Q2 2023 Norfolk Southern Corp Earnings Call
A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad as a reminder, this conference is being recorded.
It's now my pleasure to introduce Luke Nichols Senior director of Investor Relations. Thank you Sir you may begin.
Thank you and good morning, everyone.
Please note that during today's call, we will make certain forward looking statements within the meaning of the safe Harbor provision of the private Securities Litigation Reform Act of 1995.
These statements relate to future events or future performance of Norfolk, Southern Corporation, 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 discussion of those risks and uncertainties, we view as most important.
Our presentation slides are available with 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.
Turning to slide three it's now my pleasure to introduce Norfolk, Southern's, President and Chief Executive Officer, Alan Shaw.
Good morning, and welcome to our discussion of second quarter earnings.
Here with me today are Mark George our Chief Financial Officer.
Paul Duncan, our Chief operating Officer, and Ed Elkins, our Chief Marketing Officer.
I would like to begin by thanking all of my colleagues at Norfolk Southern.
The tremendous work this quarter.
As you'll hear this morning, we're delivering on our commitment to recover service quickly.
We're delivering on our commitment to make a safe railroad even safer.
We are delivering on our commitment to address quality of life issues for our hardworking craft pro routers.
And we continue to deliver on our commitment to make things right for the people of east Palestine and the surrounding communities.
We have a vision for a better way forward for Norfolk Southern.
Last December we outlined a groundbreaking strategy that balances service productivity and growth.
It is designed to create long term value.
For our customers employees shareholders and the communities we serve.
Our commitment to that strategy was tested on February 3rd with the derailment in East Palestine.
Adversity reveals character at test resolved.
I'm proud of the way our team rose to the challenge.
Our response in East Palestine has been fully aligned with our better way forward.
Making decisions in the best long term interests of the community and surrounding areas has achieved significant progress.
Our financial results were challenged this quarter as we noted in may that they would be.
They reflect the decisive actions, we have taken to advance our strategy and keep our promises and east Palestine.
With every step forward, we are doing exactly what we said we would do when we announced our strategy last December .
We are investing in the long term success of our company.
With our strategy as a roadmap we've made significant progress in the second quarter building the foundation for long term value creation.
This morning.
Sure a few notable examples of our progress.
I'll start with service.
In the first quarter, we express confidence that our service challenges, where a temporary disruption.
Due to deliberate management actions in response to the derailment and that our recovery plan, which show results quickly.
We delivered as Paul will describe shortly services now at levels comparable to our best performance in 2019.
When we announced our strategy last year I indicated that we will continue to make disciplined investments in our business through economic cycles.
As Mark will describe we are doing exactly what we said we would do.
We continue to expand the ranks of our frontline craft ROE riders and we are vesting and locomotives intermodal infrastructure, New science technology, and other assets that will drive service productivity and growth.
We're looking beyond this cycle to be ready to serve our customers and support their growth during the recovery and into the future.
Another important way, we moved our strategy forward in the second quarter was through our continuing progress engaging more effectively with our frontline railroad.
This is one of my top priorities as CEO and it is a reason I spent so much time in the field.
Learn from every conversation with my craft colleagues.
After the conclusion of our national Labor negotiations last year I promised to work with Union leadership at the local level to address quality of life issues.
We kept that commitment and I'm, especially proud Norfolk Southern was the first class one railroad to provide paid sick leave for all of our craft employees.
Okay.
We are building on that momentum.
Is an extraordinary moment to co author an open letter with weight the leaders of 12 railroad unions.
<unk> to collaborate out safety and then a few days later to share a stage with many of those same leaders in an all employee town Hall meeting to talk about safety and our strategy.
Our people are excited to be part of a vision that focuses on growth.
Our actions this quarter to advance our strategy extend well beyond operations.
They run throughout our company.
In marketing, we reorganized the team to align with our strategy.
<unk> us to maintain the deep customer relationships that characterize Norfolk southern.
Simultaneously pursuing growth in high value markets that make sense for our network.
As part of that change we made the innovative moved this quarter to create the industry's first vice president a first mile last mile <unk>.
Building, an entrepreneurial spirit and growth mindset into our organizational structure.
Continuous productivity improvement through cost management, and smart revenue growth is a core element of our strategy.
And the second quarter, we created a new performance excellence team within operations charged with building additional rigor and discipline into our processes.
This work is foundational to our strategy.
Standardizing our processes supports a high degree of plank appliance, which in turn gives us greater flexibility to innovate and test.
Targeted improvements that enhance consistent and reliable service and provide productivity opportunities. Thus.
Thus unlocking growth potential.
Additionally, we continued to make progress this quarter strengthening our safety culture, implementing best practices and accelerating technology improvements.
We look beyond the rail industry for a partner that would challenge and inspire us.
We chose Atkins nuclear solutions, which brings experience from the nuclear Navy the gold standard of operational excellence and industrial safety.
Then we reached out to the leaders of the national unions, representing our frontline craft railroader and asked them to work with us to enhance rail safety.
Our work is producing results.
As Paul will describe in more detail our safety metrics demonstrate significant improvement.
As a result of these initiatives in more Norfolk southern today as a railroad poised for long term value creation.
We are implementing our innovative strategic plan and coiling to serve our customers and capture growth when demand inevitably returns.
And now I'll turn it over to Mark for a detailed look at our second quarter results.
Thank you Ellen and good morning to everyone.
Before we get into the operating results for the quarter slide six illustrates the financial impact from the Eastern Ohio derailment.
There was another $416 million of costs recorded in Q2, primarily driven by environmental cleanup activities.
Our estimates reflect the significant progress we've made remediated the site and the continued efforts we expect to undertake related to further restoration efforts.
While our estimates reflect our expectation that activity at the site will meaningfully moderate in the fourth quarter.
Any changes in the nature extent and duration of the remaining cleanup activities and government oversight activities may impact our current estimate.
Additionally, developments with respect to the health care fund, which we are creating for affected residents as.
As well as the potential fines penalties or settlements and ongoing legal expenses will all likely impact our costs in future quarters.
Of the $803 million recorded so far this year only 287 million of the cash has been paid through June 30th.
We currently expect about half of our accrued balance to be paid over the remainder of the year.
With the rest in 2024 or later.
Our 2023 results do not reflect potential recoveries from third parties or under our insurance coverage.
Importantly, you will see in the quarter that we have started the process of pursuing recovery from third parties. A process, we will continue to explore where appropriate in connection with our other lawsuits.
As for our insurance coverage, we expect to begin filing insurance claims here in the third quarter.
This will be the first of many claims that will be made over the coming quarters.
To remind everyone. We can only make claims upon payments being made not based on accruals as.
As you can imagine insurance reimbursements and third party recoveries will take time to materialize.
Turning to slide seven.
Here, we illustrate the accounting impacts of the incident and response on our key metrics for Q2.
At the bottom you see the adjusted results excluding those impacts.
Revenues were down 8% to last year, while adjusted operating expense was flattish.
It's important to understand that the incident meaningfully harmed revenues in the quarter.
Because of the resulting service disruption, but that impact is not adjusted from our GAAP figures.
And mitigating those service impacts cost us money to fix.
And those costs are also not accounted for in the $416 million operating expense adjustment.
Consequently, the adjusted operating ratio was 66, 7%.
Had we been able to move a couple hundred million more revenue with our Q2 cost structure.
Our margins would have been much stronger.
On an adjusted basis operating income was down 22% net income was down 18% and.
And E P S was down 14%.
Moving to slide eight <unk>.
Adjusted operating expenses for the quarter were up slightly on a year over year basis.
Compensation and benefits were up 79 million or 13% in the quarter due to wage inflation and ongoing hiring to primarily shore up the remaining challenged locations on our network.
And in support of our strategic plan to build long term network resiliency.
Materials and other expenses in the quarter were up $33 million or 19% driven primarily by a continuation of the locomotive related work we discussed during the first quarter call.
Bringing part of the stored fleet back into surface to successfully accelerate the networks, which you will hear more about from Paul.
Additionally, in other the quarter was impacted by lower gains on the sale of property.
Purchased services and rents were up $25 million or 5% this quarter as the challenge network created more headwinds to the category in.
In addition to our continued investments in technology.
Depreciation was up $17 million in the quarter in line with our guidance.
Mitigating these increases where fuel expenses, which were down $145 million or 36% in the quarter.
Turning to slide nine let's look at the adjusted P&L results below the line.
Partially mitigating the $279 million reduction in adjusted operating income was a $71 million increase in other income.
Driven by favorable investment returns and compares from company owned life insurance.
Net income and EPS were down, 18% and 14% respectively in the quarter.
Moving to free cash flow and shareholder returns on slide 10.
Through the first six months free cash flow was lower by $276 million.
Due to combined pressure from the derailment related expenditures as well as investments in roadway and equipment.
Shareholder distributions during the first half were $918 million, thanks to a solid dividend and share repurchase activity.
I'll now turn it over to Paul for a discussion on our operations.
Thank you Mark and good morning, everyone, let's jump right into a safety update on slide 12.
Everything starts with safety, we continue to make progress this year enhancing safety our injury frequency ratio is trending down 12% year to date versus last year, our accident rates through the first half of the year is also down from prior years and our mainline train accident rate is trending improved 40% year to do.
Versus last year.
Let me take a moment to thank our leaders and aircraft colleagues for collectively enhancing safety and driving these outcomes for our team the communities, we serve and our customers.
We will transition to our progress and safely delivering a reliable and resilient service product on slide 13.
You will recall during our last earnings call that we expected service to improve in summer and we have delivered on that promise. We've successfully restored our double track mainline through use Palestine is a safe and environmentally appropriate way and we wasted no time resetting network performance levels, our customers expect in this quarter between the Midwest and the northeast.
We have.
Difficult, we improved train velocity dwell and service across our network to to your best resulting from these improvements.
With service improved our focus now is driving further reliability productivity and resiliency in our network in line with our strategic vision outlined in December .
Touching on slide 14, though what we told you would be an important measure of our service recovery reduction in cars online. Following the first quarter service interruptions, we had an inventory buildup, we set in place a plan to work down the buildup as quickly as possible. While also restoring our mainline and overall network conditions, we successfully executed on that plan and railcars.
Now cycling throughout our network faster than they have since before 2022, achieving greater railcar fleet productivity.
Turning to slide 15 for an update on our hiring progress our efforts to rightsize. Our teeny crew base have continued the first half of this year. We are now at a point at which the training pipeline has crested and will begin to taper down over the back half of the year, we are committed to maintaining an appropriately sized workforce to drive Roe.
Liability and long term resilience was part of our strategy.
Our productivity metrics are shown on slide 16.
Our short term service challenges described earlier contributed a productivity impacts as we work to restore service and velocity.
Mark mentioned earlier that would be returned to service a portion of our road locomotive fleet to expedite our service recovery.
With service and locomotive velocity much improved as we enter summer we have now right sized our road freezing and are now achieving velocity near 200 miles per day with our locomotives as.
As part of our strategy to become not only reliable, but more resilient. We have allocated a portion of our road locomotive fleet to surge capacity to be hot and ready to run at key locations over a network when needed.
Transitioning to the workforce teeny productivity was challenged due to the effort we put in place to accelerate the network coupled with the contraction in volumes moving forward, we expect to improve teeny productivity through a variety of initiatives improving velocity absorbing volume on existing trains and normalizing our CPE pipeline.
Lastly on fuel we took a step back for the first time in seven quarters. This was largely due to lower velocity and fewer GTS on the network. As we were restoring service. We are very confident that our initiatives that had been paying regular dividends will continue to driving us towards further fuel efficiency as we continue to see the benefits of an improving network.
Moving forward on slide 17.
Our focus will be on safely and productively delivering reliable and resilient service every conversation will start with safety as we continue to enhance it through the initiatives that we discussed with service improved our goal now is to continue to build further reliability and resiliency in the network, but to do so productively.
Prosody and service improvements will provide us further opportunities to leverage and spin our assets, while pushing to drive further process standardization into our scheduled network to drive productivity. This is the primary focus of our new performance excellence team, which was created this year. We will also continue to leverage the capital investments we have made to increase.
Productivity, including a recent signing projects between Chicago, and Cincinnati that will allow us to increase train length and capacity in this quarter. Thank you and I will now hand, it off to Ed Elkins.
Thanks, Paul and good morning to everybody on the call.
Beginning on Slide 19, I'll review, our commercial results for the quarter now as we expected the second quarter came with challenges related to ongoing soft freight demand lower commodity prices and still recovering service levels. In total we generated just under $3 billion in revenue for the quarter down.
8% from the second quarter of last year, and that's driven by a 6% drop in volume and lower revenue from fuel and S. Soils are Pugh was also down year over year. However revenue per unit less fuel improved 1%, reflecting gains in price and favorable mix and that's driven by tempered demand.
For intermodal and utility coal.
I'd like to note here that underneath this favorable overall mix narrative there was significant negative mix within markets that tempered overall revenue per unit performance, which I'll note below.
Now merchandise results were varied as favorable conditions in the markets for automotive and agricultural products were offset by headwinds in chemicals markets and that's a good example of the challenging our P mix within markets that I just mentioned.
Automotive volumes were driven by robust finished vehicle production and agriculture shipments were strong due to new lane offerings and a weak local crop in the southeast.
Offsetting this growth was weakness in several of our chemical commodities as well as challenges to meet customer demand in key markets, such as metals aggregates and finished vehicles.
Taken together total merchandize volume and revenue for the second quarter came in 1% below prior year levels.
Revenue per unit was flat year over year, but our P less fuel grew 2%.
Which makes 32 out of the last 33 quarters that we've achieved growth in this metric.
That is a clear signal that our diverse portfolio and strong pricing discipline are delivering results.
Turning to intermodal continued market headwinds were felt the strongest in our domestic lines of business, where volumes declined 14% year over year as weak freight demand high inventories and excess truck capacity weighed on performance.
Conversely in a continuation of the first quarter trend.
International volumes increased 1% year over year, and five 8% sequentially over last quarter as.
As we guided to before our customers have continued to shift highway freight back into Ipi services and storage charges have declined as supply chain fluidity and container dwell have returned to pre pandemic normalcy.
As you would expect with this performance intermodal is another segment, where our P mix within markets was challenging for us both <unk> and RP you less fuel were down significantly due to lower revenue from fuel surcharge.
And storage charges.
Lastly, coal volume was flat year over year, but coal revenue fell 4% as RP you decline.
Utility volumes were down 17% year over year due to historically low natural gas prices and elevated stockpiles.
These declines were offset by gains in export shipments as a result of increased production and robust overseas demand.
Although export volumes increased the mix between export steam and export metallurgical coal shifted unfavorably and comparatively lower seaborne coal prices yogurt lower revenue per unit.
With that let's turn to slide 20, and review our outlook for the remainder of 2023.
Overall, we're confident that our service product positions us to realize growth when market conditions improve and as the year progresses. We are focused on pursuing the opportunities in markets that have the highest potential for growth for Norfolk southern.
We expect to increase our share in these markets as an improving service product and a sharply focused organization allows us to realize more of the ongoing demand for our services.
Beginning with merchandise markets conditions vary by individual market and we see strong levels of nonresidential construction as reassuring and infrastructure projects increase which will drive strength in metals and construction volume.
Demand for U S light vehicles will continue to support metals and automotive volumes. However, we expect continued weakness in our chemicals markets in the second half.
Turning to intermodal, we expect international volumes to continue its growth trend with an expected rebound in import volumes and the continued share growth of ipi.
Stewart's Chargers will continue to be a revenue and RPE headwind compared to last year.
On the domestic side overall growth will be dependent on the U S consumer.
Retail inventory levels and the truck market, we worked really hard with our best in class channel partners to sustain our service levels throughout the quarter during the crucial climax of bid season, and we're hearing from our key partners that our strategy is helping them increase their share of bid wins.
We look forward to leveraging our capacity to realize this growth as market conditions improve.
And finally within our coal markets, we expect overall volume growth as continued strength in export markets more than offset weakness in utility coal.
Co production levels at N S serve mines will drive growth in exports shipments, although we do expect lower seaborne coal prices they negatively impact RP U.
The utility outlook is largely dependent on the weather on existing stockpiles and natural gas prices.
The net result is we expect total coal ARPA you to sequentially decline by a low double digit percentage.
Despite uncertainty across the economy, our focus on service productivity and growth remains at the core of our strategy and we're confident in our ability to grow our franchise and deliver value for our customers.
On that note I'd like to draw your attention to slide 21, which highlights the strength of Norfolk, Southern's network and our ability to drive growth, both now and in the future the.
The ecosystem for electric vehicles has been steadily developing in recent years as demonstrated by last quarter's announcement of the new Scout Motors plant on Norfolk Southern we.
We are focused on all facets of this emerging EV supply chain, including the EV battery and battery components.
Over the last 18 months more than $70 billion in new investment has been announced for building out EV battery manufacturing plants across North America. Our commercial team has worked to help locate nearly a third of that investment on our network, including most recently in the second quarter, a new $3 billion General Motors and Samsung.
Battery manufacturing plant in Indiana on a Norfolk southern mainline.
Norfolk Southern's network is well positioned for future industrial development, we reached 60% of the U S population and cover 50% of our manufacturing base. We look forward to amplifying that strength through continued industrial development wins.
Year to date, our industrial development team has reported $2 $6 billion and industry investment that's been completed along Norfolk Southern lines, bringing 3200, new jobs to the local communities that we serve we continue to invest and site readiness for our highest potential industrial sites.
And we're confident our diverse portfolio of shovel ready sites combined with the strength of our network will continue to land new opportunities across our network.
With that I'll turn it back over to Alan to bring us home.
Thanks, Ed.
Let's turn to slide 22.
As we've reached midpoint of 2023 I want to provide you with an update to our outlook.
Although we entered the year expecting to achieve revenues comparable to 2020 to the first half revenue shortfalls require us to modify our full year outlook.
We now anticipate revenue to be down at least 3% in 2023.
Implying some modest volume improvements in the back half.
We're also expecting modestly higher capital expenditures for the year as we accelerate investments in safety service productivity and growth.
Finally, I want to close our prepared remarks by Reconfirming the commitment of the entire Norfolk southern team to delivering long term shareholder value.
Top tier revenue and earnings growth at industry competitive margins with balanced capital deployment.
I'm confident that our strategy will help us achieve our full potential and I'm encouraged by our progress and investments.
We will now open the call to questions.
Operator.
Thank you well now be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question can you.
You May press star two if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
Due to the number of analysts joining us on the call today, we will be limiting everyone to one question to accommodate as many participants as possible.
Our first question comes from the line of Brandon Obrien Ski with Barclays. Please proceed with your question.
Hey, good morning, and thanks for taking my question. So Allan I guess can you give us an update on lessons learned here is you've reworked your train makeup I think through the second quarter.
And how has that impacted your operational planning going forward and does that create incremental capacity for you guys. If markets recover which I think mark was alluding to earlier.
Hey, Brendan we.
We made our train makeup.
And starting in March and we guided to the fact that we would expect service to improve as we moved out of the second quarter and ended the third quarter, coupled with the fact that we're going to get the second track back in these pallets and that's absolutely what we deliver our services on the trajectory that we have got.
Good too and what we're seeing as a result over the last couple of weeks is real strength in our volume sequentially and also relative to the rest of the industry.
With respect to our updated operating plan them trained makeup rolls it gives us an opportunity to create more capacity as we increase the utilization of distributed power, which helps our cost structure and helps our service product and helps our capacity for growth.
Thank you.
Thank you. Our next question comes from the line of Ken <unk> with Bank of America. Please proceed with your question.
Great Good morning.
Just before I get to that question two clarification, Mark that you said, one 1% of our pool gain ex fuel on mix and price. So if mix was positive or do you think pricing is less than 1% or are you, saying intra category mix hides the pricing game and then second you mentioned the real estate gain did you mentioned what it was in the quarter.
My question is is on carload growth Alan you mentioned accelerating growth in the second half of the year peers are talking about.
Our T Ams or industrial production being down slightly I just want to understand how you how you're targeting that acceleration in the second half and maybe detail that a little more thanks.
Yeah, Ken we were talking about intra category price there.
And then with regard to the real estate gains in the quarter I think we said it was $19 million.
Absolute in the quarter itself.
Go ahead.
Yeah, Ken and with respect to volumes moving forward.
Clearly our volumes were pressured in the second quarter and in the last two months of the first quarter because of the service degradation.
That's why it's really important for us to hit the service targets and the service recovery trajectory that we are committed to publicly and with our customers. We've done that and as a result, our equipment is turning faster and customers are talking to us about incorporating Norfolk southern into their long term supply chain solutions and you want to give a little bit more color on that.
Yeah, when we look at our volumes compared to the other class ones over the course of 2023, our volumes outperformed the industry average for nine of the first 10 weeks of the year and we were feeling good and then as you know the network slowed in congestion built up our performance suffered but as we started to speed up our relative performance also was starting to recover and over the last 11.
I think this is important we've outperformed the industry average for nine of those weeks and the outperformance that we've been experiencing is accelerating placing us in the top two class one railroads for four of the five last week and I would tell you spoke about it in the prepared remarks, there are a few bright spots out there were folks.
Just on delivering growth for our customers through better service that includes in the automotive industry, where we see clear line of sight on continued demand and then you think about infrastructure spending that's going on all around the country, but particularly in our footprint as well as residential construction, that's really tied to <unk>.
New home construction because.
People with low interest rates are just staying in those houses are folks need at home or going out and building a new one.
We see some clear bright spots there and that's the real key is we're focused on those markets. We're present in those markets with our sales teams and our operating teams and as the network continues to speed up we're going to deliver more value for those customers.
Great Mark Allen it. Thank you appreciate the time.
Thank you.
Thank you. Our next question comes from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your question.
Thanks, Operator, hi, everyone.
Just wondering what the what inning, we are here in terms of the sequential drawdown in intermodal yields I assume you've got some new pricing that's being implemented on July 1st you've got more run off of the storage fees whats the right way to think about intermodal yields from here and then Mark there's a lot of like puts and takes.
On profit cadence from here on one side you know, there's a lot of service issues and inefficiencies related to that in the second quarter, but then you've got the coal yield dropping off maybe a little bit more yield pressure on fuel that impacts operating income I mean, do we do we grow operating income off of the second quarter in the back half. If you can just kind of give us.
Some of the puts and takes there. Thank you.
Andrew do you want to take the first question Yeah. Yeah. If you want let's talk about RFP first particularly within intermodal.
Core pricing remains positive for intermodal and more importantly, I think I highlighted during the prepared remarks that the mix within intermodal has been pretty dynamic and because of our success in those international markets and delivering value through more ipi business that mix is negative for overall RPE within intermodal sure.
Again, you know when we think about supply chain congestion I think it's pretty much gone.
Supply chains are really about is fluid now as they were prior to the pandemic and in fact, there may be a little bit more capacity, we monitor warehouse activity pretty closely in this high teens index.
Or excuse me the logistics managers index, which we are paying attention to noted that warehouse capacity and increase the fastest rate since the start of the pandemic.
Yeah.
It's a challenge and we've seen we've seen those storage charges roll off and essentially turn you are really a pre pandemic normal you've also seen us take share from truck and the international market. Yes, that's what I was referring to with with increased ipi shipments.
The the international markets are looking for ways to add value for their customers and the service we're providing in ipi is a clear way for them to do that.
Yeah, Let me, let me go through a little bit of the first half second half dynamic because there are there are some changes here for sure we do expect.
Some modestly higher volumes from from the better service product we have here in the back half so that's definitely going into the tailwind category.
We will start to see a partial wind down of the service costs here in the second half as well.
And and you know fuel expense is going to be.
Less of a headwind than it was in the first half.
But you know we got some sizable tail sorry sizable headwinds.
Here in the back half principally on the <unk> side are the fuel surcharge really starts to diminish here in the U S.
<unk> benefits disappears on us so with this fuel will be a real negative in the back half certainly the margins are.
And as Ed mentioned intermodal intermodal storage is basically back at pre pandemic levels now, which means we're going to continue to have quarter over quarter headwinds until we lap this probably in the second quarter of next year.
Then of course, you know if if the.
Future futures hold you know, we're gonna have international seaborne coal pricing headwind as well in the ERP side, So that's pretty much the headwind and tailwind equation. So if the if the volumes come in like we think a little bit of a back half tailwind, we should get some or improvement from here.
Hum.
And the more the better because we got a lot of capacity on the railroad right.
Alright, Thanks, a lot guys I appreciate it.
Thank you.
Thank you. Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, thanks.
So mark you're saying hopefully some award just to clarify you're saying hopefully some of our improvement from Q2.
Into the back half of the year.
Yeah.
<unk> volumes, we expect to really provide us a little bit of tailwind here and I think it's all going to depend on how much volume we were able to bring onto the railroad Hey look we were really clear in may that Oh are would be really pressured in the second quarter. Because we were going to have three months of service disruption as we.
We've delivered on our commitment to improve service throughout the quarter and moving into third quarter that creates more opportunity for volume and it creates a better cost structure for us we will still have those headwinds that mark called out, particularly with respect to fuel surcharge and comps on on coal price and gold pricing right.
Underlying product and our ability to onboard volume stronger incrementals is improving yeah.
And so ultimately I guess, Mike you you've.
You've given us a little bit of color on a war and some color on coal <unk>, but how should we think about overall ARPA when I factor in the fuel headwind some of them maybe continued storage headwind like what what's the how much do you think is overall ARPA you are going to be down in Q3, just that'll I think.
Would be helpful.
Yeah. This is Ed when we look at the at the second half of the year.
No on the RFP front reduced storage and fuel surcharge revenues are going to persist as we talked about that I talked about that in our prepared remarks.
I believe those current projections raws for fuel storage in coal pricing is roughly $650 million.
Year over year revenue contraction, that's right. So is that that's the headwind we're swimming against.
650 in what period.
Second half versus second half.
Okay. That's revenue thank you.
Thank you. Our next question comes from the line of Chris Wetherbee with Citigroup. Please proceed with your question.
Yeah, Hey, thanks, good morning, so maybe a little bit on head here I guess I'm curious how do we think about you talked about the pipeline of training new rolling kind of moderating in the back half of the year. So how do we think about actual employee levels in the back half of the year, maybe three Q4, Q and then the market in the past he talked a little bit about opex and maybe putting the prop.
But it's I don't know obviously, there's RPE headwinds on the revenue piece is opex kind of flattish from where you were in the second quarter or is there ability to actually improve on that given the network kind of reopening and getting some of that productivity back into the into the model.
Well why don't you address the question on conductor trainees crap.
Crap colleagues, yes, thanks, Ron so.
As you saw on the AR in a hurry in chart on the stats, we continued to make progress on on staffing and and really at this point, we plan to reduce the <unk> pipeline to around 600 or less as we continue to focus on attrition and filling in some of those are many of the.
Locations, but at this point with what we've been able to do from a a hiring standpoint, we have further leveraged and gain velocity across the network and facilitated and having those folks that are at healthy locations a sense to some of those hotspots and again that is a contributor to the loss of improvements of the <unk>.
Service improvements that we've seen here over the past several weeks, we expect to continue through the latter half of the year and Paul your guidance on a pipeline of around 600 is more pointed towards the end of the year correct correct.
And Chris with regard to Opex I think you know we've we've obviously seen a step up in our cost structure as we've been dealing with a lot of the service issues and trying to start to build some resiliency going forward I think what you'll see now is stimulation of those service related costs as we go through the back half.
For the year, However, don't don't forget we've got that 4% wage increase that took effect July one so that was kind of start to wash each other out.
And with regards to some of the other P&L line items in aggregate.
Probably flattish sequentially.
We see those kind of holding so that's why the leverages there now to take on to take on volume are we.
Believe we've got the capacity to handle a lot of volume without much incremental cost.
And really it gets down to you know facing these ERP you headwinds that are going to provide you know.
Pretty pretty sizable headwind for us on the margin side $650 million as we just as we just touched on.
Okay, and average head you're up a little bit in the back half of the year I think is what I heard.
I'm, sorry can you repeat that.
Average head count is up a little bit sequentially in the back half of the year, Yes correct.
Okay. Thank you guys. Thank you.
Thank you ladies and gentlemen, please remember to keep to one question. So we allow as many as possible to join us.
Our next question comes from the line of Jon Chapell with Evercore ISI. Please proceed with your question.
Thank you and good morning, I'm, Mark I thought slide seven was Super helpful. And then also you noted that there's volume revenue and cost impacts that you wouldn't kind of strip out as being one time in nature is there any way to quantify them you know those two.
What's called them not adjusted impacts to the second quarter results and as we think about a return to normalization does that kind of a slow grind as the line comes back on and builds to full capacity, where you can be kind of on an apples to apples basis at the start of the fourth quarter or do you think that it's going to take all the way until 2020, Florida say a kind of a.
Base revenue based costs from the entire network.
Yeah. So.
The way, we look at it and we've done some analysis here with Ed and his team.
We think we left about $175 million to $200 million of revenue behind because of the service disruptions in the end.
The shutdown of the line there in East Palestine, So that's kind of on the revenue side and on the cost side. You know, we we were dealing with.
Throwing a lot of cost they're trying to accelerate the network and we've done that successfully.
So now we're going to probably use the next six months to really work those costs off and get back to more productive levels of service. So I think you'll see that those costs will wind down here in the third quarter and I think by the fourth quarter most of those costs will be removed from from.
From our system. So you know, we talk about probably $40 million to $45 million here in the second quarter of kind of poor service related costs and that will start to unwind here.
Okay, Great that's super helpful. Thanks Martin.
Joe.
Thank you. Our next question comes from the line of Brian Austin back with Jpmorgan. Please proceed with your question.
Hey, good morning, Thanks for taking the question so.
Maybe just go back to the average comp per employee and Mark you were talking about a 4% increase for the craft employees can you just give us a sense of what that looks like on an all in basis, because you've got overtime you got mix you got trainees.
In there what does that look like in the back half of this year and how does that carry forward into next year and then maybe on that point can you just talk more broadly about the cost for paid sick leave work rule changes and how we should think about those including any potential offsets and when you might see them. Thanks.
Yes, thanks, Brian So yeah.
I think I got it early in the year to about 35000 and change each quarter.
I'm anticipating that we were going to have this 4% step up in rates in the third quarter.
But that's that would be neutralized by the wind down of service related costs. So that guidance is pretty much holds I would you know how.
However, you all I'd be modeling around 35 and change.
Average comp per employee each quarter.
I'm sorry, the second part of that one question was what.
Yeah. The work work rule changes Oh, yes, sorry.
Okay.
Clearly these things aren't free.
So there's definitely a little bit of headwind that we're swimming against with a lot of these work rule changes I'm not going to put a fine number on it other than to say that obviously, we're gonna have to pay for that with some productivity initiatives in the future.
You know that's what Paul and his team are looking at now so but clearly some short term headwinds from from a lot of what <unk>, what you've seen published.
Okay. Thank you Mark.
Thank you.
Thank you. Our next question comes from the line of Jordan Alger with Goldman Sachs. Please proceed with your question.
Yeah, Hi morning, I'm sort of curious.
Maybe from a sensitivity perspective, you've done a really good job getting the network.
Back into shape.
In a in the second quarter, you talked about you know, maybe hopefully improving or with some volume sequentially versus the second quarter hour, but I'm actually curious is there.
Given the headwinds you've talked about and maybe even looking into next year.
Is there a level of volume growth that needs to come into the network to show year over year or improvement. Thanks.
Okay.
Well I'll jump in and just say that you would go back to our financial framework you know our our goal. The one we launched back in December kind of you know we're aiming for mid single digit revenue growth on average in most years and that would imply.
A few points at least of a volume and a couple of points of pricing. So we think that that is the right equation for us where we can then leverage it and drive productivity.
We have op income growth, that's greater than the revenue growth. So.
That's pretty much the model.
And I would expect in 'twenty for that to play out.
Great. Thank you very much.
<unk>.
Thank you. Our next question comes from the line of Ravi Shanker with Morgan Stanley . Please proceed with your question.
Oh definitely I mean, one now that you've had a little more time to digest the aftermath of the accident going up do you have a better sense of when we might know the final kind of financial impact here or kind of is that a <unk> event is the 'twenty 'twenty four we round is going to take several years.
How does that play out.
Why don't you address that please.
Sure I mean, you know this is going to take there is going to take a little bit more time to wait.
So the way to look at this Ravi as you know as we've entered Q2, we've got a lot more visibility now than we did in Q1.
And our current estimates assume that the cleanup activity continues into October and then kind of moderates meaningfully during the fourth quarter.
Future periods are going to be impacted by ongoing legal cost and may be impacted by other items as well such as fines and penalties, which are currently unknown and frankly, we can't estimate.
So what I would encourage us that maybe you look at the 10-Q disclosures later today related to the matter, we kind of go into a fair amount of detail of the types of things that could continue to impact us in the future and we will continue to monitor this and <unk>.
Keep you all apprised as things change, but right.
Right now the the largest part of what were accruing for has really been the environmental cleanup costs.
And the visibility now is we think as we get into October things really start to wind down and that's the basis of these estimates now.
I'll take a moment and just say we started the process like I said in my prepared.
Prepared remarks of seeking recovery from third parties and we are going to start here in the third quarter.
Making claims against our insurance, making claims against our insurance policy. So that's going to take some time.
To play out.
And we're probably talking quarters not months.
Understood. Thank you.
Thank you.
Thank you. Our next question comes from the line of Justin Long with Stephens Inc. Please proceed with your question.
Thanks, and good morning, we had another class one rail yesterday came out and announced it they're pausing buyback activity for the second half. So I wanted to get your thoughts around buybacks as we move into the next couple of quarters and any update on the timing of the Cincinnati.
The southern acquisition closing and how that deal will be funded.
Okay.
Yeah. Thanks.
You know, we we continued doing some share repurchasing in the second quarter similar levels to what we had done in the first and again, we get back to what our what our model is and nothing changes. The first thing we do with our returns is reinvest back into the business.
To drive safety resiliency growth productivity.
And this year.
That is going to be $2 $2 billion of Capex spend.
After that we pay a dividend and that 35% to 40% payout ratio range, sometimes if it goes outside of that a little bit but will grow back into it.
And then with the remaining excess cash we've been very mindful of our leverage.
We return that cash to shareholders through the repurchase of shares.
This year is a little unique in that we have signaled we were gonna do that CSR purchase the timing of that is also becoming clearer.
That is likely towards the end of Q1 of next year closing showed the citizens vote affirmatively in Cincinnati to go forward. So we will be mindful of that because a part of that purchase will be coming from internally generated cash flow.
That doesn't mean, we're stopping share repurchase, but it will definitely be at much lower levels than we've seen in the prior couple of years, when we were doing $3 billion a year or more.
Okay. Thanks.
Okay Justin.
Thank you. Our next question comes from the line of Jeff Kauffman with vertical Research partners. Please proceed with your question.
Thank you very much.
Hi, My question has been answered, but let me ask this one because you threw it out earlier.
Talked a little bit about bringing in first mile last mile head.
Now is not the right time, we're focused on on Rehabbing, the network and fixing what needs to be fixed but could you talk a little bit about longer term why this makes a difference and why you're one of the few rails, that's actually step in that direction.
And why don't you address that sure I'd be glad to.
We know from talking to our customers and we've done this over a long period of time, it's been a lot of time with our customers.
First and last mile is a critical component of the customer experience and we know that there are a few key vectors of value that we're gonna be that we have to focus on delivering service quality is one of those in first and last mile is a portion of service quality. It's also customer experience. It's also commercial sophistication and all three of those <unk>.
<unk> first and last mile plays is significant and substantial role and it's not just in the merchandise business. It's also in our TVT or bulk transfer facilities. It's also with our.
Third bred direct product, it's also with Triple Crown. So we view it as a key component of our future success and it's all part of our long term strategy to drive service productivity and growth.
We gotta do different things, if we want to grow.
A great example, where we're willing to take a lead role in the industry on that that's right.
Okay. That's my one thanks guys.
Yeah.
Thank you. Our next question comes from the line of Tom Waterworks with UBS. Please proceed with your question.
Yeah. Good morning, So I wanted to ask you.
You talked a little bit about maybe what what you need on the volume side to our revenue side to improve our war, but.
I I guess I'm thinking if you look at it now into 'twenty for just let's say beyond you know beyond the next quarter or two it does seem like you know you identified it pretty big revenue headwind in second half and I don't know that those revenues would come back in terms of storage or Kolar P U.
And and fuel surcharge, obviously, it can be up or down.
But I'm, just and and on the cost side. It doesn't seem like you're going to cut head count. So is it just all about volume and <unk>.
Should we.
Should we be optimistic about moving out of the mid sixties.
Or is there an operating ratio or is is there a challenge where you're kind of stuck in the mid sixties for a period of time are on the operating ratio. It just it just seems hard to see what's going to move in a big way out of the mid sixties O R. Other than volume really being a lot better.
Thank you.
Yeah.
The single biggest lever we've got right now is to absorb volume growth into our current cost structure.
So that is really going to provide.
A bit of Oh.
Peel out from where we are today and then I think.
At the same time, Paul and his team in particular, we're working hard on productivity initiatives, because we've dug service out of the hole we were in.
Maybe not in the most productive way we've been throwing a lot of cost of resources to accelerate the network. So now there's a lot of opportunity to take the costs out.
And start driving productivity again, and Thats, what Paul and his team are heavily focused on.
We're not going to give a projection here or the pace of which we're going to improve but there are a lot of levers and you touched on most of them are for you being a big piece, we'll see what happens here with coal pricing in the future. That's been a driver of the same thing with fuel that you know that's going to be it's been.
Very supportive fuels to our or in the first half and it's gonna be equally negative now here in the back half.
So that dynamic could change going forward. So we're not in a position to project, where the <unk> goes in the next 12 or 18 months, but I will tell you. We are coiled up with the investments we've made to start driving improvements by taking on volume, we are ready and poised to take on volume.
It just seems like the revenue headwinds there are a lot bigger than the $45 million a quarter cost inefficiencies.
Yeah, I mean, we laid them out there are some there are some revenue RPG type of headwinds but.
We do think that there is volume out there for the taking and as long as we don't go into an economic downturn, which is we're feeling a little bit better about lately.
We think theres some share recapture opportunity that's out there.
And other areas, where we can take the volume on but yeah. We're gonna have short term headwinds and look as a service product to stabilize it gives us the opportunity to continue to iterate, our plan and drive productivity inefficiencies into the base plan as well. So it's not just the elimination of the service recovery costs, we're going to make the base plant better and that's exactly what we do.
Now and that's the structure that Paul has built into his organization.
Great. Thanks for the time.
Okay. Thanks.
Thank you. Our next question comes from the line of Allison <unk> with Wells Fargo. Please proceed with your question.
Hi, Good morning, just going back to that $2 6 billion that you highlight our industrial development is there a way to better understand how that compares to a potential volume opportunity for you.
That's the only with the EV battery plants.
Our plan is there kind of a kind of an algorithm to think through in terms of the volume opportunity as they come online.
I appreciate the question I'm not I'm not sure I think in terms of algorithms for that for that stuff.
The value of the product that we're delivering.
There is by the size of the project and it could be it could be months to manifest volume it could be years, depending on the size of the project. We are encouraged by the EV battery.
Facilities that are located along our lines, but let me be also clear we're encouraged by EV battery production or facilities that are not on our lines because being the largest producer who we.
<unk> served more auto plants than any other railroad, we're going to benefit from that offline production as well so.
I think when we think through it it is a it is a multi year a manifestation of volume over time, Yeah. I think the salient point is is the macro trends in the economy play to the strengths of our unique franchise. Yeah. That's why we have a lot of confidence moving forward.
Understood. Thank you.
Thank you Allison.
Thank you. Our next question comes from the line of Jason Seidl with Cowen. Please proceed with your question.
Hey, Thanks, operator, Alan and team good morning, guys.
Two quick things here, one how should we think about sort of other income below. The line you guys did a great job of laying out sort of what do you think about revenue when you think about or where there's a big swing year over year and in other income. So just curious about second half and Alan any thoughts on potential regulation and maybe the recent steps by the FRE.
Great.
A public comment period on train size and weights.
Jason or other income remember a big driver of other income is a the company on the returns on company owned life insurance investments and right here in the first half we had some pretty good compares because last year in Q1 Q2, we had losses on those companies.
Life.
Life insurance policies. So now we've swung to returns again, which is historically long term given the more normal and so the $64 million or so.
Q2, which is the year over year compare on company owned life insurance will probably not be as big.
Big in the back half, so I'd get back to more back half numbers like you've seen historically in that.
1% to $30 million per quarter range.
And Jason with respect to your question about regulation.
I have been fully engaged with our elected officials and regulators really advancing in offering my full throated endorsement for a lot of the provisions that are in the various bills that are moving through the house are moving through the Senate a lot of them make perfect sense to us or just commonsensical.
See anything out there right now that is going to be too onerous on the rail industry cost structure, which includes railroads or our customers.
Good to hear appreciate it all.
Thanks, guys.
Thank you. Our next question comes from the line of Bascom majors with Susquehanna International Group. Please proceed with your question.
Mark you gave us a lot of color on the timing of recoveries versus spend and some of the issues with east Palestine.
It would be helpful. If you could kind of frame what youre feeling for free cash flow this year, and and just ballpark any amount that might be a shift into 2024 or even if that's how we should look at it given that that claims and recoveries will be ongoing and could take years. Thank you.
Yes Bascom.
It's really because of the timing with EEP and the uncertainties.
Around.
You know I had mentioned that the accrued balance that sits there today 287 of cash has gone out we've got over 800.
Oh that we had accrued for so the remaining 500 or so million.
Half of that is going to come out in the back half of this year the other half.
Probably next year, some may slip into 2025, even.
Beyond that we have no visibility to the timing on recoveries.
It's unlikely that we'll see any recoveries actually here in 2023.
As a matter of when in 2024, they start to come in.
And we will get back to again, the insurance process, where you cant really ask for insurance coverage on costs, you've incurred until you actually incur the expense. We're meeting the cash goes out. So we're only just now starting to make those claims. So it is going to take several quarters, probably before you go through the process.
And get the free cash flow benefited on the proceeds.
Do you have any thoughts without really tying you to the timing of when those recoveries may or may not happen, what free cash flow could look like for the business. This year.
I don't want to get into that level of guidance right here. Thanks Pascal.
Thank you.
Thank you. Our next question comes from the line of Ben Nolan with Stifel. Please proceed with your question.
Yeah. Thanks.
We heard a little bit about the possibility of seeing some intermodal shifting back to the west coast from the East coast given the.
The hopefully normalization of labor over there curious if you guys have seen any initial signs of that at all or if you. If you see that as a potential risk or not.
I would say, we haven't seen any real signs of it yet, but let's be clear we have a network built for volume growth from the west as well as from the east and we can benefit from a freight that comes in either case.
Okay.
Thank you.
Thank you our final question today comes from the line of David.
With Bernstein. Please proceed with your question.
Hey, guys. Thanks for fitting me in here.
So is there a way to quantify that.
Share loss in Q.
Even from the Palestinian derailment I'm, just trying to get a sense for.
How much volume might have moved away that is related to the weaker macro and then mark is there a way to think about.
Look forward to all the things that are potentially out there obviously, we've accrued for a lot of things we're going to get some recoveries. If we think about the net the good guys versus the bad Guy is there a way to think about whether it's a liability for this thing is going to net grow or maybe stay constant or maybe shrink a little bit what do you think about all the puts and takes that are on a multi year view.
This is Ed I'll start you know there's no doubt we went through a tough stretch there with service that for some of our customers to find alternatives to keep their supply chains running.
Those alternatives broadly included additional inventory drug substitution as well as other railroads and I think mark actually mentioned $175 million to $200 million in the quarter that we wish we add back I think that's fair number we worked pretty closely on that but we also know that our customers recognize the long term benefits that we deliver and I told.
You earlier that I'm already encouraged about the recent trajectory of our volumes.
We're able to save our customers money and they are they are looking forward for us doing that we focus on two things during the quarter as we got service back number one get it back as quickly as possible number to make sure. We stayed really close to our customers. So they knew that they could unwind those alternatives and come back to US we think we're seeing that.
Yeah look that's a central point to our long term strategy and consistent service as consequences.
We're gonna make service competitive service excellent service and enduring competitive strength for N S.
Thank you that concludes our question and answer session I'll turn the floor back to Mr. Shah for any final comments.
And thank you for joining us this morning, and we'll look forward to further conversations during the third quarter.
Thank you. This concludes today's conference call you may disconnect. Your lines at this time. Thank you for your participation.