, results benefitted from $37 million of real estate gains as we continued to make progress in monetizing our surplus real estate portfolio. These gains align with our goal of achieving $300 million in cumulative real estate sales through 2020. Operationally, many key drivers of favorable labor expenses also resulted in savings in MS&O this quarter, as lower asset and resource levels reduced MS&O expenses. Savings from the smaller locomotive fleet were complemented by our decision to store less reliable units. Our decisions around storage, in addition to enhanced fleet reliability efforts, drove a 33% year-over-year improvement in our locomotive out of service measure and reduced costs related to materials and contracted services. Regarding non-labor costs associated with our train crews, lower road crew starts combined with improved network fluidity resulted in decreased costs. Additionally, MS&O is benefiting from our efforts to streamline contractors and consultants, particularly in technology. In line with prior guidance, we remain on track to reduce our total workforce by 2,000 resources by the end of 2018. For other expense items, depreciation increased slightly as the benefits of asset sales mostly offset the impact of capital investments. Yield expense rose mainly due to a 36% increase in the per-gallon price, although we were pleased to achieve record fuel efficiency this quarter. We will continue to seek additional fuel savings through improved network fluidity, increased train lengths, and the use of fuel optimization technologies. Higher equipment rents expense is primarily attributed to volume growth, although these increases were partially offset by improved car cycle times across most markets. Equity earnings improved due to better performance at our affiliates, along with a non-recurring benefit from an affiliate’s property sale during the quarter. Given this recent strong performance, we now anticipate core equity earnings from affiliates to range between $20 million and $25 million in Q3 and Q4. Finally, a reminder that we are cycling 2017's restructuring charges. Below the line, interest expense increased mainly due to the additional debt we issued earlier this year, partially offset by a lower weighted average coupon rate. Tax expense decreased year-over-year, despite higher pretax earnings, due to the advantages of the new lower corporate tax rate. Our effective tax rate was 23.3% this quarter, slightly below our prior guidance, mostly because of a one-time benefit from state legislative changes. Moving forward, we expect our effective rate to be around 24.5% for the second half of the year. Now, looking at the P&L, as Jim mentioned in his opening remarks, CSX achieved record operating income of nearly $1.3 billion and a record operating ratio of 58.6%. Turning to the cash side of the equation, year-to-date capital investments fell by 14%, keeping us on track to meet our three-year $4.8 billion capital target. The reduced capital intensity of the scheduled railroading model, significant core earnings improvements, and tax reform benefits helped drive nearly a $600 million increase in year-to-date adjusted free cash flow. Substantial progress in free cash flow generation, coupled with higher leverage, allowed us to nearly double shareholder returns compared to the first half of 2017. We have now completed about $2 billion of the current $5 billion buyback authority and remain on schedule to finish the program by the end of Q1 2019. As we noted at our investor conference, CSX will continue to evaluate cash deployment and shareholder returns annually. In conclusion, I want to reiterate the three key priorities that guide this management team daily: ensuring the safety of our employees and communities, delivering excellent service for our customers, and appropriately rewarding our shareholders. Now, I will turn it back to Jim for his closing remarks.

Great. Thanks a lot, Frank. Turning to the last slide number 12, while we've achieved a lot in a very short period of time, we are far from where I believe we can go. As many of you know, we just rolled out our trip plan compliance a few months ago. We're in the early stages of driving improvement in this metric and there is significant opportunity there to get better. Trip plans are so important, as we think about delivering even better customer service and asset efficiency. It allows us to track every car and container on our network and identify at a very discrete level where we may have a problem. This allows us to know why something happened, so we can react and more importantly, fix any problems so it does not repeat. I mentioned velocity and dwell earlier. Clearly, to be the best, we have more room to improve. Our train speed specifically, we have significant opportunity to improve as we remain below the industry leaders. Our dwell is better than the industry average, but again there is significant runway for opportunity before we can call ourselves the best. Cars on line continue to be a focus of this team. We’re in the business of moving cars and the more efficient we get, the less cars we need to move the same volume. But turning cars faster, it also frees up capacity for us to take on additional business. Finally, fuel efficiency. Diesel prices are up, so this becomes even more important. There are many ways to drive improvement in this area. We incurred $270 million in costs this quarter. So we're in the $1 billion run-rate range for the full year. These are big dollars. For trip optimizer to distributed power, we will use all of these to drive improvement and lower costs. Now, on revenue. We are raising our full-year guidance from up slightly to up mid-single digits. At some investor conferences, I said we were trending to be a little better than where we thought we would be at that time of the year. This slightly higher outlook is a reflection of a number of factors, including our belief that export coal strength will continue, higher fuel prices will remain in a healthy economic backdrop. Obviously, there are factors we cannot control, mainly the economy that can provide some variability as we get into the back half and fourth quarter specifically. But this is how we see it today. In closing, we have shown a relentless focus on executing our business model, but let me assure you we have an eye on the horizon to develop long-term sustainable growth. Our business practices are new to CSX employees, but are becoming part of our DNA, as we work hard every day with the goal of becoming the best run railroad in North America. Thank you and I’ll turn it back to Kevin.

All right. Thank you, Jim. In the interest of everyone’s time today, I would ask that everybody limit themselves to one question and one short follow-up if needed. Operator, we will take questions.

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

Over the past few months, when I mentioned our goal of reaching 60 in three years, many in the room thought it was unrealistic. We have only completed two quarters, so we are not altering our guidance on what we believe is possible. We still have a significant amount of work ahead, and we received considerable support from coal this quarter. If conditions remain favorable, I am confident that we can achieve the 60 target, which I believe many would find highly impressive. There has been no change in our outlook since we outlined our goals just a quarter ago.

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

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

Should we be monitoring origin dwell time yields in that business? How can we evaluate your progress from an external perspective?

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

Yeah, it seems quite conservative. Those are my two points, so I will leave it there. Congrats again, and thank you.

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

We're pretty comfortable. Obviously, we'd like to be better on the originations. We depart our trains pretty close to on schedule. We don't get them across the network as effectively as we should. We depart, if we give ourselves, which we don't, but if you did from an accounting standpoint, give yourself a couple of hours of flexibility on either end, we depart 90% our trains to schedule and we get to destinations again with that two-hour cushion over a three-day operating period in the 80% range. That’s unacceptable. You know what, that always comes up for a number of different reasons. And so we need to just continue to be able to work to eliminate the causes of failures and that's why our trip plan compliance is in the kind of 60% range. We need to get that up to 100% and when the trains fail to arrive on time, they miss their connections and therefore we’re off the trip plan. So all of those things need to improve. And a lot of it has to do with culture, where people recognize that there's going to be a failure and they go above and beyond the call of duty to make sure that we get the box that makes the connection on the next train. As I said many times, what does a UPS employee do when he sees that a box is not going to get in the truck, he runs behind the truck down the road and makes sure that he gets the box on the truck. Our guys are going to wait for the train, see you later and the car runs a day later. So, it's culture and it's all kinds of changes that we need to take place in order to get better.

Thank you. I would like to follow up on pricing. Frank, you mentioned that pricing has accelerated solely on a pricing basis. Are there specific levels you can address, especially considering the tightness of the truck market? Can you clarify whether you are seeing growth, perhaps 100 to 200 basis points sequentially year-over-year from where you were?

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

I’m not sure if Mark is on the call, but for Jim or Mark, it seems like the improvement is happening a bit faster than initially suggested. Does this impact your perspective on the revenue outlook? At the Analyst Day, you indicated there might be slight growth in 2018, but it appears to be more promising now. With the changes made to the network and a lower cost base, does this alter the balance between focusing on price and volume?

As I mentioned at the Investor Day and consistently since my arrival, I don't see a separation between implementing scheduled railroading and maintaining customer focus while growing revenue. These efforts go hand in hand. We have been actively working to enhance our service quality and collaborate with our customers to expand our business over the past six months, which has yielded positive feedback and results. Our customer relationships have significantly improved; clients who were initially displeased with me are now even buying me drinks occasionally. I don't perceive a distinction here, nor do I categorize us strictly as price leaders or price takers. Our emphasis is on both volume and price. We aim to develop a long-term, sustainable, and profitable business that sets us apart in the market. Our customers recognize that by partnering with us and investing more for a superior product, they can save on their own costs. This is our strategy for growth, one that has been in place from the beginning and will carry on into the future.

Yeah. Good afternoon and great results. I'm sure everybody is going to refer to that, but they’re obviously very impressive. Let’s see. What do you think about OR in second half? I mean, you’re sub-60 in second quarter, it probably implies numbers ought to go up in the second half. Is it pretty reasonable to think sub 60 in second half as well or is there anything in terms of maybe no incentive comp, is it a tailwind, that would be a headwind or anything else we ought to consider when we think about second half OR relative to the really strong results in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacations, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase, around 3% wage increase in the second half of the year. So, those are headwinds that we have planned for and have expected all along. And then, the most reliable variable is the weather here in the fourth quarter, which is a new phenomenon for me and Mark, where you've got a hurricane in Florida and the Gulf, while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth, I mean it’s fourth quarter. So those are the kind of things that we look at and say, it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they will be lower than they were last year, how about that?

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

I believe, as I mentioned earlier, Tom, we are just beginning to understand the necessary changes we need to implement. Last year, it was widely discussed that we altered our approach and eliminated the hub and spoke model, which removed about 7% of our volume from revenue and the railroad. At that time, I thought we had largely completed the rationalization of intermodal services, but that is not the case. Therefore, we will approach this process methodically. We will maintain clear and open communication with our customers regarding our goals, which will involve changes in train design and potential terminal consolidations. We will execute these changes in a careful, logical, and appropriate manner, being mindful of the fact that we are anticipating a strong peak season this year. We will not undertake any actions that could disrupt the railroads. If it requires a bit more time, even an additional quarter or two, I am perfectly okay with that.

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

I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind, means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio, so that we can be the price leader in the marketplace. So I think as I said last time, we don't get stickers and bonus points for volume. And therefore, to the extent that we can sell our product as a superior product in the marketplace, we fully intend to do that. Clearly, we have as much flexibility as we want to, if there are unique opportunities in the marketplace, where a customer to us is not interested in quality of service, but is only interested in price and it makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So we have all the flexibility in the world to pursue whatever business segments we want. Our principal objective here is to be a better run network that has a differentiated service product in the marketplace that demands a higher price for that and we can grow business at the extent of truck, which we already know the customer is paying 15% to 20% more for, so why discount your better quality product when you know you can go save the customer money by having a service that’s more truck-like.

Yeah. Good afternoon and great results. I'm sure everybody is going to refer to that, but they’re obviously very impressive. Let’s see. What do you think about OR in second half? I mean, you’re sub-60 in second quarter, it probably implies numbers ought to go up in the second half. Is it pretty reasonable to think sub 60 in second half as well or is there anything in terms of maybe no incentive comp, is it a tailwind, that would be a headwind or anything else we ought to consider when we think about second half OR relative to the really strong results in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacations, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase, around 3% wage increase in the second half of the year. So, those are headwinds that we have planned for and have expected all along. And then, the most reliable variable is the weather here in the fourth quarter, which is a new phenomenon for me and Mark, where you've got a hurricane in Florida and the Gulf, while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth, I mean it’s fourth quarter. So those are the kind of things that we look at and say, it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they will be lower than they were last year, how about that?

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

I believe we are just beginning to analyze and understand the necessary changes we need to implement. Last year was well-documented when we adjusted our approach and removed the hub and spoke system, which accounted for about 7% of the revenue taken from the railroad. At that time, I thought we had largely completed the rationalization of intermodal, but that is not the case. We will proceed carefully, maintaining open communication with our customers regarding our goals, which include changes to train design and potential terminal consolidations. We will approach this methodically and logically, especially considering that we are anticipating a strong peak season this year. Therefore, we will not make any decisions that could disrupt operations. If it takes a little longer than a quarter or two, I'm okay with that.

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

I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind, means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio, so that we can be the price leader in the marketplace. So I think as I said last time, we don't get stickers and bonus points for volume. And therefore, to the extent that we can sell our product as a superior product in the marketplace, we fully intend to do that. Clearly, we have as much flexibility as we want to, if there are unique opportunities in the marketplace, where a customer to us is not interested in quality of service, but is only interested in price and it makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So we have all the flexibility in the world to pursue whatever business segments we want. Our principal objective here is to be a better run network that has a differentiated service product in the marketplace that demands a higher price for that and we can grow business at the extent of truck, which we already know the customer is paying 15% to 20% more for, so why discount your better quality product when you know you can go save the customer money by having a service that’s more truck-like.

Yeah. Good afternoon and great results. I'm sure everybody is going to refer to that, but they’re obviously very impressive. Let’s see. What do you think about OR in second half? I mean, you’re sub-60 in second quarter, it probably implies numbers ought to go up in the second half. Is it pretty reasonable to think sub 60 in second half as well or is there anything in terms of maybe no incentive comp, is it a tailwind, that would be a headwind or anything else we ought to consider when we think about second half OR relative to the really strong results in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacations, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase, around 3% wage increase in the second half of the year. So, those are headwinds that we have planned for and have expected all along. And then, the most reliable variable is the weather here in the fourth quarter, which is a new phenomenon for me and Mark, where you've got a hurricane in Florida and the Gulf, while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth, I mean it’s fourth quarter. So those are the kind of things that we look at and say, it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they will be lower than they were last year, how about that?

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

I think as I mentioned earlier, Tom, we're beginning to really analyze the situation and determine what adjustments are necessary. Last year, as you know, we changed our approach and eliminated the hub and spoke model, which accounted for about 7% of the volume removed from our revenue. At that time, I believed we had largely completed the rationalization of our intermodal operations, but that is not the case. We're going to proceed in a very careful manner, maintaining open communication with our customers about our goals, which includes changes to train designs and possible terminal consolidations. We will approach this thoughtfully and systematically, keeping in mind that we are anticipating a strong peak season this year. We won't take any actions that could disrupt our operations. If it takes a little longer than a quarter or two, I'm perfectly fine with that.

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

I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind, means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio, so that we can be the price leader in the marketplace. So I think as I said last time, we don't get stickers and bonus points for volume. And therefore, to the extent that we can sell our product as a superior product in the marketplace, we fully intend to do that. Clearly, we have as much flexibility as we want to, if there are unique opportunities in the marketplace, where a customer to us is not interested in quality of service, but is only interested in price and it makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So we have all the flexibility in the world to pursue whatever business segments we want. Our principal objective here is to be a better run network that has a differentiated service product in the marketplace that demands a higher price for that and we can grow business at the extent of truck, which we already know the customer is paying 15% to 20% more for, so why discount your better quality product when you know you can go save the customer money by having a service that’s more truck-like.

Yeah. Good afternoon and great results. I'm sure everybody is going to refer to that, but they’re obviously very impressive. Let’s see. What do you think about OR in second half? I mean, you’re sub-60 in second quarter, it probably implies numbers ought to go up in the second half. Is it pretty reasonable to think sub 60 in second half as well or is there anything in terms of maybe no incentive comp, is it a tailwind, that would be a headwind or anything else we ought to consider when we think about second half OR relative to the really strong results in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacations, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase, around 3% wage increase in the second half of the year. So, those are headwinds that we have planned for and have expected all along. And then, the most reliable variable is the weather here in the fourth quarter, which is a new phenomenon for me and Mark, where you've got a hurricane in Florida and the Gulf, while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth, I mean it’s fourth quarter. So those are the kind of things that we look at and say, it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they will be lower than they were last year, how about that?

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

I believe, as I mentioned earlier, we are just beginning to analyze the necessary changes. Last year, we discussed changing our approach and eliminating the hub-and-spoke model, which resulted in about 7% of the volume being removed from our revenue stream. At that time, I felt that we had largely rationalized our intermodal operations, but that turned out not to be the case. We will proceed carefully and maintain clear communication with our customers regarding our goals, which include changes in train design and possible terminal consolidations. We will take a structured and logical approach, fully aware that we are approaching a peak season this year that is expected to be very strong. We will avoid making any decisions that could adversely affect the railroads, so if the process takes a little longer—beyond a quarter or two—I'm perfectly fine with that.

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

I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind, means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio, so that we can be the price leader in the marketplace. So I think as I said last time, we don't get stickers and bonus points for volume. And therefore, to the extent that we can sell our product as a superior product in the marketplace, we fully intend to do that. Clearly, we have as much flexibility as we want to, if there are unique opportunities in the marketplace, where a customer to us is not interested in quality of service, but is only interested in price and it makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So we have all the flexibility in the world to pursue whatever business segments we want. Our principal objective here is to be a better run network that has a differentiated service product in the marketplace that demands a higher price for that and we can grow business at the extent of truck, which we already know the customer is paying 15% to 20% more for, so why discount your better quality product when you know you can go save the customer money by having a service that’s more truck-like.

Yeah. Good afternoon and great results. I'm sure everybody is going to refer to that, but they’re obviously very impressive. Let’s see. What do you think about OR in second half? I mean, you’re sub-60 in second quarter, it probably implies numbers ought to go up in the second half. Is it pretty reasonable to think sub 60 in second half as well or is there anything in terms of maybe no incentive comp, is it a tailwind, that would be a headwind or anything else we ought to consider when we think about second half OR relative to the really strong results in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacations, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase, around 3% wage increase in the second half of the year. So, those are headwinds that we have planned for and have expected all along. And then, the most reliable variable is the weather here in the fourth quarter, which is a new phenomenon for me and Mark, where you've got a hurricane in Florida and the Gulf, while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth, I mean it’s fourth quarter. So those are the kind of things that we look at and say, it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they will be lower than they were last year, how about that?

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

I believe, as I mentioned earlier, Tom, we are beginning to deeply analyze what adjustments we need to implement. Last year, it was widely discussed how we altered our philosophy and eliminated the hub and spoke system, which accounted for about 7% of the volume lost in revenue for the railroad. At that time, I assumed that a significant portion of the intermodal rationalization had been completed, but that turned out not to be true. However, we will proceed in a very methodical manner. We will maintain clear and open communication with our customers regarding our objectives, which will include changes in train design and potential terminal consolidations. We are committed to approaching this logically and responsibly, especially considering that we anticipate a very strong peak season this year. Therefore, we won’t take any actions that could disrupt the railroads. If it takes a bit longer than a quarter or two, I’m perfectly fine with that.

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

I believe that the operating ratio is a reflection of the efficiency of our service, which in my mind, means that we continually improve the product that we offer to our customers. We are not working diligently to drive down the operating ratio, so that we can be the price leader in the marketplace. So I think as I said last time, we don't get stickers and bonus points for volume. And therefore, to the extent that we can sell our product as a superior product in the marketplace, we fully intend to do that. Clearly, we have as much flexibility as we want to, if there are unique opportunities in the marketplace, where a customer to us is not interested in quality of service, but is only interested in price and it makes sense for us, being the low-cost provider, to pursue that business, we can do that too. So we have all the flexibility in the world to pursue whatever business segments we want. Our principal objective here is to be a better run network that has a differentiated service product in the marketplace that demands a higher price for that and we can grow business at the extent of truck, which we already know the customer is paying 15% to 20% more for, so why discount your better quality product when you know you can go save the customer money by having a service that’s more truck-like.

Yeah. Good afternoon and great results. I'm sure everybody is going to refer to that, but they’re obviously very impressive. Let’s see. What do you think about OR in second half? I mean, you’re sub-60 in second quarter, it probably implies numbers ought to go up in the second half. Is it pretty reasonable to think sub 60 in second half as well or is there anything in terms of maybe no incentive comp, is it a tailwind, that would be a headwind or anything else we ought to consider when we think about second half OR relative to the really strong results in second quarter?

Sure, Tom. From a seasonality standpoint, the second quarter for CSX is always the best. So one would assume that that's going to always be the best this year too. Going forward into the second half of the year, number one, the way we account for our vacations, we have a disproportionate amount of labor expense associated with vacations in the second half of the year. We have a 3% wage increase, around 3% wage increase in the second half of the year. So, those are headwinds that we have planned for and have expected all along. And then, the most reliable variable is the weather here in the fourth quarter, which is a new phenomenon for me and Mark, where you've got a hurricane in Florida and the Gulf, while you're worrying about freezing rain in Atlanta and snow in Chicago and along Lake Erie. So we always seem to have weather that makes it more difficult for us to operate in the third quarter and fourth, I mean it’s fourth quarter. So those are the kind of things that we look at and say, it is totally rational and what we believe to be the case that our expenses in the third and fourth quarter will be higher than the second. I can tell you that they will be lower than they were last year, how about that?

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

I think, as I mentioned earlier, Tom, we are just beginning to thoroughly analyze and understand the changes we need to implement. Last year, we discussed how we altered our approach and eliminated the hub and spoke model, which accounted for about 7% of the volume removed from our revenue and the railroad's operations. At that time, I believed that we had largely completed the rationalization of intermodal, but that is not the case. We will approach this very carefully and will maintain clear and open communication with our customers about our objectives. This process includes modifications in train design and possible terminal consolidations. We intend to execute this methodically and appropriately, keeping in mind that we are expecting a strong peak season this year, as indicated by everyone. Therefore, we will avoid any actions that could disrupt the railroads. If it takes a bit longer, say a quarter or two, I'm perfectly fine with that.