Good afternoon, ladies and gentlemen, and welcome to the CSX Corporation Second Quarter 2019 earnings call. As a reminder, today's call is being recorded. During this call, all participants will be on listen-only mode. Following the presentation, we will be conducting a question-and-answer session. To ask a question, please press star one. For opening remarks and introduction, I'd like to turn the call over to Mr. Bill Slater, Chief Investor Relations Officer for CSX Corporation.
Thank you, Shirley, and good afternoon, everyone. Joining me on today's call is Jim Foote, President and Chief Executive Officer, Kevin Boone, Interim Chief Financial Officer, and Mark Wallace, Executive Vice President of Sales and Marketing. On slide two is our forward-looking disclosure, followed by our non-GAAP disclosure on slide three. With that, it's my pleasure to introduce President and Chief Executive Officer, Jim Foote.
Good afternoon, and thanks a lot, Bill. Before we get started with the presentation, I'd like to first thank all CSX employees whose hard work once again drove the company to new record operating levels this quarter. These records include operating income, free cash flow, and operating efficiency in the form of an all-time low operating ratio for a U.S. Class I railroad. Not only did we achieve record financial results, but we continued our industry leadership in safety, with the best performance in terms of lowest personal injury rate and meaningfully reduced train accidents. During this quarter, we successfully completed PTC installation and activation across our network. We now operate nearly 13,000 PTC-equipped track miles and are on pace to have the system fully tested and operational with our tenant railroads ahead of the required deadline.
Let's move on now to slide five of the presentation and our financial results. Second quarter results were straightforward, with only a few small unique items that Kevin will discuss. Second quarter EPS increased 7% to $1.08 versus last year's figure of $1.01. Our second quarter operating ratio improved by 120 basis points to a record 57.4%. Turning to slide six, we are delivering better service to our customers, which is reflected in our merchandise volumes, as our improved reliability is leading to customers trusting us with more of their freight. This led to broad-based growth across the merchandise segment as customers are recognizing the value of our best-in-class service offering. This growth was offset by declines in coal, intermodal, and other revenue, resulting in a 1% decline in total revenue to $3.1 billion. I remain encouraged by the performance of our core merchandise franchise during a softer-than-expected freight environment.
We led Class I volume growth again this quarter and grew volumes in all markets with the exception of metals and equipment and fertilizers. Total merchandise revenue increased 2% as volume growth and pricing gains were partially offset by mixed headwinds. Intermodal revenue declined 11% on 10% lower volumes, primarily due to the impact of line rationalization implemented last fall and early this year. We'll begin to lap those rationalizations at the end of the third quarter. Coal revenue declined 2% on 2% higher volumes as growth in domestic industrial markets was more than offset by export and utility declines. Finally, lower other revenues was primarily due to decreases in demurrage charges at intermodal facilities. Let's move to slide seven. Employee safety remains my top priority.
We were again the best in the industry for FRA personal injury rates and set a new company record for the lowest number of FRA reportable train accidents this quarter. We are also finding new ways to utilize technology to further enhance safety. As one example, the use of automated track inspection cars helped reduce track-caused mainline accidents by 85% year-to-date. While I'm pleased with this progress, there is always opportunity to operate more safely, and we will work diligently to make our railroad as safe as it can be. Let's turn to slide eight and take a quick look at our operating performance. On the service side, velocity and dwell improved by 14% and 6% respectively. We also set another U.S.
Class I record this quarter by operating below one gallon of fuel per 1,000 gross ton miles as we continue to find new and incremental ways to improve efficiency and drive unproductive costs out of the system. Most importantly, our improved operations are transferring to better outcomes for customers. We dramatically improved our trip plan compliance over the last year and are seeing strong momentum exiting the quarter. We continue to hit new records and have done so while tightening the schedule in the form of shorter trip plans. We plan to roll out our trip plan compliance data to our customers later this year and look forward to the opportunities the increased transparency will provide us to engage more deeply with them. With that, I'll hand it over to Kevin, who will take you through the financials.
Thank you, Jim, and good afternoon, everyone. Turning to slide 10. I'll walk you through the highlights of the summary income statement. As Jim mentioned, total revenue was down 1% in the second quarter as the impact of lower volume, particularly in intermodal, more than offset pricing gains across most of our markets. Moving to expenses. Total operating expenses were 3% lower in the second quarter, reflecting continued strong efficiency gains. Labor and fringe expense was 3% lower, driven by a 5% reduction in headcount combined with favorable incentive compensation expense. These savings were partially offset by inflation and other items. The operating team continues to drive efficiencies in a number of areas, highlighted by fewer crew starts, down 5%, and lower T&E overtime. Re-crews were also down 77%, a significant improvement year-over-year. Active locomotive counts declined more than 300 locomotives, down 11% year-over-year.
The smaller fleet, combined with fewer cars on line and train car repair efficiencies, helped drive a 6% year-over-year reduction in our mechanical workforce. MS&O expense improved 3% versus the prior year. Lower active locomotive count drove savings in materials and contracted services. Train accident costs were also favorable in the quarter as the FRA train accident rate fell over 50%. Intermodal costs also saw a year-over-year improvement, with lower volumes combined with operating efficiencies driving expense reductions. Partially offsetting these items was an unfavorable impact from casualty reserve adjustments unrelated to the improving trends in safety. Real estate and line sale gains were flat in the second quarter versus the prior year. We continue to see a strong pipeline of opportunities. Looking at the other expense items, depreciation increased 2% due to the impact of a larger net asset base.
Record fuel efficiency and a 6% decrease in diesel prices helped drive a 13% decline in fuel expense. Our enhanced focus on distributed power utilization and energy management technology drove record second quarter fuel efficiency. Equipment rent expense decreased 8%, driven by improved cycle times and lower volume-related costs in intermodal. Equity earnings decreased $9 billion in the quarter, primarily due to lower net earnings at our affiliates, including cycling and affiliates property sales in the prior year. Looking below the line, interest expense increased primarily due to higher debt balances. Income tax expense increased $9 million, primarily due to the benefit in 2018 related to state legislative changes. For the remainder of the year, we would expect an effective tax rate of approximately 24.5% absent unique items.
Closing out the P&L, as Jim highlighted in his opening remarks, CSX delivered operating income of $1.3 billion, record operating ratio of 57.4%, and earnings per share of $1.08, representing improvements of 2%, 120 basis points, and 7% respectively. We continue to see significant opportunities to drive efficiencies across every aspect of our business. Just a few of the key initiatives into the back half of the year include ongoing train consolidations through continued expansion of distributed power and additional longer crew runs. This reduces the active locomotive fleet and associated maintenance and repair costs, as well as crew labor and related travel and balancing expenses. Yard reductions enabled by train consolidations and longer runs will reduce labor and overhead costs. Overtime also remains a significant opportunity with a particular focus on the mechanical and engineering.
There are multiple instances across our business functions where overtime as a percentage of straight time is well over 20%, and in some cases, exceeding 40%. While we hit a record this quarter, fuel efficiency remains a big opportunity for us. I expect the operating teams to continue to deliver savings. Train speed and dwell continue to be opportunities as well. The related cost benefits remain significant. Finally, we are finding new opportunities to become more efficient in our G&A costs. Recent initiatives should benefit us in the second half. Turning to slide 11. Year-to-date capital investment is down $54 million or 7% year-over-year. At the same time, we have added 12% more rail and 25% more ties while doing it smarter. Overall, our improved asset utilization from locomotives to rolling stock has enabled us to sustain lower levels of capital investment without compromising safety or reliability.
The level of PTC spending has also come down significantly in the last two years. Growth in CSX's core operating cash flow, including improvements in working capital, drove a 22% increase in adjusted free cash flow to $1.6 billion through the second quarter. Year to date, we have returned approximately $2 billion to shareholders, including $1.6 billion in buybacks and $400 million in dividends. Dividend payments in the quarter reflect a 9% increase from $0.22 to $0.24 per share we announced in February of this year. Our ability to convert earnings into cash remains a key differentiator for CSX and a significant driver of shareholder value. With that, let me turn it back to Jim for his closing remarks.
Thanks, Kevin. Turning to slide 13, I want to wrap things up by discussing our guidance for the year. We started this year expecting revenue to be up approximately 1% - 2%. Both global and U.S. economic conditions have been unusual this year, to say the least, and have impacted our volumes. You see it every week in our reported car loads. The present economic backdrop is one of the most puzzling I have experienced in my career. With natural gas prices expected to continue to impact both domestic and export coal, intermodal showing little seasonal recovery, and many of our industrial customers' volumes continuing to show weakness with no concrete signs of these trends changing, adding in the impact on crude-by-rail shipment of last month's Philadelphia refinery explosion, we are now expecting revenues to be down 1% - 2% for the full year.
We are not necessarily being pessimistic about the second half of the year, but in as much as we need to adjust guidance, we're just setting out the obvious. This outlook is based on the current business levels, and there is upside to this forecast if conditions improve in the second half. We are seeing a range of conflicting data points and economic indicators and regularly speak with customers who, despite the recent downtime and slowdown, remain cautiously optimistic about the second half. Mark is here and can add some color to this in the Q&A session. We feel it is most prudent to actively manage expenses to today's volumes rather than take a wait and see approach. We still expect a sub 60 operating ratio for the year.
Our planned cost reduction initiatives will not impact safety, service, and will ensure the business is positioned to handle any additional volumes when things pick up. Lastly, we are maintaining our $1.6 billion-$1.7 billion CapEx outlook for the year. Even though the year is off to a slower start than we had hoped, we still see significant opportunities ahead. We have a service product that is resonating with customers and a long list of opportunities to reduce expenses, decrease asset intensity, and improve efficiency by eliminating the unnecessary touches that add cost and slow us down. We are very proud of the progress to date, and there is still much more left to do. With that, thank you, and I'll turn it back to Bill.
Thank you, Jim. In the interest of time, I would ask everyone to limit themselves to one question and one follow-up only if necessary. Shirley will now take questions.
Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one. To withdraw your question, press star two. Our first question comes from Ken Hoexter with Bank of America Merrill Lynch. You may ask your question.
Great. Good afternoon, thanks for the discussion here. Jim, maybe just talk a little bit about the performance, right? A phenomenal operating ratio, yet when you show your data, the on-time arrivals continue to fall. Maybe just understand how that's possible given, are you tightening the time frames to different levels, or is that different than the improvements you're making on the performance?
Great. There's a difference between on-time originations and on-time arrivals versus trip plan compliance, which is measuring the box as it moves through the network. Our on-time departures, which we report to the STB, we're close to 100%, high nineties now, arrivals is in the mid to high eighties just most recently here. Trip plan compliance, on the other hand, which is not measuring that train performance, is measuring how the car moves through the network from the time we pick it up to the customer and when we tell the customer we'll hand it to his customer in 114 hours, how often do we make that 114-hour trip plan?
When we started measuring this, we were maybe in the high 30% of the time we were making that trip plan, now we're in the high 70%, close to 90% in intermodal and high 70% for the carload business. Yes, to answer your question, every time we start getting where we're producing really good results, Jamie and the operating team get in there and tighten up the schedule and make it more difficult for everyone because ultimately that results in a much better product for the customer.
Ken, to give you a little perspective, last year in the second quarter of 2018, we on average left, we had early departures about 76 minutes early. Whereas you look at this year, we're departing only 20 minutes early. We gave ourselves a lot of cushion last year, which obviously would translate in a lot more cost. We're tightening the windows, and you can see it in that differential, which just helps us manage our assets a lot better.
Helpful review. For my second one or follow-up, I guess, is maybe just moving over to Mark and Jim, since you opened that up. Maybe Mark, you can talk about, given the shift of the outlook, are you seeing an accelerating decline in some of the economic indicators you're looking at? It just looks like car loads, you're right, if we take out the intermodal, which stays around that down double-digit, given your lane closures, are you seeing an underlying deceleration in some of the outlook? I don't know if you want to go by commodity or just overall.
For the opportunity. I think exclusive of the PES refinery explosion that Jim just talked about in Philadelphia, which just happened a couple of weeks ago, our change in our revenue guidance is largely evenly attributable between our three segments, so coal, merchandise, and intermodal. On the coal, export coal has been below our expectations, mostly driven by thermal and lower API 2 benchmarks, which we think will likely continue into the second half. On the domestic utility side, our volumes are down relative to our expectations, driven by continued lower natural gas prices. Going into the year, we thought Henry Hub was going to be somewhere around, and our guidance was for Henry Hub to be somewhere around $2.85. Now we're hovering between $2.40 and $2.50, which is now reflected in our guidance.
On the merchandise, as Jim mentioned, clearly there are signs of slowing economic conditions in both IP and GDP for Q3 and Q4, pointing to a less robust economy in the second half. We've obviously seen evidence of this in our own business, and now see a softer industrial environment with signs in our automotive, chemicals, and metal segment. We're calling it as we see it, and the run rates we're seeing are based on the trends that we saw in June and coming into Q3. On the intermodal side, listen, we clearly hope for more of a recovery, particularly in the fourth quarter of the year. We're not immune from some of the pressures that the entire U.S. intermodal industry is facing right now with the weak trucking market coming off an exceptionally strong 2018. There's a lot of excess capacity in this market.
As a result of what we saw in 2018, a lot of trucks came into the market. That needs to be worked out. Listen, we're staying disciplined on serving our customers and providing everyone with, as Jim mentioned, great service. Now, what would help? Obviously, what would help in the back half would be a resolution or clarity on trade and tariffs, would obviously help, that is obviously beyond our control. What is within our control is providing a high-quality service product to our customers, uncovering new opportunities to use that service product for both new and existing customers, and to make sure that we are extracting a fair value for the service that we provide. Hopefully, that covers a little bit of the explanation on what we're seeing.
No, truly appreciate it. Thanks, Jim, Mark, Kevin, Bill, thank you for the time.
Thank you. Our next question comes from Allison Landry with Credit Suisse. You may ask your question.
Thanks. Jim, earlier you outlined a number of concerns in the freight environment and what you're hearing from customers. It sounds like maybe the risk is to the downside instead of an upside recovery. I guess my question is, how much of a volume or revenue decline can the business model withstand and you still grow EBIT on a year-over-year basis in 2019?
I don't know that we've ever modeled how much we could actually take out. This is not something we woke up yesterday and said, "Well, guess what? Things are going a little bit softer than we had expected." We've been watching this throughout the first half, hoping as everyone did, that things would turn around and that business levels would start to tick up instead of this just kind of slow, lazy, malaise type drift down across, which, as Mark said, kind of then accelerated as we got into June. We've been planning for this and watching it and taking steps for months now to, first of all, obviously focus on that G&A, because the one of things we don't want to do in these situations is reduce costs in the transportation side of the business that could impact service.
Then you impact service, then your business can get softer, then it gets softer, you cut more, then you impact service, you start this downward trend. It would be much easier for us to respond if suddenly business just dropped 10% today. Then we would know exactly how to right-size the business for it, we'd know exactly where we could and could not take out the expenses in order to handle the volumes.
We are doing the best we can I think the team did an amazing job in the second quarter of getting a lot of things done, getting a lot of things right-sized based upon what we were anticipating and what we were seeing, not really go and enter any kind of cost reductions on the transportation side of the business is where the majority of our expenses are. If we see, or if we saw, hopefully we don't, if we saw a significant quick decline in our business levels, we would respond quickly and aggressively do everything we could to try and maintain our cost structure and our advantage. At some point in time, there's just no way that we can take out the order of magnitude or the amount of costs that are necessary if there were a significant decline in revenues.
We'll continue to do our best and monitor it. So far so good. This is not doom and gloom. This is not end of days kind of thing. This has been a very slow drip from the beginning of the year. As aggravating as it is, under the current rules of engagement with the investment community, once we put guidance out, when things start to look like we're not going to be able to achieve that guidance, we're obligated to give a new guidance. We've thought hard about it and said, based upon where we are today, if this is kind of the new run rate from today, then we'll probably be down 1% or 2%, especially when we just blew up an oil refinery that was a big customer of ours, which is by itself on an annualized basis, 1% of our volume.
Factored into this, the number that we've taken down is a one-time 1% hit in volumes, half of which we'll recognize this year, associated with the refinery explosion. To get back to your question, we can do a lot if we know directly what it is we're trying to achieve. In this environment, it's just a lot more challenging.
Okay. That's really helpful. Maybe just piggybacking on that a little bit. Obviously the volume declines accelerated and maybe in Q2, you try to do a little bit of right sizing. Should that, along with the comments that you guys made about having plenty of opportunity going forward for efficiency gains, should we read that as a signal that the year-over-year improvement in the OR could accelerate from the 130 basis points in Q2? Not that wasn't a good number, just trying to understand the trajectory going forward and how are you thinking about that? Thank you.
Allison, you're killing me. We do a fantastic job. You want more. Come on. I think we'll just stick within this environment, going back to the original. This revenue top line view reflects a pretty significant reduction in revenue. What we're saying right now is we're going to achieve our goal of hitting an operating ratio below 60%, despite what everybody else does out there, maintaining our leadership position as the most efficient railroad in North America.
Thank you, guys.
Thank you. Next question comes from Brian Ossenbeck with JP Morgan. You may ask your question.
Hey, good afternoon. Thanks for taking the question. Mark, one for you on export coal. You mentioned API 2, but I wanted to ask about met coal. Are there any other changes that we've seen this cycle with maybe some longer-term contracts or reservation systems at the ports, or even restructuring of the coal producers in Appalachia? Anything that you think can actually help extend this cycle for a little bit longer?
Yeah, Brian, thanks. On export coal, let me just start at a high level. I think we're still expecting export coal roughly around 40 million tons for the year. Thermal coal, as I talked about, obviously some tough headwinds there given the API 2 numbers. There's some tough things going on in Europe as Jim talked about, with some low natural gas prices, the mild weather, and low natural gas prices in Europe. That's causing a little bit of a headwind. On the met side, again, the benchmarks remain strong. They're about $190. We price those contracts quarterly. We're working now with all our export coal producers to look into next year. I'm not going to give you any guidance, we're having some success there and starting to lock up some volumes. Not anything hugely significant, especially on the thermal side, which is encouraging.
We work with these guys every day, our customers, and everyone's incentivized to move a lot of coal heading into next year. Hopefully, as we get closer to the end of next year, we'll give you maybe a little bit more clarity on what our expectations are for 2020.
All right. Thanks, Mark. Appreciate that. Maybe if you follow up on the PES refinery. Jim gave us the rough magnitude of that. I was curious if, we've seen some other headlines with U.S Steel bringing down, I guess, keeping down some blast furnaces. In the past, you mentioned that tariffs have actually helped domestic steel production, domestic met coal consumption. I was wondering if that was or any other distinct events are reflected in the updated guidance.
Yeah, certainly, we had a big volume quarter in steel and industrial coal. What's happening with some of those announcements, unfortunately, some of those producers, world's changing a little bit, and we just talked about the declining or the softening industrial environment, which is obviously impacting them. Following the tariffs, they saw an increase in production. Unfortunately, now with the markets, so huge inventories went up. The market's getting a little softer. Prices are coming down, and there's probably an excess in capacity there. Yeah, we expect that our metals and equipment volumes in the second half, just because of the softer industrial environment, will get a little bit softer, unfortunately.
Okay. It sounds like it's considered in your current update.
It is.
All right. Okay. Thanks for the time, Mark. Appreciate it.
Sure.
Thank you. Our next question comes from Amit Mehrotra with Deutsche Bank. You may ask your question.
Thanks, operator. Thanks, everybody. Congrats on the good operating performance. Jim, can you, I guess, maybe talk about the pricing environment? Is it harder to push pricing in the current volume, and low inflation environment? Can you just give us maybe a flavor of your ability to just simply put, charge a higher price for the better service that you guys are delivering?
Let's focus on, there are two different business segments. There is Intermodal and there is Carload. Intermodal, our obligation there is to deliver a product that is as close as truck-like, and to do so at a price that is cheaper than a truck because of the service differentiation between the fact that the length of the time in transit is going to take longer. As there is a very soft truck market out there right now, and as Mark said, a lot of excess capacity based upon some recent historical changes in the marketplace, it is a little more difficult for us. On the other hand, what we are really focusing on and as we talk a lot about, because it is two-thirds of our business and very profitable long-term business for us, is the Carload business, from a high level perspective.
In that situation, we know that our customers are paying a 15%-20% premium to move their product in a truck, because they want to buy service reliability. As we become more reliable in that supply chain, we should be able to get more and more of that business, and we should be able to do so at a premium price, because the customer is actually saving money by taking the business off the highway and putting it in a rail car. That is where we focus intently on leveraging this service product. Mark, you want to add to this?
No, I think that is exactly right. As we become more reliable and consistent, as the market soften and customers are holding on to product and just-in-time deliveries become more important, our service comes at a premium, and I think customers recognize that. We do a good job for them. We get it there when we say we are going to get it. Our deliveries, our trip plan compliance is very good. They are willing to pay for that premium service.
Just as a quick follow-up to that, why wouldn't we see that then, those market share gains show up in the revenue? I mean, the revenue revision is not surprising given all the headwinds you have discussed, but would have thought with the improvements of the network on the Carload side, the market share opportunity you just talked about, the realignment of the sales organization, those could translate to some market share gains. Maybe it just takes a little longer than I appreciate. If you can just talk about where you are in kind of the evolution of capturing that market share, because it does not seem like it is showing up in the revenue numbers this year at least.
Well, again, I'll have to point out again, the carload, we are the most transparent industry in the world in as much as we report our sales volume on a weekly basis. Our merchandise business segment, even though everybody says, "Oh my God, something's wrong with CSX, the volumes are down 10%." Well, it's all Intermodal, and we already told everybody in the world why our Intermodal business was going to be down. Nobody focused on the fact that our merchandise franchise was outperforming everybody else in the industry. This is what exactly what we're talking about. Up until most recently where we saw a couple of our industrial segments get much softer, we are very confident that the strategy of having non-cyclical growth in our merchandise segment is achievable based upon our service product.
Unfortunately, as I said, half of this or a significant portion of this merchandise business that we've now taken our guidance down on was associated with this one-time customer event. The rest of it is just kind of basically market-driven where, in certain segments with our industrial customers, again, our grain business is doing really great. A lot of our segments of our business are doing really great.
Great.
Not all grain moves in a unit train. A lot of grain moves in a boxcar, individual boxcar that we're taking from a truck and putting it in a boxcar. Across the board in this merchandise segment, we're seeing gains, we're seeing traffic come to us. If you're a customer right now that's kind of looking and saying, "Wow, maybe things are a little soft for me. Maybe I better see what I can do to right-size my business and take control of my cost structure. How can I save money in running my business?" I go, "I can reduce my transportation spend overnight by taking the traffic off the road and putting it in a boxcar." 10 years ago, I wouldn't have done that because, Jesus, the product would have never got to where it was supposed to be.
Nowadays, I'm willing to do that, and I can save money. We're pretty confident on that, and we think that the numbers are beginning to prove us correct.
If I could just ask one follow-up for Kevin with respect to the cost opportunities you laid out. Kevin, do you expect to see OR improvement in the second half versus the stellar results you guys put up in the second quarter? Q3 typically looks a lot like Q2, but I'm not sure if there's any further opportunity given the cost items that you laid out.
Yeah, I think Jim addressed this previously. I don't think we're going to get into back half versus first half dynamics in terms of OR. What I can tell you is there's a number of initiatives that we've been working on over the last month that are new to our plan to react to this downward guidance in our pipeline. Yes, we're reacting quickly not only across G&A, it's across all aspects of our business. Jamie, Ed, Bob, and Brian are on board, new ideas are coming to us every day. It's our job to identify those and go after them. We're not going to get into nuance of second half versus first half.
Okay. I'll try, I appreciate the response. Thanks, everybody.
Yes.
Thank you. This question comes from Brandon Oglenski with Barclays. Your line is open. You may ask your question.
Hey, this is David Zazula on for Brandon. Thanks for taking my question. Just a little bit of drill down into the prior question about pricing getting. In terms of merchandise versus intermodal, some of the service metrics you showed on intermodal in terms of trip plan compliance show really good trip plan compliance on the intermodal side. Could that make you potentially a victim of your own success in that there's not as much room to go positive on the service side and try to drive conversion from the truck? Are there more nuanced aspects of the service that you can still provide that would be beneficial to shippers currently using truck?
Our metrics in intermodal versus carload business reflect the nature of two different kinds of businesses. The intermodal is terminal to terminal, point to point. It's much easier to have those kind of high trip plan compliance numbers versus carload. A lot of things we can do there on the terminal side in order to improve that customer experience. I'll let Mark tell you about some of the great stuff we're doing on the technology side in intermodal that we think is going to differentiate ourselves as well.
Yeah. Well, again, across the board, lots of great things going on across the board in terms of gate reservation systems, all kinds of things at the terminals, making it easier for customers to do business with us, whether it's on the website, lots of opportunities. Clearly, when we talk about converting a lot of business, merchandise is really where we see the greatest of opportunity in driving that conversion from truck into our merchandise business. Lots of opportunity there. We're seeing some great results. We're converting a lot of business as we speak because of our service that's improved so dramatically. Our customers are responding to the reliability and the consistency that we're providing at a great price. So I think there's a lot of opportunities left. Clearly, both on the intermodal side and on the merchandise side, there's opportunities for continued growth there.
Thanks, Mark.
Thank you. This question comes from Chris Wetherbee with Citi. You may ask your question.
Hey. Thanks. Good afternoon. Wanted to ask about the guidance, maybe specifically, can you help us sort of break out what you think the volume expectations are for the back half of the year? I don't know if you want to sort of handle that on a merchandise versus intermodal type of dynamic, because clearly there's some company specific initiatives on the intermodal side that are reducing volume. Just any help there to kind of think about that mix of what's yield and what's volume in the back half.
Well, Chris, we're expecting that the volume in the second half, at this point in time, we're going to have to work really hard to make the volume equal to or better than what we had in the first half. That's the challenge. As I said, again, we came into the year expecting to be up 1%-2%. The first quarter was under the circumstances with a lot of noise going on. It was still a pretty good quarter, but a lot of the segments, especially intermodal, just didn't bounce back with the way everybody expected it to be. What we're saying right now is kind of take today as the run rate. Hopefully, we can do a little bit better than we did in the first half, even with a pretty strong quarter.
We don't have a big hockey stick anywhere here anymore to work with. Relatively flat. We should get a kick up in the fourth quarter of the year, just simply because the intermodal starts over, we start to get out of some of this demarketing of certain lanes. On an absolute numbers basis, this is pretty much a pretty good, for planning purposes, for our guidance right now, and I'm pleased that I hope I'm proven wrong, and we do see things turning stronger in the later part of the year. We're just assuming that this is kind of the new norm for guidance purposes.
Chris, with our first half of the year, revenue was up 2%. We're now guiding for the full year down 1%-2%. I think the math is pretty simple there.
Okay. That's helpful. I appreciate that. Just on the pricing side and maybe just thinking about yields in general, drilling down to the coal numbers, there's some puts and takes, and when export volumes move around a little bit, you tend to have fluctuation in the coal yields. When you think about the back half, should we be looking at 2Q as a reasonably good benchmark to use for the back half when we're modeling out? Just trying to get a sense of if there are other sort of movements between met and thermal that we should expect as we move into the back half of the year. Sounds like the guidance for 40 million tons still holds. Just wanting to get a sense if there's any moving parts within that. Is 2Q a good number to use for coal yields?
I think so. I think so, Chris. Listen, again, as you're looking at the RPUs in coal, as you know, in any given quarter, always lots of moving parts there. Q2, coal RPU was down, obviously, but that was really a reflection of some gains that we got in shorter haul business in our utilities business to the north, which is generally lower RPU than the utility business to the south. As I talked about in an earlier question, some of the steel and industrial growth that we saw some strong volumes there, which is again, some lower RPU than typically we see on the whole book of coal. I think, going forward, sort of what you see is what you get for what you should probably think about as you plan out the back half of the year.
Okay, great. Thanks for the time. I appreciate it.
Thank you. Next question comes from Tom Wadewitz with UBS. You may ask your question.
Yeah, good afternoon. Wanted to ask you first on the just kind of broader approach on price and volume. I'm confident you'll show discipline, how do we think about how you want to approach the dial of the levers? Will you get more aggressive in terms of competitive position to support the volumes as you see just less volume out there? Is it something where you kind of let the volume flow with the market and you try to keep price that reflects what's good service and discipline and all that?
Hey, Tom. Again, Jim mentioned what we're going to do on the volume side, we're going to take it as it comes, we got a long pipeline of initiatives of things that I've talked about in the past, whether it's on the marketing side, whether it's on the business that we do with our short line partners, whether it's stuff that we're doing on the regional sales, whether it's a whole host of industrial development projects that we've got going on. Clearly, a long list of initiatives that we're working on, we're going to convert that volume as it comes to us, we're working hard every day to bring more volume onto the railroad. Let's be very clear. We're still achieving very strong value on the renewals and the momentum that I spoke about in Q1 on pricing continued into Q2.
Every contract that we have, it still needs to come across my desk for approval, I can tell you that I'm extremely pleased with the discipline that our team is bringing. We're working hard to pull on both levers, we're taking a disciplined approach.
Okay. Yeah, great. That's helpful. Thanks, Mark. One other question. Just how should we think about the operating ratio in an environment, not necessarily second half of the year? I know you've given us the kind of full-year commentary, but perhaps if we look to 2020 and you say, well, you're in an environment where revenue is flat. Do you have enough initiatives left? I know Kevin identified some, but do you have enough efficiency gains left to improve the OR if revenue is flat? How might we think about that, perhaps from a kind of a broader perspective or 2020, or however you want to frame it?
Well, I think what we just said is we're going to improve the operating ratio more than a point when revenue's down. If we're faced with similar circumstances, that's the hand we're dealt. We'll do everything in our power to manage the business accordingly.
You think that could be the case beyond just second half?
Well, God, I hope. Like I said, this is not end of days.
Yeah, right.
Obviously, there's a certain amount. The two variables that we obviously need to work with are volume and inflation on the operating side. To the extent that we do get some cost reduction associated with volume reductions or increases, if it goes the other way, our challenge each and every year is to offset whatever the inflation number is. Hopefully, if we're providing a high-quality product, as Mark said, and we're pricing appropriately, that should help us a lot to get us going in the right direction from a cost, which would help on the operating ratio side, in addition to keep finding ways to improve efficiency. We have a long ways to go and a long list of initiatives to work on. In all of these various categories, we're far from best in class.
We like to brag, but we benchmark against just about everything that everybody else does, not just in the railroad industry, to try and figure out where we can improve. We have a long ways to go in just about every segment of the way we do business.
Okay, great. Thanks for the perspective, Jim. Appreciate it.
Thank you. Our next question comes from Justin Long with Stephens. You may ask your question.
Thanks. Good afternoon. Last quarter, I think you talked about headcount being down 6%-7% this year, which would roughly be in line with attrition. Based on the volume weakness you've seen year-to-date, and it sounds like you'll see in the second half, what's your flexibility to reduce headcount further, and do you have any updated thoughts around what that percentage looks like in 2019?
We're still well on track to meet that forecast that we had in the 6%-8%. I think I mentioned in my opening comments that really overtime is a big focus of ours right now. It's a significant cost and a significant savings opportunity going forward. Certainly, we're going to continue to look at headcount, but we're going to use attrition where we can. We have a great line of sight to what that number looks like, and probably we'll see if we need to go a little bit harder there depending on how the volume's coming back half of the year.
Okay. Secondly, I wanted to circle back to domestic intermodal and your expectations for growth on that front. I know it's a little bit noisy with some of the lane rationalizations, but if you take that out of the equation, what do you see as the underlying growth rate for domestic intermodal as we get into the back half of this year and longer term?
Well, tell me what the economy's going to do in the back half of the year, and I'll tell you what intermodal is going to do. As we talked about the excess supply that's out there, the truck supply capacity. We hopefully are flattish intermodal. We think there's going to be a good peak, but it's probably going to be somewhat muted versus the extremely strong peak that we saw in 2018. I think volume levels are going to pick up a little bit, but probably not as peakish as we have historically seen. Longer term, domestic intermodal, my view is there's no reason why this franchise should not be able to grow on an annualized basis whatever GDP gives us plus two or three points.
Just to clarify your comment on flat, Mark, is that flat domestic intermodal volumes excluding rationalizations in the back half? Is that what you were saying?
No, including our rationalization. Again, we're going to officially lap the end of the rationalizations in January of next year. We took off again in January of this year of 2019, 5%. Overall, since we began this journey in December of 2017, we've rationalized over 15% of the intermodal network. A lot of that lapsed in October, the final bit lapsed in December. In January, excuse me.
Great. That's helpful. I appreciate the time.
Thank you. Our next question comes from Scott Group with Wolfe Research. You may ask your question.
Hey, thanks. Afternoon, guys.
Hey, Scott.
Kevin, I don't know if I missed it, but you guys usually give some guidance on the other revenue expectations. Any color you can give us there?
Yeah, I think you should expect about around the current levels that we did in the second quarter to continue through the back half of the year.
Okay. Helpful. With a more cautious sort of volume revenue outlook, does this change the way you guys think about target leverage ratios? Does it change the way you think about CapEx? Meaning, do you see some flexibility on the $1.6 billion? I guess just following up on that headcount piece, why not do more on headcount if the volumes are coming in worse?
I certainly think if we continue to see downward pressure on volumes, which is not our expectation, that you'd probably see some more opportunity there. There is variable cost in our business. We would take a look at some other things as well. On the balance sheet right now, we're sitting on $1.6 billion in cash. We expect to generate a lot of cash in the second half of the year, going to give us significant flexibility to be proactive and opportunistic if the market gives us an opportunity. We're well within our 2.5x-2.75x leverage targets, EBITDA. I think we're comfortable living in that area. We're at the bottom end of that today, it gives us a lot of flexibility going forward.
Again, with our cash balance, what we have today and what we expect to generate through the back half of the year, it gives us a lot of opportunity to be opportunistic here.
Okay. Thank you for the time, guys.
Thank you. Our next question comes from Ben Hartford with Baird. You may ask your question. Ben, please check your mute feature.
Hi, guys. Sorry about that. Thanks for the time. Mark, I'm interested in your perspective on IMO 2020 and how customer conversations are shaping up in front of that. Do you expect it to have any sort of impact, either in terms of international intermodal pull forward, anything along the crude or petroleum side of the equation? How are you guys thinking about that impact in the back half of the year and in the early part of 2020?
Yeah, great question. We're obviously working and talking to our customers. I'll be visiting with a lot of the international steamship guys here in the next month or so, where I know that's going to be a huge topic of discussion. Clearly, early indications, we don't think it'll have a material change for our business. I know they're working on these issues as we speak, but where we stand right now, and again, maybe a little premature, maybe remind me to bring that question back up on the Q3 call, and I'll give you maybe a little bit more color. It's a topic of discussion coming up, but clearly, I think right now, we feel pretty comfortable that we're not going to see any material change.
Okay, that's helpful. The outlook you gave on intermodal was helpful. I'm curious on the merchandise side as well. Obviously, a lot of talk about the macro and the softness, as you guys embark upon expanding the addressable market, what's the probability in 2020 that you can make enough progress, either selling service, developing some of the sales and marketing efforts to be able to drive to whatever a U.S. industrial production growth number might be, plus some sort of multiplier within the merchandise category in 2020? Is that simply too soon? Is it too near of a time horizon to be thinking about an offset yet from some of these initiatives?
Well, it's a great question. Listen, again, as Jim said earlier, we're outperforming the U.S. rail industry today on our merchandise volume growth. We're up after the second quarter, over 2%. The others are down for the year on merchandise. Clearly, the initiatives that we're working on, the changes to our service plan, and the service that we're delivering are clearly having a big impact. Now, we're facing reality, the industrial economy has kind of swollen down here, we've got a few headwinds going into the second half, which we have to live with, and obviously, the PES explosion was a major factor to us revising this. As I said earlier, we have a number of initiatives going on, and the team that Kevin used to lead in the marketing department before he became the interim CFO here is doing some great work analysis.
We got a team of data analytics people downstairs that are doing some great research and exposing a lot of opportunities for this organization. We're excited by that. There's obviously some big opportunities, we're going after everything methodically, and we're looking to grow this organization. We're not just taking what we can get. We're going out there, we're being proactive, and this is about growing CSX. It's not just taking what the customer gives us. We're going to find opportunities to grow and convert truck traffic, and we're doing just that.
Appreciate it.
Thank you. Our next question comes from Bascome Majors with Susquehanna. You may ask your question.
Yeah. Thanks for taking my question here. You made a few changes in the C-suite in the second quarter. I'm not sure if Farooq is on the call, but if he is, I was hoping you could help us understand the responsibilities of this new role of Chief Strategy Officer and anything about the long term or midterm vision that might entail, realizing he's six weeks into the job here. Kevin, anything, if you'd want to highlight your priorities for the finance organization under your leadership, that would be helpful. Thank you.
Sure. I've known Farooq for many years. We go way back, all the way back to the privatization of the Canadian National, where we worked together on that initiative at that time, and have kept up with his career.
I've moved around the industry as well. I just felt that we're embarking on a significant transformation of CSX and a lot of things that we want to do differently. A lot of them in the area that Mark spoke of, in terms of expanding our reach and our interface with our customers. Farooq instantly came to mind because I felt that he had had a great experience in working in that area. It's all about what it is we can do to make our service offering, our core rail product offering, better to our customers. To me, that involves a significant amount of a new thought and a new direction, a new vision from what has historically been done in the railroad industry, and that's what Farooq's going to work with me on and make it happen. Kevin's phenomenal. He's doing a great job.
We all appreciate that he was here and his skill set and his ability to step right in and pick up where Frank left off. Frank did an amazing job for CSX, and we're all happy that Kevin was here to help as we worked through the transition. I am in the process, as Kevin well knows, he's looking at me kind of sheepishly, as he well knows, we're doing an external search to see if we could find the right person to fill this role. As part of that process, Kevin's going to be considered.
Thank you.
Thank you. Next question comes from Jordan Alliger at Goldman Sachs. You may ask your question.
Yeah. Hi, guys. Thanks. Just a little pushing on the Intermodal, the trip plan compliance looks really strong. I'm just sort of wondering, the demarketing is going to lap by the end of the third quarter. Let's just say the economy sort of gets back to a 2.5% GDP type number or 2.5% as we move into 2020. Do you feel comfortable that at that point, you'll be able to start more aggressively remarketing the Intermodal and do that GDP plus two to three points, or is it premature?
As I said, longer term, I think that would be our goal. Clearly, I'm not going to sit here in July of 2019 and provide you 2020 guidance. Longer term, as we think about the Intermodal business, that would be my hope and expectation, given our franchise, the strength of our franchise and the service that we provide to the customers, which we're pretty proud of, that we would able to do whatever the economy gives us, plus 2 to 3 points above that. That's my wish, that's my goal. That's what we're going to work on. We're settling in on our footprint. We're doing really well in the lanes that we're in now. We're showing our customers what we're made of. When the growth comes, we're ready to handle it. We've got excess capacity, and we're ready for the growth when it comes.
The next question. Fully understand the need to be prudent in the guidance with all the various crosscurrents going on. I think you might have mentioned in the very opening remarks, Jim, that customers remain cautiously optimistic. I'm just sort of wondering which areas might be where that optimism is and if their optimism plays out and you sort of run that through your system, could we get back to that 1% type of revenue growth if the cautious optimism plays out?
I think yesterday Jamie Hunt said they were pretty excited about the second half of the year. I think it was about two weeks ago on the front page of the newspaper, General Motors was talking about how great things were, and on and on and on. Not necessarily our customers per se, but I think Jamie Dimon said this morning, students, stop being so pessimistic. Things aren't that bad. All we're doing is saying that there's been this, as I said, this slow drip since the beginning of the year where everyone has expressed concern. I think all of our customers, Mark interfaces with them more than I do on a daily basis, and maybe he wants to comment as well, but I think all of them have said from the very beginning, yes, 2019 was expected to be a slower year than last year.
As we went into the year with all of the confusion and chaos, more driven by governmental issues than anything. If we didn't, with government shutdowns, you name it, on and on and on, tariff this, tariff that, if we didn't bring calmness and noise down in the marketplace, we could begin to do things to damage the economy.
Nothing really has changed to make everyone feel different over the first six months. We're looking at, is this the new norm for the rest of the year? Now we're talking about another government shutdown, maybe as early as September or October. As I said, unfortunately, in this day and age, I'm obligated, we're obligated, to update guidance when it changed. We were trying to figure out where to put the peg in. We said, "Let's assume that what we have today continues for the rest of the year, and let's hope that we're wrong and that things pick up," as opposed to saying, "Well, we don't really know. Let's not take a realistic view." We can always just take our guidance down again next quarter. You don't want to get into that situation.
We think this is a realistic look at the state of the economy and where we fit in. We're confident with that. Plus it gives us the ability internally to say, "Hey, guys, this is the new norm. Let's tighten our shoes. Let's get to work, and we're going to achieve our targets.
Okay. Thank you.
Thank you. Our next question comes from David Vernon with Bernstein. You may ask your question.
Hey, guys. The down -1% to -2% for the full year, I'm just trying to get a sense for what we should be expecting for sort of operating income dollars, not necessarily the operating ratio. The Street's right now got you up +3% inclusive of land sales, up +6% ex land sales. What kind of EBIT growth on a down sort of -3% to -4% back half of the year should we be expecting?
David, as you know the math, if I gave you the EBIT growth, you would know the OR. By default, if we're not giving you the OR ratio into the back half, we're probably going to.
Is it reasonable to expect up a little, down a little, flat? Can you give us some directional guidance on where the EBIT number will be?
Look, I think we gave the revenue guidance, and we gave an OR target, and I think we're going to stick with that for now. We'll obviously update as we get further through the year.
All right. Maybe just as a follow-up, if you look at the sequential downturn in the other revenue, was that just like changing the rules on when you're charging demurrage? Because the volume was sequentially flat in the intermodal, and that was what was called out in the report. I'm just trying to get a sense for what drove that sort of sequential move lower in the other revenue.
Well, when your intermodal volumes are down 10%, there's a lot less boxes sitting in terminals, and we're charging a lot less. Clearly, look, as we've told everybody before, accessorial charges are something that we're not looking to make a lot of money there. It's really changing customer behaviors and getting boxes to flow and assets to move throughout the network. Some of that is working, and we're working with our customers, and we're seeing some good dwell numbers, and so we're happy with where that's trending. Obviously a lot of that was driven by just lower intermodal volumes.
The volumes from one to 2Q were flat.
Pardon me?
The 1Q to 2Q, the sequential volume was kind of flattish, and you went from like 168 - 124. I was trying to understand, did you see a really big pick up in the yard performance, or was this just that you dealt with some changes in volume?
Again, most of this is international intermodal, and this is where these guys are the guys that say they can't have off-site storage. They must store their box in our terminal. Well, guess what? When you start charging them, suddenly they find ways, and they move their boxes to container storage facilities located near our intermodal terminals. That's just the nature of the beast. Yeah, volume on the international side, overall volume was down, and intermodal volume on the international side was relatively flat. The customer behavior that Mark just alluded to, these are the first guys that take advantage of that and get them out of there.
All right. Thank you.
Thank you. Our next question comes from Jason Seidl with Cowen. You may ask your question.
Thank you, operator. Jim and team, thanks for squeezing me in here. I have one question. Looking out at intermodal, obviously, you guys demarketed some of the business because there wasn't enough on some of the lines, and the profitability just wasn't there. It's clearly important to raise the profitability of intermodal. How much of that is improving service, and how much of that is going to be you guys going after higher prices?
Yeah. A lot of the work that we're working on right now is changing the footprint and working on taking out all the unnecessary touches and switching that we used to do with intermodal that was crazy. Changing this hub-and-spoke system that we inherited when we joined the railroad, which caused a lot of inefficiencies in our intermodal product and in our service, and drove up our intermodal cost significantly. We have changed that model. We have gotten out of a lot of the lanes that were clearly very unprofitable for us. We're focusing on what we do well and the lanes that we do well. In our contracts, we have longer term contracts, so we're not susceptible to the very sort of mid to high single digit exposure to the spot market. It doesn't really affect us too much.
Most of our pricing is under long-term contracts with rate escalators, annual rate escalators. We're working there, and we're doing a good job, and we're going to see the profitability of that business segment improve over time.
Okay. Thank you for the time, as always.
Great.
Thank you. Our next question comes from Walter Spracklin with RBC Capital Markets. You may ask your question.
Yeah, thanks very much. Good afternoon, everyone. I'll keep it to one as well. Just, again, on the intermodal side and your effort, I think, Mark, you were saying targeting trucking. One of your peers, obviously, in Canada, is taking a little of a different approach to that. They're not only targeting the trucking market, but investing in and buying intermodal assets within that market to kind of jumpstart and accelerate that conversion, that truck-to-rail conversion. Is that something you would consider? Is that something you've looked at? What's your overall view on that strategy?
I think they're smart people. Jim and I know them really well. Obviously, I spent a lot of my career at that railroad. I admire what they're doing. We have a little bit of a different model here in the United States than up north. We look at what they're doing, but I'm not going to share with you on the call today strategies for the future. Listen, as Jim alluded to, we're looking for growth opportunities everywhere, whether that's in merchandise, whether that's in intermodal, and you never say never to any opportunity that comes across your desk.
If JJ and Keith are looking at it, we're watching what they're doing.
Yep.
Fair enough. Maybe if I could sneak one in there as well, an extra one. R&D, Mark, again, you mentioned it. Technology, I think the rail industry's ripe for it. Can we see, or do you expect to see, this is better for Jim, perhaps, more of your CapEx dollars going toward potential investment in accelerating the R&D applicability to rail to get some of those extra efficiencies from that trend? Just curious your thoughts on that.
Hey, this is Kevin. First of all, tech dollars are up this year. We are spending more on CapEx technology. I'll let Jim answer the rest of that question.
Well, again, it's something we're always looking at. We're here to grow the business, simple as that. This is not, despite what a lot of people say, and not you guys, but a lot of people say, we're here to shrink the business to profitability. We're here to make the business run better so that we can grow it. We'll look at every opportunity where we can make a buck, and make in the process, make the shareholders rich and famous. That's what it's all about. We're always studying every opportunity that we can pursue.
Okay. That's it. Thank you very much.
Great.