Good afternoon, ladies and gentlemen, welcome to the CSX Corporation First Quarter 2018 Earnings Conference Call. As a reminder, today's call is being recorded. During this call, all participants will be on a listen only mode. Following the presentation, we will be conducting a question and answer session. To ask a question, press star one. For opening remarks and introduction, I would now like to turn the call over to Mr. Kevin Boone, Chief Investor Relations Officer for CSX Corporation.
Thank you, Michelle, good afternoon, everyone. Joining me on today's call is Jim Foote, Chief Executive Officer, Frank Lonegro, Chief Financial Officer. On slide two is our forward-looking disclosure, followed by non-GAAP disclosure on slide three. With that, it is my pleasure to introduce our President and Chief Executive Officer, Jim Foote.
Thank you very much, Kevin. It's great to be here this afternoon with everybody on the call. Before we start with the slides, I would like to make a few comments. CSX had a very good quarter. We are drastically changing the way we operate the railroad by taking millions of unnecessary steps out of the business process that we use to run the railroad. This is producing record operating performance, improved customer service, when combined, impressive returns to shareholders. The women and men of CSX have accomplished a lot. Clearly, first quarter results are a reflection of all the hard work that has taken place over the past year. We are proud of these results, I would like to thank all CSX employees for their contributions towards achieving them. With that said, the plan recently laid out at our investor conference is a three-year plan.
We're only one quarter in, one out of 12, we still have a lot of work to do to achieve our goals. The good news is that every day I feel a little more confident in our ability to deliver on these targets. I want to take the time to highlight safety. On my watch, safety will always come first. We have some work to do to improve, the team is committed to do so. To be the best run railroad, you have to be the safest. Let's get into the deck. We'll start with the slide five on our highlights. This should be a pretty simple quarter to walk through. We only had one extra day in last year's first quarter, other than the restructuring charge last year, just a few relatively minor one-time events that Frank and I will point out.
EPS increased 53% to $0.78 versus last year's adjusted EPS of $0.51. The increase was driven by lower costs on flat revenues, which drove a 19% improvement in operating income versus the prior year's adjusted results. The new lower tax rate and share count, down about 4%, also contributed to the significant year-over-year increase. Our operating ratio improved 570 basis points to 63.7% when compared to last year's adjusted OR of 69.4%. A record first quarter. I might be a little biased, but I think it's CSX's best quarter ever. Lower costs in labor and MS&O partially offset by price driven higher fuel costs drove a significant year-over-year improvement. Going to the next slide six, total revenue was flat as price, fuel surcharge, and supplemental revenues offset a 4% decline in volume and negative mix. We did see a slight sequential improvement in pricing, excluding coal.
Looking at the business segments, each was to some degree impacted by either outside influences or a prior period de-marketing decision. Chemicals was impacted by a few items, including no fly ash movements that occurred last year, lower plastic and pet coke shipments, and basically no crude by rail. Lower North American vehicle production and challenges with railcar availability, which was an industry issue, reduced auto. Ag and food was mainly impacted by lower ethanol business, which we exited because of its low or no margin. Fertilizer revenues, as I mentioned previously, were down due to the Plant City facility closure. Domestic utility coal declines were somewhat offset by a continuing strong export coal market. Intermodal saw strong international volumes. Other revenues increased year-over-year as liquidated damages contributed $19 million, and the remaining increase was driven by higher demurrage and other supplemental revenue.
Obviously, we have changed the business practices in this area and are working with our customers to create a more fluid network. On slide seven, let's take a quick look at our operating performance. We've highlighted some key metrics that are familiar with you. As we outlined at the Investor Day, we continue to make significant progress year-over-year in both train velocity and car dwell. We also saw improvement in train length and GTMs per available horsepower, which represent improved asset utilization and efficiency. It seems like almost every day we set a new CSX record in one area of our operations or another. We are making progress, but there is clearly more opportunity ahead. Since the beginning of the year, we reduced another 142 locomotives and a total of 816 year-over-year.
Service design improvements have seen a reduction in over 40.8 million expected annual car miles and 351 weekly crew starts year-to-date. Brian Barr in our mechanical department has done an exceptional job with line of road failures, improving 35% and doing it with a smaller workforce. Now let me hand it over to Frank, who will take you through the financials and provide more details on the benefits from the operational improvements.
Thank you, Jim, and good afternoon, everyone. Turning to slide nine, let me walk you through the summary income statement. Reported revenue was roughly flat the first quarter as a 4% decline in volume was offset by the benefits of increased supplemental revenue, higher fuel surcharge recoveries, and solid core pricing gains. Moving to expenses, the P&L reflects our adoption of the new pension accounting standards, where only the service cost component of our pension expense is now included in operating expense, while the remaining aspects of pension accounting now fall below the line in other income. Prior year results, including the geography of last year's restructuring charge, have been restated to reflect this new standard. Total operating expenses were 13% lower in the first quarter, 8% lower after normalizing for last year's restructuring charge.
Overall, labor and fringe savings of $100 million or 12% year-over-year were driven by an 11% reduction in average headcount. Scheduled railroading enabled train crew savings on multiple fronts. A 22% increase in velocity and a 5% increase in train length enable an 8% reduction in road crew starts, while the elimination of eight hump yards last year and a 20% improvement in cars processed per manhour drove savings in yard staffing levels. Improved network fluidity, seen through the velocity and dwell metrics, combined with a 20% improvement in GTMs for available horsepower, has helped eliminate rolling stock assets. Our active locomotive fleet was down 23%, and the number of cars online came down by 11%, the combination of which enabled resource reductions within our mechanical workforce.
In addition, the efforts we started in early 2017 with our management restructuring to streamline the management workforce, eliminate bureaucracy, and improve the speed of decision-making across the system and here in Jacksonville have resulted in significantly lower labor expense. Fewer management resources also resulted in lower incentive compensation expense versus the prior year quarter. MS&O expense was down 16% against the prior year. The asset efficiency of scheduled railroading, combined with improved year-over-year locomotive availability, resulted in lower fleet counts, yielding lower materials expense, lower maintenance and repair costs, and lower levels of consumables. Given the sustainable nature of these asset reductions, we have sold or scrapped hundreds of engines and thousands of freight cars in the past 12 months. The locomotive fleet reductions have also allowed us to rightsize our contracted maintenance services agreements.
Fewer crew starts and a more balanced network operating plan also drove reductions in ancillary costs such as hotels, meals, and taxis. Efforts to streamline the workforce and reduce organizational complexity also apply to our contractor and consultant workforce. Working towards our broader total workforce targets for 2018 and beyond, we have made significant progress in reducing our labor footprint, with savings from contractor and consultant reductions flowing to the MS&O line. Finally, continued efforts to monetize our surplus real estate portfolio resulted in $32 million of real estate gains in the quarter versus $2 million in the year-ago period. The gains in this year's first quarter are consistent with the guidance we provided at the investor conference that we would achieve $300 million of cumulative real estate sales through 2020.
Looking at the other expense items, depreciation increased slightly due to changes in the asset base driven by capital investments offset by asset sales. 24% higher fuel prices year-over-year presented a significant headwind. Although our continued focus on fuel efficiency through better matching of horsepower to trailing tonnage and increased use of energy management and distributed power technologies drove year-over-year improvement in fuel efficiency despite harsher winter conditions this year. Equipment rents are up slightly due to higher incidental rents, though we are continuing to drive days per load improvements to reduce our car hire expense. Equity earnings were favorable, primarily due to improved performance at our affiliates and tax reform true-ups. Lastly, we are cycling 2017 restructuring charges, part of which are now housed below the line due to the new pension accounting standard.
Below the line, interest expense increased, primarily due to the additional debt we issued earlier this year. Tax expense was roughly flat on a 57% increase in pre-tax earnings, illustrating the favorable impacts of tax reform. Our effective tax rate in the quarter was 23.8%, though we continue to expect around 25% for the full year. All told, these pieces sum to the headline item Jim highlighted in his opening remarks. Importantly, the 63.7% operating ratio we achieved in the first quarter represents a meaningful step toward the 60% operating ratio target we set at last month's investor conference. Turning to the cash side of the equation on slide 10, capital investments in the first quarter reflect our recently announced three-year capital target of $4.8 billion, driven by the reduced capital intensity of the scheduled railroading model.
As we've said many times before, and reiterate here, our commitment to investing in safety and reliability remains unwavering. We have undoubtedly become a less capital-intensive company through improved asset utilization that reduces yard infrastructure and rolling stock needs, and better processes that serve as an effective alternative to capital investments. Our free cash flow growth of 3% was more muted than our earnings growth would have implied. First and most importantly, estimated federal tax payments for the first quarter are not paid until April. As a result, you see the year-over-year benefits of tax reform in our earnings, but not yet in our free cash flow. Second, as with any quarter, there are timing items that can impact free cash flow on a short-term basis. Here, we made back wage payments in the quarter to employees affiliated with unions that have concluded national bargaining.
There were also timing differences in state tax payments and prepaid expenses. Bigger picture, the combination of core earnings growth, lower CapEx, and lower cash taxes will drive significant free cash flow conversion at $8.5 billion of cumulative free cash flow through 2020. Finally, we were pleased to provide significant returns to our shareholders during the first quarter. On February 12th, we announced a 10% increase to our quarterly dividend and meaningfully increased our share buyback program to $5 billion, with expected completion in the first quarter of 2019. As you evaluate our buyback cadence in the quarter, remember that our buybacks in the first half of the quarter were premised on a much smaller $1.5 billion program. Since implementing the larger program mid-quarter, we have capitalized on recent market fluctuations and repurchased shares at a faster than pro-rata pace.
With that, let me turn it back to Jim for his closing remarks.
Great. Thanks a lot, Frank. As I said at the very beginning, it's a very simple and clean quarter for everyone to understand. In conclusion, on the last slide here, a little bit about the financial outlook. As I said before, previously slide, we expect the revenue to be up slightly for the year, and I have increased confidence in this outlook given the start of the year. Also, as many of you are aware, as I am happy to say, not only to say it, but I am happy that we are no longer under the requirement to have weekly calls with the STB. We have improved our service, and I expect that to continue. As we demonstrated in the first quarter, we expect a solid step-down each year in the operating ratio.
There remains significant work ahead in order to deliver on our 2020 target of a 60 OR. However, our goal of making CSX the best-run railroad is in sight, and we are working hard to achieve that. I would like to turn it back to Kevin now. We can start, Frank and I will be glad to answer any of your questions.
Okay. Before we get started, in the interest of trying to get to everyone in the queue, I will ask that analysts limit themselves to one question and a follow-up as needed. Michelle, I think we're ready to take questions.
Thank you, sir. As a reminder, if you would like to ask a question, you may press star one. To withdraw your question, you may press star two. Our first question comes from Chris Wetherbee from Citigroup. You may go ahead.
Yeah, hey, great. Thanks, and good afternoon. I guess maybe wanted to start on the revenue side. Jim, you kind of outlined the outlook for some modest revenue growth over the course of the year. I guess when you think about volume and price, can you give us a little bit of help there? When you looked at yields in 1Q, they certainly were good. Can you give us a sense of maybe where core pricing is and maybe what that assumption is, a mix of volume and prices as the year progresses?
Yeah, I think what I said was prices sequentially improved slightly if you exclude coal. If you look at the revenue, clearly, we are going to continue to see a slight tick up as we go through the year in our supplemental revenues, as we've implemented more specific demurrage policies, as an example. You'll see that in other. Fuel surcharge, it's going to move up and down as the year moves around. I think there's a reasonably solid environment out there for pricing.
Based upon kind of an expectation that we've put out there in terms of a year-over-year slight increase, the run rate you're seeing there today in terms of volume and these other elements that increase or bringing together total revenue should be reasonably consistent with what you saw here. As you remember, we've had a lot of one-time items in the prior year that we demarcated, as an example, the 7% volume of intermodal that was taken off the railroad in the late summer of last year, as well as some other items. Those items we begin to cycle, that's why we're a little more confident that the volume in the later part of the year begins to see more of an improvement than what we're having right now.
Okay, cadence could get a bit better as the year progresses. That's helpful.
That's one sort of way of saying it, yes.
Yeah I appreciate it. No, your color was greatly appreciated. I guess, just trying to get a sense of what maybe normal seasonality from an operating ratio perspective might look like. You guys are doing some dramatic things on the cost side, so it's a little hard to kind of see through that and relate it back to your historical patterns from 1Q and then how the rest of the year typically plays out. Is there anything you can help us with, and maybe Frank, sort of headcount expectations. We saw where you ended the quarter, but anything you do on the cost or cadence of the OR improvement in 2018 would be helpful. Thank you.
Clearly, the first quarter, I think in everybody's opinion here, the first quarter is the toughest operating environment for CSX. I'll let Frank jump in if he has anything additional to that.
Chris, the only thing I'd add is you imply seasonality for the rest of the year. Remember that we had a couple of fairly significant one-time items in the second quarter, you probably need to adjust a little bit for that one. On the headcount side, you see the 3,000 year-over-year in the first quarter, and it really doesn't matter whether you look at average headcount or ending headcount, we're down about 3,000 employees year-over-year. When you add in contractors, it's a little bit more than that on a year-to-date basis, about 1,100 down year-to-date, and that's against the goal that Jim set on the fourth quarter call of around 2,000. We feel like we're in pretty good shape on that one. Hopefully that gives you enough color to go on.
Okay. Very well. Thanks very much for the time. I appreciate it.
Thank you. Our next question comes from Ken Hoexter from Bank of America Merrill Lynch. Sir, you may go ahead.
Hey, great. Good afternoon. Hey, Jim, your thoughts on the service failures of some of your peer railroads, does that impact your ability to continue this pace of improvement, just given the amount of traffic that is interchanged between rails, whether it's your fellow eastern peer or even going west or north? Can you just talk about the constraints that you see from that?
Well, Ken, clearly it's a network out there. We're impacted to a degree by our interchange partners, whether they be in the west at Chicago or Memphis or wherever, or the Canadians, again, in Chicago or wherever we interchange traffic. Obviously, we would like to have a more fluid network. It's better for us. I think if you look at our operating performance in the first quarter, and if you look at the way we ran our network during the first quarter, if you wanted any proof that the scheduled railroad model works, you'd want to stress it. I think we passed the stress test in terms of Hunter didn't build a dome over this railroad. We are operating in the same winter conditions as everyone else, and in the same soup, so to speak, with everyone else.
We improved dramatically, I think that shows the resiliency and the strength of our organization to perform even better in the future, just based upon historical operating performance metrics.
Yeah, truly a great job. Just didn't know if there was a limitation based on what you saw, but great job. The follow-up would just be on the sustainability of your other revenue surcharges. Does business adapt now that they see that you're increasing your rates on demurrage and other items, or does that come back down as your customers adapt, or do you expect that to continue to grow as you've changed the business based on what you've seen in the past?
Hey, Kenny, Frank. We broke out for you the liquidated damages piece in the prepared remarks, you've got that as an item, obviously, to look at on a one-time basis in the quarter. We're not trying to make tons of money on supplemental revenue. We're really trying to change the behavior of the customers so that we get into seven-day-a-week service, we get into balance, we get into the things that scheduled railroading is all about. In some respects, we need the customers' help in turning cars faster. This is really intended to be a behavior changer. I wouldn't imply the run rate that you saw here in the first quarter for the rest of the year. Think something more like the 115 type of a number for Q2, 3, and 4.
Obviously, we're expecting the customers to change their behavior and not want to pay these charges going forward. Jim's commentary on the top line should give you a sense of where we think we're going to be on a volume basis. We feel pretty good about it.
Great job. Appreciate the insights and time. Thank you.
Thank you. Our next question comes from Tom Wadewitz from UBS. He may go ahead.
Good afternoon, congratulations on the great results, really strong OR and cost performance. Wanted to, I guess, get your thoughts, kind of a granular one and then maybe a broader question. The comp and benefits per worker, we were thinking maybe be up year-over-year, was down, I guess incentive comp was down. Can you help us think about, against the backdrop where performance is good, is incentive comp going to be down in coming quarters, or was that kind of a one-off? How do we think about comp per worker as we look to second quarter, third quarter? Does that continue to be down, or how would we think about that relative to first quarter?
Got you. Hey, Tom, Frank. You're right on a comp per person basis in the quarter, we were better by about 1%, and you're right, the driver is largely the year-over-year favorability on incentive comp, probably a tad of employee mix in there as well. You think about modeling into the future, if you assume static employee mix, you're really just talking about inflation and then just spreading out your fixed costs. I think what you're going to see on the incentive comp piece depends on how we do against our plan as the year goes on. We did have a fairly significant headcount reduction year-over-year that drove it lower in the first quarter. As you think about the fourth quarter, remember, we had a fairly significant reversal of incentive comp in the fourth quarter of last year that will cycle.
That was the reversal of Hunter's options, if you remember, about $30 million number. Just as you think through how to model that, those are probably the big moving parts.
Okay. Instead of comp might be down, you hit fourth quarter, it's tougher comp, it could be up. Is that-
I think that's fair, yeah.
The broader question I have, I think you were asked this a little bit earlier, but with the 63.7% OR in first quarter, if you just apply normal seasonality, you could see 300, 400 basis points of improvement in second and third quarters versus that. That puts you at a 60%, 61% potentially, second quarter, third quarter. Is that a reasonable framework that that's possible you deliver that? Should we step back from that and there were one-offs in first quarter, whatever reason that type of pattern wouldn't apply?
Tom, as I said, we delivered a very solid and impressive performance in our historically most difficult period. As I said many times in my opening remarks, this ain't easy. We're going to continue to grind, and we're going to continue to do everything we can to continue to improve. One quarter out of 12 isn't the game done, game, set, match. You figure it out, this is hard work and hopefully we're going to get better. I wouldn't draw any kind of drastic conclusions from the enormous step down we just had in one quarter.
One other thing, Tom, just as you think about your year-over-year comparisons, Q1 of last year was pre-precision railroading. You're not necessarily comparing apples to apples, whereas I think as you go forward in this year, obviously we made significant step downs in Q2, three and four year-over-year against 2016. Just sort of put that into the hopper as well.
Great. Thank you for the time.
Great, Tom.
Thank you. Allison Landry from Credit Suisse, you may go ahead.
Thanks. Good afternoon. Given the tightness in truckload and the service issues at Norfolk, do you think that your intermodal volumes could recover a lot sooner than you originally expected, and I think is consistent with your comments at the Analyst Day. How should we think about perhaps the cadence for the balance of the year and maybe what the potential upside is?
Yes, intermodal this year, like I said, though, has a big hole to climb out of to a degree. As we move forward, I think that clearly there is a lot of opportunity for us on the intermodal side, both internationally and domestically. We have two specific goals in mind as we look forward for intermodal, which I think we outlined at the investor conference, is one, to make sure we improve the overall efficiency of the network and concentrate in the key corridors that are best for us. Secondly, focus on the profitability of the business. Just because there might be a lot of intermodal and truck business that's available in the marketplace right now, I'm not going out and just chasing it to put volume on my railroad.
We're going to logically and methodically move forward with the rollout of our growth plan. Therefore I'm not looking for a major upside in what we've already told you.
Okay. That's all for me. Thank you.
Thank you. Scott Group from Wolfe Research, you may go ahead.
Hey, thanks. Afternoon, guys. Wanted to start on coal, maybe if you can share some views there. Met prices dipped a little bit below $200 and how you think about export volumes and maybe coal yields on a sequential basis given some of the step down in met prices and then maybe just some views on utility coal volumes that were down a bunch in first and how you're thinking about that the rest of the year.
Yeah, let's take the second part of your question first, utility coal volumes. You know what the challenges are there in terms of the southern utilities here are now the ones that are becoming more vulnerable. Northern utilities were stressed a few years ago, domestic utility coal volumes, and now it's moving into the South. As gas prices stay low, we're going to try to do everything we can to keep those utilities up and operating. It's a challenge for us. We're expecting that the domestic utility side of the business is going to remain under pressure absent some other forces that would change that. On the export side, both the thermal and met coals have remained relatively strong, stronger than we had originally expected, and the outlook for this year is that that strength should continue.
We're not seeing, even though some of the metrics that are used to price the business, like the API2, are starting to trend down slightly, the demand is still there. We'll continue to do everything we can to maintain the domestic utility franchise, and we'll continue to run the wheels off the rail cars to move as much of this export coal, whether it be thermal or met, as we possibly can, as long as the demand is there.
That cell phone. Jim, do you have a big length of haul difference to southern versus northern utilities?
I think we do, yes.
Longer to the south.
Yes.
Okay.
The mines are more located in the north, so we run it further.
Okay. Frank, just quickly, can you just clarify what your point was about the buyback? I know you didn't have the new, bigger buyback until sort of the middle of the quarter. What sort of quarterly run rate should we be thinking about for dollars on the buyback?
Well, it depends on what the stock price is, to be honest with you. No, we're obviously in the market pretty heavily, about $835 or so million in the first quarter. The point I was trying to make was, if you were looking for a straight pro rata version of the $5 billion over five quarters, given the fact that we entered the program mid-quarter, we didn't obviously hit that. From a run rate perspective, if you had forgiven the first six weeks, which were under the earlier program, we were ahead of a pro rata from that level. Obviously, it's going to depend on our prognosis for our performance for the year. It's going to depend on what we think the economy's going to do, and it's going to depend on what the market's reaction to our performance is.
We're clearly going to return a significant amount of capital to shareholders over the coming four quarters. We've dimensionalized that for you. The exact cadence, I think, is just going to depend on the factors that I mentioned.
Okay. Thank you, guys.
Thank you. Our next question comes from Fadi Chamoun from BMO Capital Markets. You may go ahead.
Okay. Thank you. I just want to go back to the volume kind of questions. You've outlined at the Investor Day to us that ultimately the improved cost, improved service, your ability to start leveraging that to grow the business faster is more of a 2019, 2020 story. I'm wondering, given some of the service issues we're seeing elsewhere and the trucking capacity problem, is there an opportunity here to see an acceleration? How is the conversation with customers going? How do you feel about your ability to begin to leverage this service and cost story a little bit earlier?
It was only six weeks ago, or whatever it was, we were in New York and laid out this plan. The weather conditions across North America were brutal at that time, and the railroads, to a large degree, were having issues at that point in time. Everybody in the world knew about ELDs and all kinds of challenges that were there. There haven't been really any kind of external influences that would make us change our minds right now in terms of what we see for the rest of the year, which is what I said in summary. What I said six weeks ago is kind of where we still are. Obviously, we were running our railroads six weeks ago really good. Like I said, not only externally, but internally, there's not a lot changed.
Our service is second to none, and our strategy to leverage that service, and make sure that we are appropriately compensated for the service that we provide is still our strategy. That is not something that you want to turn on a dime and discount in order to put volume on the railroad. It's going to be a methodical, strategic, rational growth story as we go forward and as we improve the efficiency and as we clearly distinguish ourselves in the marketplace, and show to the customers that we can create value for them. We will begin to have the growth. I believe we will continue to have the growth, or we will achieve the growth that we outlined to you in 2019 and 2020. I see no reason to try and do something to accelerate that strategy.
Okay. Maybe just one quick follow-up. When we look at the intermodal pricing, what you're reporting in RPUs and intermodal, how well aligned is this with the current market rates that we're seeing on the truckload side? Is there an opportunity to move that materially as you begin to touch a little bit more of your contracts?
I do not have the ability to price my portfolio of business to the markets on a daily, weekly, or monthly basis. We have long-term contracts with our existing customers, a large part of that business is locked up. The pieces of the business that aren't, I will take advantage of the market environment to price the business appropriately. That's kind of a methodical, these things roll over a little bit here, a little bit there, a little bit in the summer. More so than just a tightness in the truck market is the differentiation now that in the quality of my service and the reliability of my service is what's going to be the main factor in driving growth in the future.
I appreciate the feedback. Thanks.
Thank you. Our next question comes from Amit Mehrotra from Deutsche Bank. You may go ahead.
Thanks, operator. Just first question, Jim, can you update us on how the apology tour is going and anything tangible you can share following the disruption last summer? Kind of related to that, Canadian Pacific put out a release last week saying that there's still significant gaps, quote-unquote, in terms of them reaching an agreement with their unions. If you could just help us think about what the exposure, if any, I'm sure there is some, for CSX, if there's any type of work stoppage at CP, either on the revenue side or related to the cost actions. Thank you.
Boy, no apology tour anymore. That's canceled. Nothing to apologize for. The railroad is running great. Again, if you look at the metrics, our railroad is running better than anybody else in North America. I got a suitcase that says, "I apologize" on it, so maybe one of the other railroads wants to borrow it, I'm not using it. In terms of the Canadian Pacific, I don't know if they're going to have a strike or not. I don't think they know if they're going to have a strike or not. I can't really speculate, and I can't comment on that.
Well, I'm not asking if they're going to have a strike. What I'm asking about is if they do, what's the exposure to CSX?
I think that's a hypothetical question, so I just said I'm not going to speculate.
Okay. I'll move on. Thanks. Just one quick one for Frank on the buybacks and debt levels. Just from the perspective of the rating agencies, I guess the rating agencies look at balance sheet capacity and buyback. I guess they have a couple different metrics and can maybe even conflicting with each other in terms of retained cash flow and the way they compute that versus maybe adjusted debt to adjusted EBITDA. You could be well in the parameters of retained cash flows or percentage of total debt, but out of the parameters of adjusted debt to adjusted EBITDA. Maybe it's a little bit too technical for sure, but if you could just help us think about how CSX thinks about its balance sheet pro forma for all the share purchases.
You certainly have the capacity, but just philosophically, if you can just help us with that, we'd appreciate it. Thank you.
Hey, sure, Amit. We spent a fair amount of time with the rating agencies earlier in the year as we looked at our credit profile, we looked at the debt we wanted to raise this year, we looked at the sizing of the buyback program, et cetera. I think we have a good understanding of where the breakpoints are. They obviously look at two key things at a very high level. One is leverage and the other is coverage. I think what tax reform has done is probably allowed a little bit more room on the leverage side because you've got more coverage, because you've got more free cash flow. I think we've struck a very good balance.
I think we have a very good understanding, I think everything that we are proposing to do on the buybacks, as well as on debt issuances later in the year, are all right in line with the conversations that we had with them. We feel like we're in really good shape.
If we just to press you a little bit more, if I could. As we look out beyond sort of the $5 billion framework that you provided and we kind of flex the beyond 2019, is it now kind of two and a half times net debt to EBITDA, which is maybe obviously a little bit higher on a gross debt basis? Is that the right sort of benchmark that we should think about from a modeling standpoint?
We said at the investor conference, I'll reiterate here, that we're going to look at that on an annual basis.
Okay. Fair enough, guys. Thank you. Congrats on a good quarter. Appreciate it.
Thank you.
Thanks.
Thank you. Our next question comes from Brandon Oglenski from Barclays. You may go ahead, sir.
Hey, good afternoon, everyone, and thanks for getting me on the call. Jim, can you just remind us of the level of business that you've looked at and said, we don't really want to have that on the network anymore? As we look at your volumes trending early in the second quarter, I think you guys are close to flat on the publicly available reports. How do we put that in context of the business that you walked away from?
Well, again, on the intermodal side of the business, as I think we've said, in the middle of last year, we started to transition away from what was referred to as the hub and spoke model in intermodal. In closing a number of lanes that we served, we took about 7% of the intermodal traffic off the railroad. We're getting close to getting intermodal volumes back to flat with prior years, so we're replacing a large percentage of that business. If our run rate is getting close to, on a volume basis, flat, that would give me, as I said earlier, a little more confidence that we're going to be able to have a revenue line for the year, which is slightly up.
It all fits in with our prior view of the year, that the volumes would strengthen across the board, with coal as always being somewhat of a question mark for us. They would strengthen as the year progressed, and we'd see enough in the second half of the year, to offset what is a 4% decline in volume in the first quarter.
Okay. Appreciate that. When you look across the network, you do have headcount down quite a bit. Like everyone's talked about, your OR has improved pretty aggressively here. What is left on the structural side? If you did have a big influx of demand, do you think the headcount levels can still come down, or are you at a point now where you would have to be thinking about hiring more people and bringing on more assets?
Clearly, you'd have to have some sort of monumental increase in volumes for us to be considering hiring employees back and assets. No, we've got 800 locomotives in storage. We're in great shape to handle any kind of increase in volume. Forget about taking assets out, we still intend to improve the fluidity of the network. We still intend to improve velocity. We still intend to drive down dwell. We still intend to increase train length. All of those initiatives do two things. One, improve our operating leverage, by driving down our costs and improving our efficiency, but they allow us, because of that, to add additional volumes with our existing asset base that we have today. We're handling just about the same amount of volume that CSX handled a year ago with eight fewer hump yards, 1,000 fewer locomotives, 4,000 fewer employees, 20,000 fewer rail cars.
Putting more volume into this railroad, that it's going to continue to improve to be operated more efficiently, is not going to be a challenge for us.
Okay. Thank you.
Thank you. Our next question comes from Brian Ossenbeck from JP Morgan. You may go ahead, sir.
Yeah, thanks for taking my question. Jim, just to follow up on the train lengths. We've been able to track those improving in the West and up North, but it's more recent phenomenon in the East. I was wondering, in a potential network, are there actual physical limitations to building train lengths, with grade crossings or something like that? Or is it just more temporary, and you just need longer sidings, the right balance to keep that trend going?
No capital necessary in order for us to improve train length. We are not restricted by siding length. We'd have a long, long way to go before we would need to spend capital to be able to get, say, 12,000 foot trains out there. If we were, that'd be a good news problem, which I'm sure we'd consider if necessary. That's not in our three-year vision to have to spend capital to do any of this stuff.
Brian, two other things I'd add to Jim's good comments. One is, we invested a fair amount on what we call the Southeast Corridor, Chicago into the Southeast, in the last decade or so. We're leveraging that clearly. As Hunter, Jim, Ed, and others have really looked at the network operating plan, we've done a fair amount to reduce congestion, i.e., to reduce the number of active trains. The number of meets and passes that you have in any given day is a lot less than it used to be.
Okay, thanks. Is there anything specific to the East, physical limitations, tighter short distances between grade crossings that would limit train length growth in the year?
No. No different.
Okay. Just wanted to clarify that. Thanks. The other question was just to go back to intermodal for a second, talking about disciplined growth in that business. We get a sense as to how you're handling the demand, but dwell times are up at terminals across the whole industry. Specifically wanted to get your comments on some of the terminal performance near the larger hubs like Memphis and Chicago, in addition to the dray capacity serving those markets.
We have improved the efficiency of our Chicago terminals, both Bedford Park and 59th Street, significantly. Everybody had challenges at Christmas time, in Chicago and Memphis, when the winter weather came in on Christmas Day and just hung around for a month. It slowed everybody down. Our dwells on Originating containers in our intermodal terminals, and containers that arrive in our intermodal terminals, our dwells are down because our train service is becoming more reliable and predictable. Therefore, the dray community can rely upon us to be there and have a load for them to haul away. Then at the same time, as we mentioned earlier, with us being more clear in what we expect of our customers in terms of when those containers come into our terminals, that we want them out.
If they don't want to get them out, they have to pay to store them. That is increasing the throughput and the fluidity of those two main terminals there. Again, Memphis has been a challenge for us, but Memphis is now running smoothly, I have a big focus on our intermodal terminals for this year, I'm positive. In fact, I was just in Chicago going through our Bedford Park and 59th Street terminals. I'm sure that we can make improvements there that'll improve throughput, which basically adds a significant amount of capacity without spending any money.
Right. Okay. Thanks for your time. Appreciate it.
Thank you. Matt Reustle from Goldman Sachs, you may go ahead.
Yeah, thanks for taking my question. Maybe I could touch on asset sales for a moment here. Made some progress in the quarter. What do you expect to be the driver of what determines whether you hit that $300 million base case or that $800 million in upside that you highlighted at the Analyst Day? Is it simply demand in the market? Are there certain assets that are tied to federal grants that make up a big portion of it? I guess if you could categorize the market for asset sales now, that would be helpful as well.
On the real estate side, we're seeing, obviously, pretty stiff demand for what we put out there for sale. Mark Wallace and his team are working awfully hard to free up assets that maybe haven't been for sale for a while. Obviously, you saw a good down payment on that $300 million in the quarter. From a line sale perspective, you've probably seen a little bit of traffic out of the STB on a couple of items that we have out for bid right now, you'll continue to see us focus on that. It is not a demand side problem. There is a lot of demand out there for infrastructure type assets. We think we're hitting the market at a pretty good time.
Okay, got it. Just one more on the higher demurrage charges. Is this a case where you're hiring the rates on customers, or is it becoming more strict on the chargeable days? Maybe you can walk through that. It seems like quite a jump for some of these customers in just one quarter.
Well, basically what you're talking about here is demurrage or detention, which is a standard operating practice throughout the transportation industry, whether it's the railroads, whether it's the steamship companies, whether it's the terminals. If your asset sits around on somebody else's property and you don't get it out, they charge you for what sits there because they can't use it while your equipment is sitting there. All of these charges, to a large degree, have been on the books of CSX for a long time, but were not necessarily enforced aggressively, or for one reason or another, a customer here or a customer there was given an exception to the policy because it was viewed as an incentive to the customer to come and do business with CSX.
Under our current model, under scheduled railroading, we're focused equally on providing our customer with a fair value for what they pay us, but at the same time, having an intense focus on the value of our infrastructure and the value of our asset, and we are not going to just give that away anymore. Again, as Frank mentioned in his comments, this is not something necessarily that we want to view as a profit center, that we want to, in any way, shape, or form, gouge our customers.
It is a simple fact of life that, again, when the car sits on our network, or it is our car that has been delivered for unloading and it's not unloaded, we expect to be compensated for either the use of our track space where the cars are sitting or the use of our asset while we can't use it for another piece of business. Again, these are standard industry practices that we just are applying in a more uniform and consistent manner.
Got it. Thank you.
Thank you. Our next question comes from Justin Long with Stephens. You may go ahead.
Thanks. Congrats on the quarter. Maybe to address service first and take a bigger picture approach. Clearly, you've shown improvement, but some of the other rails are struggling. Jim and Ed, you've seen a lot of service disruptions in the industry in the past. You know what it takes to fix some of these issues. With that in mind, when you look at the North American rail network as a whole today, do you have any thoughts around the timing of when we can return to an environment of normal fluidity?
No. I can comment on how CSX is run. I can't comment on when other railroads are going to do that. That'd just be inappropriate for me to comment.
Okay, fair enough. Maybe to go back to pricing for my second question, seems like things are moving higher, coal being the exception. Could you talk about your view on coal pricing going forward? I'm just curious if you expect this downward pressure to continue, and if you're pursuing any changes as it relates to the percentage of your contracts that have a fixed component.
Well, two pieces of business here. The export business, both the thermal and the pet coke pricing is kind of driven by other indices that we really don't have a lot of control over. That piece of business kind of goes up and down with those indexes. On the utility side of the business, clearly the coal-fired utilities, in competing with other utilities, generating facilities, that are using natural gas to generate, to run their turbines, the coal guys have a disadvantage, just on a cost per million BTU basis. To the extent that we can work with those customers, those coal-fired utilities, to give them a lower cost basis on a delivered per million BTU basis, i.e., mine mouth cost of the coal plus our transportation, we're going to try and do that, and see what happens. There is a lot of coal to the utilities.
The majority of the coal that comes from either the Powder River Basin or the Illinois Basin going to our utilities. There is a longer haul, the transportation component of that is larger than what has historically been the case, just because it's moving farther distance. If we can do something in that marketplace that will help our customer, that will allow us to use the fact that we've got coal assets, the cars and locomotives to move it, and it produces to us a very good return, we're going to try and do that.
Okay, great. Thanks for the time.
Thank you. Our next question comes from Ben Hartford from Baird. You may go ahead, sir.
Yeah, thanks for the time. Jim, any perspective on international intermodal particular, your service being a standout relative to the other rails, but any concerns from the steamship lines with regard to network fluidity broadly and diverting some of the flows away from the east and the Gulf Coast over to the west, to improve transit times? Have you heard any talk about that as we enter the spring peak?
Boom. I'm putting up a big for sale sign in, let's see, Jacksonville, Savannah, Virginia, Baltimore, New York, New Jersey. Open for business. Bring it in. We can handle it all. I'm good to go. I'm ready to handle their freight. Not a problem.
Okay. Then more broadly on protectionism, several weeks now into a lot of the rhetoric around tariffs, obviously on the steel and aluminum side and on the grain side now more recently. Any thoughts that you have as it relates to consequences near term that may have arisen given the rhetoric that we've now been absorbing over the past couple of months?
No. I keep being asked to become an expert on tariffs, and I'm not. Right now, everybody, yes. Everybody, it depends on what day it is, as to whether or not this is viewed as a good thing or a bad thing. Anecdotally, we're looking at moving some more petcoke and we're looking at some steel mills on our railroad opening up. That's just anecdotally. I'm sure as things play out, if anything does come to be, there'll be negatives and positives in it, and it's too early to try and guess what those might be.
Okay. That's helpful. Thank you.
Thank you. Cherilyn Radbourne from TD Securities. You may go ahead.
Thanks very much. Good afternoon. Just wanted to ask a question around routings. One of the things I was struck by at the Investor Day was just how in closing hump yards and in moving away from the hub and spoke system in intermodal, you'd eliminated some, what would seem like very dysfunctional routings. Could you just speak about what impact all of that has on length of haul in merchandise and intermodal, and what, if any, implications that has for RPU in those franchises?
Well, again, if you route a car in an inefficient manner, basically you have artificially increased the length of haul, assuming that you can haul it in a more direct fashion and assuming that you do. By improving the efficiency of your network and by taking out all of these millions of out route miles that we move cars on an annual basis, you're going to theoretically, and I would think actually, reduce your length of haul. At the same time, your revenue, if you just look at it on a revenue per unit basis, it's not going to change much. If you can get to a $0.01 per revenue ton mile, you would see an increase, because you're going to get the same amount of revenue and having less of a ton mile.
There are different metrics, but I think what you're trying to get to is, taking something and moving it in a straight line versus a crooked line is going to be less miles, and you're still going to get paid the same amount of money for doing it.
Great. Maybe just by way of a quick follow-up, in terms of the equity earnings of affiliates, that's a new income statement line item. Frank, can you just give us some help on how to think about a normal annual run rate for that?
That's a great question, Cherilyn. The equity earnings of affiliates, the reason that we had to create that was because of the non-consolidated subsidiaries, you might know those as Conrail, TTX, and the Belt Railway of Chicago, amongst some others. They had to actually revalue their deferred tax liabilities, and because of the size of those revaluations, we had to carry it as a separate line item. You saw a $25 million benefit in the quarter against a $13 million benefit last year. Obviously, those affiliates, when industry volumes are up, they do better. When industry volumes are down, they may not do as well if they're not pulling costs out at the same time. We did have some tax true-ups in there. We said on the call for the fourth quarter, we said, think about a $10 million-$15 million per quarter credit there.
We're probably at the top side of that one, if you're thinking about it from a run rate basis.
Great. That's all for me. Thank you.
Thank you. Our next question comes from David Vernon from Bernstein. You may go ahead, sir.
Hey, I just wanted to clarify, Jim, it sounded like you were talking a little bit before about the coal business trying to maybe get a little bit more aggressive to grow some utility coal business using price. Did I hear that correctly, or what were you trying to get at with the utility coal pricing commentary?
Basically what I said, yes, is on the southern electric utilities, to the extent that we can work with our customers, i.e., if it makes economic sense for us, CSX, to be more aggressive on price to keep those utilities up and running and using coal, we will try to do that.
Can you bound that for us as far as any sort of directional indicator of how much room there is to move in that stuff, on the rate?
We have room to move.
All right. Maybe, I'll follow up with Kevin offline, but maybe, Frank, question for you on the MS&O. How do you reconcile taking a lower accrual on the personal injury when the accident rates are up as significantly as they are in the quarter?
What the actuaries do, this is not something that we do, it's something that we work with actuaries on. They look at probability and severity. It has to do not just with the number of incidents, but also the severity of incidents, and it's over a longer term period of time. We give them all the data, they run the numbers, and we adjust the accrual as necessary. In some quarters and years, it might go up, and other quarters it might go down.
Our accident rates, actual accident rates in the first quarter of this year are not.
Yeah, the raw incidents that we had were roughly flat, both on a personal injury and a train accident basis. Obviously what moves the ratio is the denominator, which is per 1 million train miles on train accidents and 200,000 man-hours on PI.
Yeah. They're indexed to the volume of activity, right?
I got it. Right. I'm not suggesting that that's inappropriate. I'm just saying, someone can look at that number and say, "Oh my God, they're having a lot more accidents," when actually we're either equal to or slightly less than, depending upon what day it is, going forward in the year, kind of back where CSX historical run rates, and moving up vis-a-vis the rest of the industry in terms of these numbers.
The thing you have to remember, David, is in the frequency index, a sprained ankle counts the same as an amputation. I hate to be that graphic about it, but what we look at and what the actuary looks at is what is the frequency, so we talked about that, and then what is the severity based on our recent experience. That's why you see the change.
All right. Thanks for the color.
Thank you. Our next question comes from Walter Spracklin from RBC. You may go ahead.
Yeah, thanks very much. Good evening, everyone. What I'd like to focus in on is some of your opportunities after the full implementation of your precision railroading is rolled out and your service levels are really saleable. Jim, can you focus in on what you've seen as areas or sectors that you really see CSX as being able to grow into a little bit more than either competitors or more than it has in the past? Are there any sectors that really excite you with regards to that, of selling your service model once we get through this phase of de-marketing and slower volume growth in 2018?
Clearly, much, as you're familiar with this, much as the way we looked at this at the Canadian National in the early days, the benefits of this are on the merchandise side of the business. Having on a revenue basis two-thirds of your business tied to the merchandise segment, that's where you want to focus, and that's really where the value comes. Those are the customers today that are the easiest to convert because in all cases, they're shipping already today by rail. They're comfortable with shipping by rail. They're sophisticated and big customers who are shipping by rail, and they're paying a premium price to move a large product, same product that they're moving by rail, in a truck where they want to get reliability.
The big area of opportunity is to convert those customers and other customers like them to your network on the merchandise side of the business. Half of the intermodal business is looking at just for price, the other half of the business is looking for just price, but at the same time, a real high premium service. The area where you can focus and do the best good for CSX and the customer base is on the merchandise side of the business, we'll be transitioning a much greater focus on the top line in the out years than just throwing up and improving the basic operation of the railroad.
That makes a lot of sense, Jim. Reliability, clearly you're going to be increasingly have a reputation for higher reliability. How long do you think before those truck customers buy in and trust that by going over, they're going to get that reliability? Is this something that you've got to build out over quarters or over years? How long do you think that'll run?
Days, weeks, quarters, months, years. It depends upon who the customer is. It depends upon where you're doing it. Most of it, as in any business, you got to go in and sell the customer on the idea of converting. As I said earlier, these guys are sophisticated purchasers of transportation that know rail, they know truck. They'll scream at you every day that they have to pay premium prices when your service is not good, i.e., they got to pay more to put it in a truck. You just got to go into them and prove lane by lane by lane by lane by lane that you can handle their product to their valued customer, and do it in the same way, that the same level of efficiency and reliability that they get out of a truck.
They don't necessarily need it there in 24, 48 hours. They need it there with a degree of reliability that if you say you're going to do it in four days, it's there in four days, 85%, 90% of the time.
Right.
If you can do that and not have the outlier where, oh, that load didn't get there for 12 days and this one didn't get there for 10 days, that's how you win it back.
Makes a lot of sense. Okay, last question here. Senior management now, when you look across the group, you got a good set of railroaders here. Any areas where you think you're going to be looking to add or ameliorate over in 2018 in your senior management ranks at all?
Well, clearly, based upon the results and the performance and everything I've said since I've been here, we've got a great team of people that know what the heck they're doing. As I said, I'll match these guys up with anybody in the industry, and I think we've proven that with our first quarter results that we can perform with anybody. Yeah, there are some holes to fill in the organization that everybody is aware of. Ed and I are working really hard to make sure that we find the right people and the right talent who can fill those roles. We'll probably be moving some things around during this year to give people, again, opportunities to show what they can do in certain roles. We're not sitting still and sitting back on that area either.
Everything here is all systems go, improve the place and run it better and better every day and make sure we have the future leaders for CSX ready to go when called on.
Okay, exciting times. Okay, thanks very much, Jim. Appreciate your comments.
Thank you. Our next question comes from Jason Seidel of Cowen. You may go ahead, sir.
Thank you, operator. Wanted to touch back on price a little bit, excluding the coal franchise. Jim, I think you mentioned there was some sequential improvement there. Can you give us a sense of how much of your book of business for 2018 has already been repriced?
In what segment of the company?
Ex coal.
All right. I guess it's safe to say that we have, best way, say a third of the business rolls over every year. That's kind of a good metric to use. Again, I can't give you any much more guidance than that.
Okay. Piggybacking on some of your comments on the call, you mentioned that you might change some of the pricing dynamic. Should we think about it as maybe you guys setting this up as something that links to a natural gas index, like a Henry Hub, to be more flexible given some of the utilities needs?
That would be the obvious methodology to use.
Okay. Gentlemen, thank you for the time. Nice job on the quarter.
Thank you. Our last question comes from Ravi Shanker from Morgan Stanley. You may go ahead.
Thanks. Evening, everyone. Just wanted to make sure I understand your strategy on intermodal here with what is going on in the truck market. Are you saying that you are focusing more on getting pricing from existing customers versus focusing on truck to rail conversion, or are you pursuing the volume opportunity as well?
Clearly we're focused on two things. One, growing the business. Two, profitably. Volume with price equals top line growth. Whether that's an existing customer who can give me more volume or whether it's a new customer that can give me volume I don't have today, but that is always the equation. I do not have a scorecard in my office that says R2R or whatever we call it, road to rail, and how many did I get today? That's not a game that is going to make me any money. Just taking a truck off the highway and putting it on the railroad, if it's not priced right and it's not moving in the right and specific corridor, it adds no value to me.
At the end of the day, it adds no value to the customer because we probably don't do a very good job for him. Whether it's an intermodal customer or it's a merchandise customer, the whole objective here is to go to the customer and say, "I can provide you with value," whether it's the merchandise customer that we talked about before or whether it's the intermodal customer who wants to take advantage of the railroad in connection with his over the road trucking operation. I need to provide value to him and make sure that that value to him I get paid for. If the two don't align, if the guy wants me to add value, and expects me to give him a discount at the same time, the stars don't align, and he probably goes someplace else.
Got it, understood. Just one housekeeping for Frank. On the real estate gains, I think you had indicated at the Analyst Day that you expect that run rate to step down in 2018 versus 2017, but you had $30 million higher this quarter versus last year. I know that's a lumpy line, but what can we expect in terms of the cadence of that in the coming quarters? Because right now it looks like it's going to be a significant headwind unless you guys step into the extra $500 million market.
Ravi, we're not trying to time this at all. When the assets are up for sale and they are ready to close, we close them. Like you said, it's going to be lumpy in terms of quarters and years. We set that goal of $300 million in real estate sales. It's aggressive but achievable, and you might remember that in Mark's remarks at the investor conference, he actually said he thought there was some upside to that, which isn't in the targets that we set. We're not trying to time it at all. We're going to go as fast as we can and put the money in the bank as fast as we can.
Great. Thank you.
Well, I think we're done with all the questions, so we'll wrap it up here.
Thank you. This concludes today's teleconference. Thank you for your participation in today's call. You may go ahead and disconnect at this time.