Q3 2022 Norfolk Southern Corp Earnings Call
Greetings and welcome to the Norfolk Southern Corporation third quarter 2022 earnings call.
At this time, all participants are in listen only mode.
A brief question and answer session will follow the formal presentation.
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As a reminder, this conference is being recorded.
It's now my pleasure to introduce Luxe Nichols senior director of Investor Relations. Thank.
Thank you Mr. Nicholls you may now begin thank you and good morning, everyone.
Please note that during today's call, we will make certain forward looking statements, which are subject to risks and uncertainties and may differ materially from actual results.
Please refer to our annual and quarterly reports filed with the SEC for a full disclosure of those risks and uncertainties, we view as most important.
Our presentation slides are available at an S Corp Dot com in the investors' section along with a reconciliation of any non-GAAP measures used today to the comparable GAAP measures.
A full transcript and downloads will be posted after the call.
Turning to slide three it's now my pleasure to introduce Norfolk, Southern's, President and Chief Executive Officer, Alan Shaw.
Good morning, everyone welcome to Norfolk, Southern's third quarter 2022 earnings call.
I'm joined today by Cindy Sanborn, Chief operating Officer, Ed Elkins, Chief Marketing Officer, and Mark George Chief Financial Officer.
The Norfolk Southern team delivered strong financial results in the third quarter, achieving quarterly records for revenue.
Net income and earnings per share.
We also demonstrated our focus on productivity and efficiency with significant or improvement.
As Mark will describe in a moment.
Thank you.
All the men and women of Norfolk Southern for their remarkable work this quarter and throughout the year proudly, serving our customers and improving the quality of our product.
We are qualifying conductors that are robust pace executing and refining our top S. P. G operating plan and further strengthening our leadership team and operations.
The impact is evident across our network, we see improved operating metrics, such as higher train speeds and shorter dwells we.
We see improved customer facing service metrics, we hear improved feedback from customers, who are talking to us about adding business.
Volume is the lagging indicator and we are confident our broad and continuing service improvement will drive growth opportunities in the months ahead.
Today, the U S team is providing better service, creating network capacity for growth and demonstrating the customer centric operations driven approach that is the foundation of our success.
During the quarter, we reached tentative agreements with the unions that represent our craft colleagues.
This was a critical first step.
The tentative agreements recognize the significant contributions of our people and keep them among the highest paid craft workers in any industry.
And my continuing field visits with frontline railroad is in local supervisors I've been able to express my appreciation for the vital work they do for Norfolk Southern.
Our customers in the U S economy.
Working on the railroad has always been a great opportunity to build a fulfilling career and we want to keep it that way.
And the final days of the cooling off period as the possibility of service disruption land, we took a transparent no surprises approach to communicating with our customers, which help them make informed decisions about how to keep their goods and materials moving.
This is an excellent illustration of what it means to be customer centric.
Even though it created a modest headwind on volume as Ed will described we received positive feedback from many of our customers will take that same no surprises approach every time, because its how we will deepen customer trust and enhance long term value creation and growth.
Now I'll turn the discussion to Cindy for additional detail on our strong operating progress during the quarter.
Cindy.
Good morning.
Turning to slide five our resolve to improve service levels is paying off during the quarter, we executed a smooth rollout of the latest evolution of our P. S. <unk> based operating plan top S. P. G and ended the quarter with network velocity more than 20% improved from where it was entering the quarter.
As a result, the service recovery glide path. We charted earlier this year for the STB is trending well ahead of schedule.
We have more improvements to make with progress being fueled by staffing initiatives top S. P. G and disciplined field execution, we are gaining momentum and will continue to drive to enhance our customer service and create capacity.
Slide six highlights where we are with staffing levels of our transportation workforce.
Our pipeline of trainees remained robust and we have reached the waypoint target of approximately 7300 qualified teeny staff a month ahead of schedule.
This was accomplished through our innovative approach to recruiting and reinforces the advantage we have to recruit a high quality craft workforce that takes pride in moving the economy forward.
As you heard from Alan we are pleased to have reached tentative agreements in the quarter to keep that workforce among the highest paid in the nation.
Slide seven continues the discussion on service improvements we are making.
Last quarter, we shared with you the decision to adjust a couple of our existing major terminals from flat switching to humping.
Those shifts went smoothly and are paying dividends today.
We are leveraging a similar number of crew starts as we had entering this year inside our yards and terminals and are now moving cars more fluidly through those facilities.
As a result.
The railcar fleet is moving faster through our terminals were operating at high levels of productivity and creating capacity within our switching resources to drive further growth and productivity.
As I said last quarter, we will remain flexible to most optimally manage assets control costs serve our customers and do so safely.
Moving to slide eight G. T EMS were flat year over year, coupled with crew starts that were up 1% produce flat train length and white. We are very focused on the implementation of top S. P. G. In the quarter and are now poised for growth on our train network.
Active locomotives, we're up for the fourth consecutive quarter in support of service recovery and I am pleased to say that as we regain fluidity over the last couple of months active locomotives are trending down on both a sequential and year over year basis.
The skill of our mechanical workforce, coupled with our DC to AC modernization strategy allowed us to deploy surge fleet capacities to support service recovery at historic levels of reliability.
As I've discussed, we're continuing our modernization program in support of reliability and capacity in the future.
Lastly, this marked our fourth consecutive quarter of fuel efficiency gains again due in part to our fleet investments along with shutdown compliance initiatives augmented with enhanced communications technology and many more efforts.
Slide nine hits on a pillar of our digital strategy to power the workforce, which crosses our entire operations group.
Through empower the workforce, we provide mobile self service capabilities to our field forces and enable them to better manage their work with modern mobile applications.
They are no longer tied to fixed based reporting and can input and retrieve information when they need it in modern user friendly mobile applications.
We have our mobility group of technology specialists that are responsible for providing consistent consumer grade mobile applications to our transportation engineering and mechanical forces.
Whether it's an application for reporting railcar pick up some set offs <unk>.
<unk> track authority are recording bridge inspections, we are providing information, where where and when our employees need it in order to better manage their workday.
To wrap up slide 10 is a snapshot of our progress on operating safely we've been aggressively hiring and have a strong focus on equipping our workforce with the training and tools to perform safely inefficiently I.
I want to thank our entire workforce for their focus on the job at hand throughout the very dynamic third quarter I am pleased with our progress, but we'll never be satisfied until you reach zero accidents and injuries.
Thank you and I will now turn the call over to Ed.
Thank you Cindy and good morning, everyone.
Alright, turning to slide 12, let's review our results for the third quarter.
Where we achieved record quarterly results in several categories.
Total revenue improved 17% year over year to $3 3 billion as fuel surcharge and favorable price conditions more than offset a 2% decline in volume.
Most notably revenue per unit, excluding fuel increased significantly and established a new record and both our merchandise sector and for Norfolk Southern overall.
These results reflect a strong price environment and the deliberate efforts of our commercial teams to pursue these opportunities.
Before I comment on our individual business groups I would like to address the impact of our collaborative mitigation efforts in response to a potential labor disruption this quarter.
Coming out of August we were encouraged by the upward trajectory of our volumes as we move through September and concerns of a labor disruption grew stronger we acted to guard against the potentially negative impacts on our customers and the communities that we serve and keeping with our no surprises approach to customer engagement, we spoke with our.
<unk> early on about our plans to limit the risk of stranded hazardous materials and security sensitive freight like intermodal by restricting service for these products.
We estimate that this approach accounted for roughly 40% to 50% of the volume decline in the quarter or $20 million to $25 million in lost revenue, mostly in our intermodal markets.
Our goal.
As a customer centric organization is to gain credibility as a transparent and trusted service provider. So that our customers integrate N S. Further into their supply chain needs. We can only achieve that goal with proactive communication and planning that minimizes disruption.
Our customers told us that they appreciated our industry, leading communication and.
And we're confident that our approach will deliver long term value for Norfolk, southern for our shareholders and for our customers.
We are pleased that our labor disruption was avoided and we remain committed to providing quality service that our customers can rely on for their supply chain needs.
Now.
Continuing to our business groups performance in the third quarter merchandise volume was down 2% year over year, driven by declines in our steel and ethanol markets that were partially offset by higher demand for sand and aggregates with respect to steel.
Service challenges related to equipment availability negatively impacted our ability to meet demand.
Ethanol shipments were also down as consumption of gasoline declined in the third quarter on a year over year basis.
On the positive side shipments of sand increase more than 43% year over year on higher demand related to the strong market for natural gas production.
<unk> were also up due to higher levels of construction activity.
Merchandise revenue improved 13% year over year to a quarterly record of $1 $9 billion on higher revenue from fuel surcharges and from price gains.
Moving on to intermodal revenue improved 16% for the quarter. Despite a 5% decline in volume revenue per unit reached a record level this quarter driven by higher revenue from fuel surcharge and price.
Intermodal shipments continue to be pressured by supply chain congestion and equipment shortages.
This temporary shift was felt most strongly in our domestic business, where volume was down 4% year over year.
International Intermodal volume declines were driven primarily by car supply and private chassis shortages.
Both reducing customers' demand for inland point intermodal and limiting our ability to satisfy that demand.
Lastly.
Coal market conditions were again favorable for us this quarter, enabling us to deliver 43% growth in revenue for the franchise from volume growth price improvement and fuel surcharge revenue.
Volume growth was led by shipments of utility coal that were up on higher demand spurred by high natural gas prices export coal volume was also up due to some carryover from the second quarter and generally improved coal supply.
Coal volume growth was partially offset by year over year declines in coke shipments due to facility closures.
Overall, our performance for the quarter reflects continued progress on our strategic plan to drive value for our customers and shareholders, while simultaneously working to address pressures related to volume.
Moving to our outlook for the remainder of the year on Slide 13, our service is trending in the right direction, and we expect that to be a tailwind to volumes in the fourth quarter.
Additionally, we are optimistic that consumer spending in manufacturing activity will support volumes for the remainder of the year.
Those expectations are somewhat muted in light of looming recession risks and tightening financial conditions that are pressuring economic activity, especially in interest rate sensitive markets like housing.
Volume in our merchandise segment will benefit from growing activity in the automotive markets with U S. Light vehicle production currently expected to increase in the fourth quarter of <unk> 22 compared to 2021.
Also contributing to growth will be new opportunities to move corn and other grains much of the south east corn crop is down significantly versus last year.
This is likely to increase demand for Midwest originated corn by rail.
Since emerging from the pandemic low.
Manufacturing activity has been increasing at a steady rate.
But we're beginning to see that growth level off with forecast, calling for growth to moderate to 3% year over year in the fourth quarter.
As the fed tightens interest rates mortgage rates have increased to levels that are cooling the housing market.
This reduced demand effects several of our merchandise as well as intermodal markets.
Overall, we expect merchandise volumes to be relatively flat in the fourth quarter with some upside potential as service continues to recover.
Within intermodal our expectation is for volume to be down slightly year over year.
With opportunities from easing terminal congestion and equipment supply being offset by expectations for weaker demand and a softening truck market.
On the domestic side national intermodal volume trends are showing signs of slowing suggesting.
Suggesting weaker peak season demand.
However, consumer spending which has historically been a big driver of this market is currently forecasted to hold steady through the end of the year.
Providing underlying support for our domestic intermodal volumes.
We continue to see volume opportunity for domestic intermodal as our service recovers and we expect customers to shift loads from the highway to rail as we intently focused on improving domestic intermodal service.
International Intermodal will continue to struggle with congestion and equipment supply.
And we expect intermodal storage charges to remain elevated so long as those issues continue.
When supply chain congestion does ease we expect to deliver additional international volume for customers as inland point intermodal or ipi becomes more attractive.
And finally, our expectations for coal are that volumes will continue to improve year over year in the fourth quarter driven by strength in the markets for both utility and export coal.
E I as latest forecast is for natural gas prices to remain elevated through the end of the year.
This will increase demand for coal as a competitive alternative.
Seaborne coal prices are expected to remain at relatively high levels through the end of the year, indicating continued demand for U S coals abroad.
We also anticipate increased coal supply in the fourth quarter, primarily for export which will create opportunities for coal volume growth.
To summarize.
We have a number of uncertain market signals in front of US right now, but our focus remains on impacting the things that we can control to deliver quality service to our customers and increased value for our shareholders.
Overall, we have a fantastic portfolio of customers and as always I want to take this opportunity to thank them for their business and for their ongoing partnership.
I will now turn it over to Mark for an update on our financial results.
Thank you and good morning.
Starting on Slide 15, Ed walk you through the drivers of our 17% growth in revenues.
You'll see operating expense of $355 million or 21% and that includes a $117 million true up to our compensation accruals based on the terms of the tentative labor agreements.
This resulted in the operating ratio increasing year over year to 62% for the quarter.
Operating income grew $136 million or 12% despite that headwind.
EPS was up 34% or a dollar for thanks to strong earnings growth coupled with share shrink, but also from an adjustment to income tax expense related to Pennsylvania's rate reduction that was enacted in the quarter. You will recall, we did signal this in our second quarter earnings release.
Let's take a moment on slide 16 to drill specifically into the labor cost adjustments that we recorded.
As I mentioned, we increased our wage accruals by $117 million in Q3 with $88 million of that amount related to past periods.
And 29 million related specifically to Q3 2022.
The columns represent the period in which the adjustments relate these.
These amounts, including the impact of the bonus payments represents more than two X what we had been assuming.
We anticipate another $23 million of incremental expense in Q4, bringing the total amount for the year to $140 million, which represents as much as 110 basis points of headwind to the full year or from what we had been expecting.
It is also worth noting that there is an additional $50 million of incremental labor cost that will be capitalized into property additions this year.
Now, let's take a moment on slide 17 to reconcile the drivers of or any P. S. Since there are some movers in the quarter.
The impact of the $88 million out of period wage accruals in Q3 was meaningful representing a 270 basis point headwind to the or and 28 cents on EPS.
We did have a favorable legal settlement in the quarter that provided a nickel of help to EPS and 40 basis points of help on the or.
The favorable state tax rate change caused a $136 million reduction to our deferred tax liability, which equates to 58 cents of EPS lift.
That leaves a core improvement in EPS of <unk> 69.
And improvement in the operating ratio of 50 basis points, which I'll point out includes the absorption of 90 basis points of headwind from the $29 million in period incremental labor cost adjustments that I spoke to on the prior slide.
Moving now to slide 18, and the changes in operating expenses of $355 million, which represents a 21% increase year over year.
Fuel was the primary driver up $175 million or 84% due almost entirely to price, but as Cindy noted, we did enjoy benefits associated with a 3% fuel efficiency improvement.
Compensation of benefits it is up 21% due to the elevated labor costs associated with the tentative agreements.
Moving on you'll see purchase services and rents collectively up $52 million.
Inflation and slower network speed continue to drive up these two cost categories.
Materials claims and other expenses were down 4% or $7 million year over year helped in part from the $15 million favorable legal settlement in the other category.
Turning now to slide 19 for the P&L below operating income.
Other income was an expense of $2 million in the quarter 16 million unfavorable compared to last year driven by losses on the company owned life insurance investments due to negative equity and fixed income market returns in the quarter.
While pretax income was up 11% in the quarter net income was up 27% due to the 12, 4% effective tax rate in the quarter. Thanks to the benefit recorded from the state tax rate change.
EPS was up 34%.
Greater than net income growth supported by our capital allocation strategy that includes share repurchases.
Shifting to slide 20 cash from operations through nine months is up 111 million, while property additions were higher by $257 million.
As we discussed last quarter I expect capital expenditures to be at the high end of the one eight to $1 $9 billion guidance range.
With materials inflation, and now incremental wage inflation, creating meaningful headwinds.
Free cash flow conversion stands at 86%.
Shareholder distributions have been strong this year with a 15% increase to our dividends plus continuing solid share repurchase activity.
And with that I'll hand back over to Alan.
Okay.
Thank you Mark.
Noting the considerable changes that occurred in the third quarter.
I'd like to update you on our outlook for the balance of 2022.
As you'll see on slide 21 based on the strong Q3 revenue performance, we now see full year revenue growth of 13% plus year over year.
Ongoing strength in our P. You.
Driven by fuel surcharges and strong price gains are helping us overcome lagging volumes.
Which is Ed laid out we expect to be flattish overall in Q4.
Turning to the operating ratio, we are tracking to our previous guidance exclude any impact from the tentative labor agreements.
Mark laid out $140 million of incremental impact for the year, which.
Which is roughly 110 basis points of Oh, our headwind.
As such we now expect the all in O or for the full year to be roughly 62% based on our current assessment of the market.
Since I became CEO in May you have heard me speak to the strength of our team and culture are powerful network and the macro economic trends supporting highway to rail conversion.
I have shared some thoughts on our customer centric operations driven approach and spoken to the bright future ahead for Norfolk Southern.
I continue to be encouraged by my engagements with all of our team members and their commitment to serving our customers.
As we approach our December 6th Investor Day, we are eager to share a more detailed view of our long term strategy for value creation.
We will now open the call to questions.
Operator.
Thank you well now be conducting a question and answer session.
I'd like to ask a question today. Please press star one from your telephone keypad.
Confirmation tone will indicate your line is in the question queue.
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For physicians, who are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
There's a number of analysts joining us on the call today, let me everyone to one primary question and one follow up question to accommodate as many participants as possible.
Thank you and our first question today will be coming from the line of Justin long with Stephens. Please proceed with your question.
Thanks, and good morning.
Just to start on the 2022 guidance if I look at what you're guiding for for revenue and your commentary on volumes. It implies that yields will be down at a decent amount sequentially in the fourth quarter. So I was wondering if you could provide some more color on that specifically.
[noise] around call RP, you and then maybe secondly, there've been a lot of inefficiencies in the network. This year. It is though is there a way you can put a number on what that cost has been in 2022, as we think about service recovering in that potential future tailwind.
Hey, Justin Good morning, Yeah, certainly, we see some potential headwinds and some of our markets moving into the fourth quarter, specifically energy as you called out and I'll, let Ed talk about the.
Projected impact on the top line.
Sure.
We've seen how seaborne coal prices have fallen, but that's not a new floor.
They remain at relatively high levels.
On the utility side, we expect there is still a lot of demand out there for that.
You factor in what's going on in Europe , and we feel pretty good on the utility side on the steam coal side. The medical side is there's a different story. There is a lot of crosscurrents in headwinds, particularly from from China that we see.
Steel production in China remains muted and the housing situation, there, which consumed a tremendous amount of steel.
Steel and that market remains.
Off kilter, so to speak so we were more guarded about the met coal side of the business.
Does that answer your question and also add you talk about your outlook for fuel surcharge revenue.
Yes fuel surcharge you know when we look at the forward curves and we know we have a two month lag we are expecting that that there is a headwind to us when they come into play in the fourth quarter.
Okay. So it sounds like it's more of a function of.
Fuel and call RPM versus any slowdown in core price.
That's right Yeah, we are.
You've heard US talk about this before we price to the value of our service in the market, we're very diligent about that.
We are confident with our commercial teams that were identifying places where we're adding value. We had let's see our P less fuel records and merchandise and overall this quarter and we've had.
Almost six years of revenue improvement or are you improvement in intermodal and almost seven years on our merchandise side.
Is.
That's through a lot of up and down cycles freight recessions and freight boom times, and we've consistently been able to deliver so we're very focused on that side of the business and as we price to the value of our product the value of our product is improving yes.
Got it and maybe mark on that network inefficiency cost question.
Yeah, clearly, we're suffering incremental service costs related to where we are in our in our service product today.
Honestly, it's at least $40 million a quarter.
And those things are you know they show up in comp and Ben the it shows up in purchase services.
And as things improve going in going into 2023, we will start to see relief from the P&L there.
Very helpful. Thank you.
Yeah.
Our next question is from the line of Jordan <unk> with Goldman Sachs. Please proceed with your question.
Yeah, Hi, a question so you've talked about volumes in and hopefully seeing some improvement there, but I'm just sort of curious.
When do we see the service metrics more fully translate to volume capability based on end demand in and why has there been such a lag effects.
Jordan as we noted volume is a lag.
The service, we have seen a lot of improvement in our volume sequentially, adding up to a potential work stoppage in mid September .
We're starting to see some improvements now at year end.
I'll repeat what I said earlier, you know we felt like we had a lot of momentum going into that that strike or the potential for a strike and we've talked previously about.
The ipi issue.
At our railroad and that continues to impact volumes in the third quarter as our international customer portfolio made decisions to do more towards services, specifically on short haul lanes that are typically sensitive to spot drug prices.
You look at our revenue per ton miles and intermodal declined 1% on a 5% volume decline that really confirms to us that the headwinds are highest in these very short haul lanes.
We see some factors that have driven these ipi decisions like ocean freight rates, they're really reverting to a more normal course.
We have a very broad base of international customers and when you look back pre pandemic Ipi business. The inland Port International played a significant role in our customers' supply chain.
Inland congestion eases.
Those supply chains are going to return to normal and we think our customers well we know our customers are telling us that they expect to increase their use of ipi as that happens. We are we talked to our customers every day and we are very encouraged by the feedback we're getting we have customers coming to us they're recognizing the change in our service product for the better.
Looking to put additional volume on the railroad as one example, outside the AG markets, where we've been able to.
Really participate in some of the spot markets that previously we weren't able to because you have new capacity because of the improvements in our service product. That's just an example.
Thank you.
Our next question comes from the line of Chris Wetherbee with Citi. Please proceed with your question.
Hey, thanks.
I guess, we are seeing some warning signals in terms of economic factors and I guess I just wanted to make sure I understood sort of how you guys are going to manage the network as you sort of potentially deal with those maybe in the first half of next year, maybe over the course of next year, you've got the service improvement underway. It looks like hiring is kind of where you needed to be.
I guess, how flexible can the network be through potential volume volatility as we progress over the course of the next several quarters.
Chris we are intently focused on continuing our service recovery.
It is the value of our product and as Ed noted, we price to the value of the product as our product value improves we continue to see more volume and revenue opportunities for us. We're encouraged by the number of conductor trainees in our pipeline right now it's about 950, which is I.
And I think pretty close to our high end 2022, and we are continuing to hire for some specific locations as we've talked about we have about 95 different crew hiring locations.
We're going to reassess our legacy legacy assumptions on staffing and we're not going to make any unilateral commitments on what we're going to do going forward I will commit that we will be data driven and our approach and we're going to make decisions based on the long term value creation balancing.
Service.
Cost control and growth Cindy you, you're you're thinking about some specific opportunities to add more flexibility. Yeah. So you know in the short term. We obviously do have some training opportunities to replenish our locomotive engineer ranks that we set back to conductors and allow us to step them up when we need to because it takes longer to train an engineer.
And then it does it conductor I will also be enhancing our go team membership the folks that we're going to have in our go team. We hope it won't be a huge number of people, but that will also be a resiliency tactic that will take and and and.
And the effort to improve.
Our conductor availability through the downturn that we've had through the challenges that we've had we've territorially qualified them on a single segment, because that's where they would stand to work.
And now we need to qualify them on other segments radiating out of that same supply point. So theres a number of actions that will take care to make sure we're fortified and ready to go into any any upturn going through a downturn will manage through these opportunities and then as we come into an upturn and they'll be available to us.
Okay, that's helpful and I guess yeah.
I think theres been some concern for the industry broadly that if we were to see maybe a more sudden drop off in volume that the industry would be less sort of equal to react as quickly as possible serve resulting potentially at worst decremental margins than we've seen in previous downturns I think that sort of has something to do with you know with furloughing employees, maybe a bit more aggressively than previous.
Todd.
Any thoughts on whether you think that is a valid concern as we go into next year or are there enough levers that you have to pull to be able to offset that.
Well I think you know we as you've noted I mean, the labor market is different than the past in our recruiting efforts are a little bit different than in the past and we know how long it takes to train and hire an employee them and we've talked about having 95 different hiring groups that we have to manage that through.
So I will say that you know we have to make sure we managed through downturns in such a way that we're in a good place to handle the ups. So that's how we're going to manage and that's what we're gonna grow the long term. So we have levers such as attrition that can help us if we need it but we also know that we have to be fortified in having a good hiring pipeline or a line of sight.
To that hiring pipeline. So that we can manage the upturn we don't just want to manage one side.
Okay. Thanks for the comment I appreciate it.
Our next question is from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, Thanks, Good morning, Mark you talked about at least $40 million a quarter of sort of network inefficiencies I'm wondering how much of them.
Storage revenue, though where are we seeing per quarter and what's a more normal number. So the service gets better that $40 million cost goes away, but maybe how much of the storage revenue goes where I'm just trying to understand the puts and takes.
Yes, Scott.
Clearly there is some storage revenue that helps mitigate that the accessorial.
Revenues that we talk to and certainly as as a service.
Recoveries will start to see those accessorial.
Revenues come down and I don't know if you want to talk about the pacing and what you see.
Earlier this year, we thought that the supply chains would unlock faster and we would start to see that our stores number come off as customers got more fluid into warehouse and on the street.
Frankly that hadn't happened if you look at many of our hinterland markets, particularly a deeper into the Midwest. We continue to see the same issues that we saw earlier. So so the storage number continues remain elevated.
We expect right now that it's going to continue to be elevated.
In the fourth quarter I think next year, we're hopeful that supply chain, one lock and there'll be more opportunities move volume instead of storage.
And it's also true that while storage revenue is elevated year over year comps are slowing down Oh, absolutely yes.
We've left yes.
So when you think about the puts and takes for next year.
I think it probably another good year of pricing service improvement and there's some uncertainty with volume wage inflation do you think the pieces are there to start getting margins higher again next year.
Well, we're actually putting together the budget for 'twenty three now and there's a lot of big assumptions that have to be made.
So we'll be back to you with 23 guidance you know certainly that's our goal at this point in time.
We've got to get inflation under control, we've got to try to get some offsets on the topline from that.
How much volume, we can get is gonna be a big a.
Big lever as well.
So we'll come back to you with the 23 numbers.
Okay. Thank you.
Our next question is from the line of Jason Seidl with Cowen. Please proceed with your question.
Yes, thanks, operator, Alan and team. Good morning, I. Appreciate you guys. Taking my question I wanted to look a little bit about our intermodal growth rate and sort of how much do you think it's been impacted by a your service levels and B. Some of the labor issues that we saw last quarter. So in other words, what's a good economic base.
So to look at 'twenty three off of 'twenty two.
Intermodal is clearly a growth driver for us going forward Ed why don't you talk about how we're going to continue to leverage that unique franchise strength.
We think we have the most powerful franchise.
In North America, when it comes to intermodal, where we're located square in the heart of the U S consumer markets as well as manufacturing with access great access to all of the East coast ports and all the western railroads.
We talk to our customers everyday they are investing for growth our channel partners, our primary themselves to grow with Norfolk, Southern as our service improves.
And.
As our service improves we are creating additional opportunities for them to satisfy supply chain issues that that are still manifest themselves out there we are.
We know that Theres a lot of crosscurrents in a lot of what I would call mixed signals out there in the macroeconomic environment were encourage by by what's going on.
In manufacturing, which had a great report in September future orders appear to be somewhat of a drag.
It's undeniable that with interest rates going up and Inflations staying stubbornly high theres some demand destruction out there, but we're confident that for our customers and for our channel partners intermodal is still going to be a great way for them to save money going forward, a very inflationary environment as they take freight off the highway and put.
On the railroad, Jason we're looking forward to sharing more of our long term vision for value creation at our Investor day in six weeks and clearly intermodal is a key component of that.
I look forward to hearing that down there I was just trying to get sort of if you guys could even put a ballpark figure on sort of how many growth points service labor issues lack of equipment might have cost you this year on a.
Three quarter basis, so far.
Well I think you've nailed them all and then I think you should also add and this ipi issue, where the short haul business from the ports is being trucked despite that and despite the fact that our intermodal volumes were down by 1% in the quarter as Ed noted our revenue ton miles and intermodal were up 5%.
Gotcha. So you think that if we didn't have all these issues you guys would have positive volumes at least this year.
Absolutely no doubt.
Okay.
Really quick if I could get one more in the Pennsylvania tax benefit in the quarter or is there going to be an ongoing benefit that will impact your future tax rate.
Pretty modest at the total level in any given quarter.
It's kind of within that within that range that we guide I don't think it's going to adjust the range your effective tax rate that we guide.
Okay Fair enough I appreciate the time as always gentlemen.
Alright, thank you.
Our next question is from the line of Tom out of it since UBS. Please proceed with your question.
Yeah. Good morning, So I'll give you the two questions upfront. So the first one would just be on pricing Mark you talked about you know you the big assumptions in the budget for 2023 that you know you need topline to offset some of the inflation I Wonder maybe for Ed. If you can just give some commentary on how send.
It is you think prices in your book to a weaker truckload market and falling truckload contract rates.
Can you accelerate pricing against that backdrop, or whereas weaker truck are something we should really be mindful of and then the second one is just on volume you know I think.
We've had this assessment that improving service that you're delivering I am more capacity would translate to stronger volume it sounds like that's maybe not the case.
Because the markets are getting a bit weaker so I don't know if you know that that's right or if you still think there are segments that are going to see stronger volumes as you continue to improve the service. Thank.
Thank you.
Sure.
Thank you for that Tom.
On the revenue side on the price side.
Like I said, we've been talking to your customers every single day about where price is going we've got a great track record of being able to deliver price as we increase the value that we're delivering to our customers and they can transfer that on.
Our service is improving and.
And I would tell you that our customers are confident that as our service improves they can put additional volume against the railroad and looked that helps save money for.
For our customers and long term.
We price to the value of the market, we know that there's a lot of noise around the spot market, which goes up and goes down we stay focused on the long term trajectory of our contract rates and our customers understand that.
Okay.
On the can you repeat your volume question again.
Okay, I guess just to finish that thought there, but do you think we ought to be careful about the truck market you're getting weaker are you say no that's not not a big impact on our pricing and in twenty-three rpms.
Yeah.
I think.
The macro economy is going to tell us where we're all going in terms of economic trajectory.
We've been able to price and continue to be successful in pricing because of the value that we're delivering to those customers. I think are a recession. If there is one common or a downturn that's going to dictate how much volume we can put against the railroad how much is available to put against the railroad, but we're confident that we're going to be able to do that.
On the on the volume side I will tell you that we have a strong portfolio of customers that are like I said, there will stick to the script here, they're investing to grow we see that happening and I think as the ipi situation reverts to normal in terms of conditions that allow that our customers are.
Find value in that market as well.
Oh.
Okay, Yeah, and what about in industrial like if service improves do you expect metals in forest products and chemicals volumes to improve.
Improving response to that.
Yes, and in fact, we're.
We're seeing on the bulk side of our network additional throughput capacity that we're putting up against customers right now in the spot markets. That's indicative of the opportunities that are out there.
I noted in the third quarter, we had cycle times on equipment, that's still inhibited our ability to serve everyone that wanted to.
To be served and so as our fluidity improves we're going to we're going to be able to put additional capacity against them to <unk>.
Customers are telling us that theres additional volume out there that they want to put on the railroad if you look at.
If you look at most of the manufacturing sectors, there's still a lot of unfilled orders out there that they're working through even.
What I would call a declining demand environment Theres still a lot of our back orders. So we're confident about our ability to continue to grow volumes and service improves.
Okay. Thanks for the time.
Thank you so as a reminder, due to the number of analysts joining the same yes. Please ask one question. The next question will be coming from the line of Amit Malhotra with Deutsche Bank. Please proceed with your question.
Yeah.
Thanks, Operator, hi, everyone, Marc I, just wanted to deconstruct the.
So the guidance of <unk> 62, or I think includes the 88 million.
Excuse me prior.
Period labor adjustments and then the $15 million.
Legal side of it so I'm just trying to I'm trying to figure out you know it looks like it's really like 61, and a half if you kind of strip out some maybe extra ordinary if you could just talk about that and then you know the implied.
Fourth quarter.
Like I think like 63.
Or something like that to get to about 61, and a half I mean you'd have to go back to like the fourth quarter of 19 to get something.
That low or.
Hi.
And you know yield is up over 20% since then revenues up over 10%. So then so I'm just trying to reconcile first if my numbers are correct and then two why.
Why would there be such a deterioration despite even some of the headwinds.
Based on kind of the improvement you've seen in the business from a yield and service perspective.
Thanks, Amit so yeah. The guidance that we gave of 62 for the full year includes a retroactive wage adjustment as well as the ongoing wage adjustments.
Basically the $140 million it is the all in including the.
Items that we called out this quarter. So it's.
But that's that's kind of where it comes to it I'm not getting to your 63 number implied for Q4. So if.
If if you do the all in I think it's largely in line with Q4 should be largely in line with the full year number.
Okay, maybe I'll take that offline, but I'm just I'm just trying to think like if you strip out the 88 million.
We're really looking out obviously, that's not an ongoing.
Prior period, so correct, maybe correct, maybe so maybe 61 and a half is kind of the right way to think about the jumping off point as you move into 'twenty. Three is that is that a fair way to think about it.
Yeah, we were at.
When you ignore the the 88 and you look at our restated two.
Q3, and then you can look at Q4 inclusive of the 23 million that we told you about.
It's obviously, it's a it's a much lower number than than the 62.
Right, Okay, all right very good thank you.
Thank you.
The next question comes from the line of Bascom matrix with Susquehanna. Please proceed with your question.
As we look out into next year with the visibility into the Union labor wage increases can you talk a little bit about.
Either broader rail inflation or something and our cost per employee kind of contacts that we can think about modeling just you know with without getting all the way to to preliminary guiding next year, just just what sort of cost inflation on the labor front or overall are you expecting versus history.
This is mark so the if you look at our comp.
Comp per employee in the third quarter and you take out the retro wage adjustments.
It's you'll get to about 34250.
For the quarter.
And you know I would probably guide you all to think that same number would apply in Q4 because that is the new the.
The new number is baking in this 7% higher wage.
That took effect in July so that would kind of go sideways there in Q4.
And then as you think about 2023, what we typically see in the first quarter is a resetting of the.
Payroll taxes.
And so that'll that'll knock it up.
A couple of points us in conjunction with assumptions for higher bonus payouts as well, so you'd probably see oh.
A point or two increase in that number going into the first half of next year and then of course when you get to the back half of next year you have another.
Wage jump that comes from the contractual.
Agreement numbers that you would've seen published so that will probably go up another few points in the back half.
So that's probably the way I would look at it it probably wants to go up more than a few points, but we will have some.
Service cost relief as service improves and some of those costs that we are incurring related to overtime drayage not traded sorry overtime.
Training costs et cetera start to start to subside so.
I would I would model it out that way you know.
Or two elevation here from that level in the first half and then another call a few points in the second half.
Thank you for the detailed Walker.
Welcome.
Our next question is from the line of Ben Nolan with Stifel. Please proceed with your question.
Hey, Thanks, guys.
Sure.
As I'm looking at the <unk> sort of <unk>.
Service improvements that looked like they are having an effect with train speed and dwell and so forth and then matching that up with the the increase in head count that you have.
Just curious if you can frame out how much if the service improvements you can say put it put at the feet of.
Being more fully staffed or appropriately staffed or whatever versus just sort of the.
Well any other factors that are there that might be helping there.
Thanks for the question Ben I think hiring is a critical part of our service improvement efforts.
And we established a target that we shared with the S. T. B of about call. It 70, 550 qualified teenage by mid 2023, and we are well ahead of that target as we as we head into November and and when we think of that number. So I you know, we're really clear and that topline number we have to recognize there's 95 hiring locations under.
So while that number is important that we also have to have folks in the right critical locations I would say another lever that we pulled and we've talked about it in prior quarters as our top S. P. G. Operating plan initiative that is that is in place. It is.
It's it's really helped us I think being more having more executable plan.
And it's it's it's it's it's boiled down into a comprehensive review of connection standards are just distributed power playbook and.
Helped us to recalibrate train me, so as we get closer and closer on time that fluidity continues to allow us to be more fluid I guess, that's the best way to put it. So I would say those two things are the are the biggest levers that we that we've had.
Then recall that we implemented the first phase of top SPG at the very end of the second quarter.
And the third quarter, our train speeds increased by 20% and as Sandy noted it and apply the principles of <unk> and it's really focused on balance simplicity and execute ability.
Alright, well I appreciate it thank you guys.
Our next question comes from the line of Jon Chappell with Evercore ISI. Please proceed with your question.
Thank you and good morning.
Cindy sticking with some of the service questions and updates to issues from the recent past hasnt been much talk about chassis recently is that because the availability. There has cleared up meaningfully and how does that impact as you think about the excess equipment or spare capacity on the network. Once you are appropriately resource and the economic backdrop youre looking at.
For next year.
And some of the chassis issues in the past have been our own some of our customers do you cover that please sure and we've been successful in getting getting a portion of our order online of our chassis.
And we're seeing that helped in terms of fluidity I would tell you on the on the international side. There still remains a lot of shortages out there mostly because I believe those units are deployed on the street or out of warehouse and it continues to be an issue on the international side of the business, particularly in these hinterland markets.
We talked about earlier.
We deployed a number of countermeasures, which includes some temporary storage facilities that we've been able to open to help accommodate our customers.
But we are continue to look for additional fluidity going forward, particularly on the private chassis side.
So just to be clear I mean is it is there any improvement or any line of sight towards improvement because it was kind of major focus let's call. It nine months ago, and maybe not so much anymore, but it sounds like it's still having a really big impact, especially on your international intermodal.
On the international intermodal side of it is having an impact.
And that's not a chassis or a or an asset that we control per se.
For our chassis on our equipment, we've seen some relief both in terms of the fluidity side, but mostly because we've been able to add some chassis.
Okay. Thanks.
Our next question comes from the line of Brent and a glass he with Barclays. Please proceed with your question.
Hey, good morning, and thanks for taking my question.
Look I don't mean to be near term quarterly focused here, but can we come back to the implied.
For Q sequential on the operating ratio because mark if I back out the $88 million of prior year accruals and maybe even the legal settlement it still looks like you're guiding or up maybe 400 to 500 basis points sequentially, which I think would be one of the worst outcomes. If we go back in time for your company. So what are we miss.
On the cost side or is this really you know a deceleration on the revenue front that we should be thinking.
Yeah.
I think the story here, it's mainly a topline story.
We see the expenses largely in line with the third quarter. When you exclude the labor adjustments that were historically I'm, sorry that was retroactively made as well as the favorable legal.
Item that we called out so really what we're talking about is more of a top line story.
So.
You know.
<unk> talked a little bit about the ARPA you.
Assumptions that we made on.
Energy pricing hope.
Hopefully that's conservatism that comes back.
But it's it's really less about cost and more about just a little bit of deceleration well I don't want to clear up a point, there's nothing that we're looking at that suggests a 400 to 500 basis point.
Decline or worsening of our ore in the fourth quarter, we don't see that math.
And in our core pricing story remains absolutely intact.
All right I'll follow up with you guys. Thank you.
The next question comes from the line of Walter <unk> with RBC capital markets. Please proceed with your question. Thanks very much I appreciate taking my call. Just a quick housekeeping question on the tax rate you mentioned that it has not changed or are we in the $23, 524% range is that right.
Yeah, that's for the time being that's that's where the implied guidance is an overall tax rate that includes obviously the federal rate.
You know, which is a 21% but it also includes a multitude of states not just Pennsylvania, where we operate that brings it up a little bit higher and yes, Pennsylvania's rate goes down a little.
But but we've still got all the other state tax that we pay got it perfect. Okay. And then my second question here is on carryover impacts.
Whether it's headwinds or tailwind that would impact or going into 2023, and one of your peers mentioned they started out with a target for free for the beginning of the year, obviously, you weren't able to achieve due to the headwinds, but he indicated that it's off the table for next year due to some of the the carryover. So ive ever seen he is the best one I asked this before but is there.
You know is there headwinds to what you would have expected your to be.
Say the beginning of the year that won't allow you to kind of achieve some of the benefits akin to what other industry peers are seeing or is that kind of specifics that I mean do you believe that you can see a material improvement in your or.
Because those headwinds don't exist going into 2023.
And as I noted before were going to be more than happy to share our vision for long term value creation at our Investor day.
And in about six weeks.
Okay.
Okay fair enough look forward to it appreciate it thanks.
Yeah.
Our next question is coming from the line of Ken <unk> with Bank of America. Please proceed with your question.
Great. Good morning, Thanks for getting me in here.
I'll, let this thing just to highlight earlier I thought that was a really important point on the Furloughing and Decrementals I think that's probably one of the most talked about discussions on the future of the railroads is going to be what happens in the rail.
As variable as they had been.
But I just wanted to visit did I catch you right, but did you say you.
Labor costs were two times your target seems to be a very big step relative to the other rail gaps and is there any reason for that and then I guess on the my follow up on the top S. T. SPG. What's the issue now is as you ramp employees is it equipment chassis is is it getting the homes back to speed, what what else needs to be done.
Going forward year to finish at improving the service.
Yeah, Ken I'll start on the on the labor cost I mean, the Pea recommendations were obviously higher than we expected and we laid out very transparently for you. The details of how those increases were allocated including those retro adjustments.
And we advised throughout all of Q3, and we were in we were accruing in line with historical increases and which is what we had on the table with labor prior to the P. E V. So the adjustment is really just the math.
Go ahead, let me talk about the service, we improved our train speed by 20% in the third quarter and our service metrics are better than what we had projected to the surface transportation Board.
Earlier this year, our service metrics and our service product is that a level as Ed described that's allowing us to participate in some lucrative spot opportunities that we didn't anticipate we could participate in a couple of months ago. We made a lot of improvement what we're allowed to do now because of the health of our network is narrower focus.
A little bit more on some specific areas in which we need to continue to improve our service product.
That is our focus it's job priority number one on Norfolk southern.
And I would add on the S. P. G piece Hum Ken that you know, it's it's a constant iteration refinement simplification all of those types of things again, it's very ESR oriented to making sure we get asset turns as we need to and be able to create fluidity that not only helps us from a from a cost perspective.
That's exactly what our customers need so there there's continuing work going on there as well.
Can I just clarify thanks any clarification Mark did you mention that headwind on the lost fuel surcharge for the fourth quarter was there or was it just we're going to have that one I didn't know if you'd put them.
Actually Ken Thanks for the opportunity to clear.
Clear that up a little bit that was another thing that's driving the fourth quarter.
Operating ratio in the implied math too is fuel surcharge.
The net fuel surcharge was actually benefit here in the third quarter and based on where fuel prices are going it spins to become a headwind again just like it was in the first half.
I appreciate that did you put on a level a number or just that's going to be I did not did.
No it's going to be a well we have to see where the prices are going we've just seen a dramatic spike just in the past week and a half, which initially we weren't expecting to see and we thought that maybe we would not have the headwinds that we're facing but right now it's a it's fuel has moved up and because of the lag effect.
We'll end up having an or headwind here in the fourth quarter won't catch up until the first quarter. So again in periods of rising fuel because of the lag we ended up with or headwinds.
When fuel stabilizes and starts to go down you tend to get fuel tailwind. So in Q3, we ended up having a reprieve on that and we've got some or help from a from the fuel surcharge program, but it looks like it's gonna spin again to a headwind here in the fourth quarter.
Great Alan just like we had in the first half.
I appreciate it. Thank you. Thank you. Thank you Ken.
Our next question is from the line of Arey Rosa with Credit Suisse. Please proceed with your question.
Hi, good morning, So I wanted to start with just a philosophical question. Just maybe you could address how youre thinking about balancing desirous for volume growth versus or improvement I know for a long time I think the argument for us has been well we grow.
Going to outgrow the industry and therefore, maybe all our borrowers will lag peers, a little bit maybe you could just update us how you're thinking about the tension between those two and here we are in an environment, where you're obviously, adding resources in terms of head count and other things, but you are looking for volume growth to be essentially flat in fourth quarter. So maybe you could talk about that and the opportunity to maybe get volume.
Over time to kind of meet those higher resource levels. Thanks.
Yeah, all right, yes, we firmly believe that service and margin improvement support each other.
And frankly, you saw that in the third quarter as service improved our margin improved versus the second quarter.
With respect to the fourth quarter volumes, just note that normal seasonality would suggest generally about a 5% decline in volume in the fourth quarter relative to the third so as our service continues to improve we believe we're going to outperform normal seasonality on our volumes and longer term our commitment.
As to industry competitive margins with above market growth.
Yeah.
Okay. That's helpful. And then just really quickly you mentioned that.
That youre getting increased inquiries from customers based on kind of some of these service improvements I was hoping you just add some color around where those inquiries are coming in what's the nature of those inquiries again, it it's a little difficult to reconcile that with the notion of volume.
Volume growth, maybe being a little bit flat or at least it as implied by the guide just maybe give us some color around the nature of those conversations with customers.
And you're talking to our customers every day as am I, but you're you're certainly much closer to this yeah. We you know.
Overall sentiment from our customers is that things have improved and we're continuing to move in the right direction, where you are in that everyday from a range of customers.
One thing that we are certain about is as we increased train speed and reduce the amount of dwell we're going to have more capacity to deliver value to our customers and we're hearing that from them.
Use the AG markets as an example on the bulk side, where we're seeing customers come to us and come to us with spot opportunities that we probably wouldn't have been able to execute on it.
Prior periods, but we're able to now and so we're diligently looking at these opportunities.
It really means looking at opportunities, where we can be successful and add value.
There are several of those on the bulk side and we will continue to look for them.
Okay.
Got it makes sense thanks for the time.
Our next question is from the line of Cherilyn Radbourne with TD Securities. Please proceed with your question.
Thanks, very much and good morning.
Just looking for a bit of clarification on the $88 million retroactive labor accrual and the extent to which it reflects based wage increases.
Propose bonuses and to the extent that it's more weighted to bonuses versus the base wage increase should we then assume that that means the company was correctly anticipated based wage inflation and therefore should have been passing that on its contract or.
Or how should we think about that accrual.
Yeah, we didn't provide the split of impact between the bonus.
And the base wage Charlotte, but.
We can let me look at providing that to you offline, but I do think that.
We are.
The overall impact that we've got from the 88 that relates to 2000 22021, and the first half of 2022 now.
Now becomes something that we have to absorb overtime.
And mitigate with not just pricing, but with productivity and efficiency and the go forward on that that's our goal.
How we offset that.
Yeah.
Helpful. Thank you.
The next question's from the line of Jeff Kauffman with vertical research. Please proceed with your question.
Thank you very much and congratulations.
A lot of my questions have been answered. So let me just go with one modeling detail question.
That was relatively flat interest expense up 7 million. Obviously interest rates are rising can you give us a sense of your interest rate sensitivity and lets say the fed does an additional 150 basis points here and then slows down.
What would be a good way to think about run rate interest expense as we enter 2023.
Well, Jeff I mean, it will.
The weighted average interest rate in our overall debt portfolio today is below current rates. So.
With every new net new debt issuance that we have.
It will be at higher rates than the average it will start.
As maturities roll off new ones come on it's going to interest will start to.
To go up a little bit.
Not so worried frankly, because we do have a portfolio of depth that exceed 14 billion or so so I.
I don't think it's going to be a meaningful drag on us going forward and we haven't we haven't really seen the interest rates at levels, yet that caused me much concern.
Okay. So it's more a function of new issuance, replacing old issuance as opposed to any interest rate sensitivity on future increases.
Act.
Thank you that's my one.
Thank you I appreciate it.
We thank you for joining our call and we look forward to continuing this these discussions at our December 6th Investor Day.
Thank you. This will conclude today's conference you may disconnect. Your lines at this time and thank you for your participation.
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