Norfolk Southern Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2023

There are 18 speakers on the call.

Operator

Greetings, and welcome to the Norfolk Southern Corporation Second Quarter 2023 Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to introduce Luke Nichols, Senior Director of Investor Relations.

Operator

Thank you, sir. You may begin.

Speaker 1

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 Full discussion of those risks and uncertainties we view as most important. Our presentation slides are available at nscorp.com in the Investors section, along with a reconciliation of any non GAAP measures used today to the comparable GAAP measures.

Speaker 1

Turning to slide 3, It's now my pleasure to introduce Norfolk Southern's President and Chief Executive Officer, Alan Shaw. Good morning, Welcome to our discussion of 2nd 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 Norfolk Southern for their tremendous work this quarter. As you will hear this morning, we are delivering on our commitment to recover service quickly.

Speaker 1

We are 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 railroaders 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. Adversity reveals character and tests resolve. I'm

Speaker 2

proud of

Speaker 1

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 interest 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 in 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.

Speaker 1

With our strategy as our roadmap, we made significant progress in the Q2, building the foundation for long term value creation. This morning, I'll share a few notable examples of our progress. I'll start with service. In the Q1, we expressed confidence that our service challenges were a temporary disruption Due to deliberate management actions in response to the derailment and that our recovery plan would show results quickly, We delivered. As Paul will describe shortly, service is now at levels comparable to our best performance in 2019.

Speaker 1

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 railroaders We are investing in locomotives, intermodal infrastructure, new sidings, technology and other assets that will drive service, productivity and growth. We are 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 Through our continuing progress, engaging more effectively with our frontline railroaders.

Speaker 1

This is one of my top priorities as CEO And it is a reason I spend so much time in the field. I've learned 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 1st Class 1 railroad to provide paid sick leave for all of our Craft employees. We are building on that momentum. It was an extraordinary moment to co author an open letter with the leaders of 12 railroad unions Committing to collaborate on 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.

Speaker 1

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, positioning us to maintain the deep customer relationships that characterize Norfolk Southern, while simultaneously pursuing growth in high value markets that make sense for our network. As part of that change, we made the innovative move this quarter to create the industry's 1st Vice President of First Mile Last Mile, 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. In the second quarter, we created a new performance excellence team within Charged with building additional rigor and discipline into our processes.

Speaker 1

This work is foundational to our strategy. Standardizing our processes supports a high degree of plan compliance, which in turn gives us greater flexibility to innovate and test Targeted improvements that enhance consistent and reliable service and provide productivity opportunities, thus unlocking growth potential. Additionally, we continue 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.

Speaker 1

Then we reached out to the leaders of the national unions representing Our frontline craft railroaders and ask 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 and more, Norfolk Southern today is 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.

Speaker 1

And now, I'll turn it over to Mark for a detailed look at our Q2 results.

Speaker 3

Thank you, Ellen, and good morning to everyone. Before we get into the operating results for the quarter, Slide 6 illustrates the financial impact from the Eastern Ohio derailment. There was another $416,000,000 of costs recorded in Q2, primarily driven by environmental cleanup activities. Our estimates reflect the significant progress we've made remediating 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 Any changes in the nature, extent and duration of the remaining cleanup activities and government oversight activities may impact our current estimates.

Speaker 3

Additionally, developments with respect to the healthcare fund, which we are creating for affected residents, as well as the potential fines, penalties or settlements and ongoing legal expenses Will all likely impact our costs in future quarters. Of the $803,000,000 recorded so far this year, Only $287,000,000 of the cash has been paid through June 30. We currently expect about half 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 3rd parties, A process we will continue to explore where appropriate in connection with our other lawsuits.

Speaker 3

As for our insurance coverage, we expect to begin filing insurance claims here in the 3rd 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 you can imagine, insurance reimbursements and third party recoveries will take time to materialize. Turning to Slide 7.

Speaker 3

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 in the $416,000,000 operating expense adjustment. Consequently, the adjusted operating ratio With 66.7 percent, had we been able to move a couple of 100,000,000 more of revenue with our Q2 cost structure, Our margins would have been much stronger.

Speaker 3

On an adjusted basis, operating income was down 22%, Net income was down 18% and EPS was down 14%. Moving to Slide 8, adjusted operating expenses for the quarter were up slightly on a year over year basis. Compensation and benefits were up $79,000,000 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 We're up $33,000,000 or 19%, driven primarily by a continuation of the locomotive related work we discussed during the first Additionally, in other, the quarter was impacted by lower gains on the sale of property. Purchased services and rents were up $25,000,000 or 5% this quarter as the challenged network created more headwinds to the category, In addition to our continued investments in technology, depreciation was up $17,000,000 in the quarter, in line with our guidance.

Speaker 3

Mitigating these increases were fuel expenses, which were down $145,000,000 or 36% in the quarter. Turning to Slide 9, let's look at the adjusted P and L results below the line. Partially mitigating the $279,000,000 reduction in adjusted operating income was a $71,000,000 Net income and EPS were down 18% 14% respectively in the quarter. Moving to free cash flow and shareholder returns on Slide 10. Through the 1st 6 months, Free cash flow was lower by $276,000,000 due to combined pressure from the derailment related expenditures as well as investments in Roadway and Equipment.

Speaker 3

Shareholder distributions during the first half were $918,000,000 Thanks to our solid dividend and share repurchase activity. I'll now turn it over to Paul for a discussion on our operations.

Speaker 2

Thank you, Mark, and good morning, everyone. Let's jump right into our 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 Our accident rate 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 date versus last year.

Speaker 2

I want to take a moment to thank our leaders and our Craft colleagues We're collectively enhancing safety and driving these outcomes for our team, the communities we serve and our customers. We'll transition to our progress in safely delivering a reliable and resilient service product on Slide 13. You will recall during our last earnings call that we expected We have delivered on that promise. We've successfully restored our double track mainline through East Palestine in a safe In an environmentally appropriate way, we wasted no time resetting network performance to levels our customers expect in this quarter between the Midwest and the Northeast. We have significantly improved train velocity, dwell and service across our network to 2 year best resulting from these improvements.

Speaker 2

With service improved, our focus now is driving further reliability, productivity and resiliency in our network aligned with our strategic vision outlined in December. Touching on Slide 14 on what we told you would be an important measure of our service recovery reduction in cars online. Following the Q1 service interruptions, we had an inventory buildup. We set in place a plan to work down the build up as quickly as possible, while also restoring our mainline and overall network conditions. We successfully executed on that plan and railcars are now cycling throughout our network faster than they have since before 2022, Achieving Greater Railcar Fleet Productivity.

Speaker 2

Turning to Slide 15 for an update on our hiring progress. Our efforts to right size our T and E crew base have continued the first half of this year. We are now at a point at which the trainee pipeline has and will begin to taper down over the back half of the year. We are committed to maintaining an appropriately sized workforce to drive reliability and long term resilience is part of our strategy. Our productivity metrics are shown on Slide 16.

Speaker 2

Our short term service challenges described earlier contributed to productivity impacts as we work to restore service and velocity. Mark mentioned earlier that We 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 rightsized our road fleet and are now achieving velocity near 200 miles per day with our locomotives. 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 of our network when needed. We continue to have a solid outlook for our locomotive fleet.

Speaker 2

Our DC to AC program is ongoing, which will provide us with a capacity dividend, Not only in terms of AC traction, but also improvements in fuel efficiency. Transitioning to the workforce, T and E productivity was to improve T and E productivity through a variety of initiatives, improving velocity, absorbing volume on existing trains and normalizing our CT pipeline. Lastly, on fuel, we took a step back for the first time in 7 quarters. This was largely due to lower velocity and fewer GTMs on the network as we were restoring service. We are very confident that our initiatives that have been paying regular dividends will continue to driving us towards further fuel efficiency as we continue to see the benefits of an improving network.

Speaker 2

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 further reliability and resiliency in the network, but to do so productively. Velocity and service improvements will provide us further opportunities to leverage and our assets while pushing to drive further process standardization into our scheduled network to drive productivity.

Speaker 2

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 recent siding 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.

Speaker 4

Thanks, Paul, and good morning to everybody on

Speaker 5

the call.

Speaker 4

Beginning on Slide 19, I'll review our commercial results for the quarter. Now as we expected, the 2nd 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 $1,000,000,000 in revenue for the quarter, down 8% from the Q2 of last year, and that's driven by a 6% drop in volume and lower revenue from fuel And accessorials. RPU 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.

Speaker 4

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 agriculture products were offset by headwinds in chemicals markets, and that's a good example of the challenging RPU mix Within markets that I just mentioned, automotive volumes were driven by robust finished vehicle production and agriculture shipments were strong Due to new lean 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 merchandise volume and revenue for the Q2 came in 1% below prior year levels. Revenue per unit was flat year over year, but RPU Less Fuel grew 2%, which makes 32 out of the last 33 quarter We've achieved growth in this metric, and I think 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.

Speaker 4

Conversely, in a continuation of the Q1 trend, international volumes increased 1% year over year and 5.8 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 RPU mix with end markets was challenging for us. Both RPU and RPU 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 RPU declined. Utility volumes were down 17% year over year due to historically low natural gas prices and elevated stockpiles.

Speaker 4

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 yielded lower revenue per unit. Again, a key segment where RPU mix within markets 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 and markets that have the highest potential for growth for Norfolk Southern.

Speaker 4

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 non residential construction As reshoring and infrastructure projects increase, which will drive strength in metals and construction volume, Pinup 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.

Speaker 4

Turning to intermodal, we expect international volumes to continue It's growth trend with an expected rebound in import volumes and the continued share growth of IPI. Storage chargers will continue to be a revenue and RPU 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.

Speaker 4

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 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 offsets weakness in utility coal. Coal production levels at NS Serv Mines will drive growth in export shipments, Although we do expect lower seaborne coal prices to negatively impact RPU. The utility outlook is largely dependent on the weather, on existing stockpiles and natural gas prices.

Speaker 4

The net result is we expect total coal RPU 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, 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 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 are focused on all facets $1,000,000,000 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 $3,000,000,000 General Motors and Samsung Battery Manufacturing Plant in Indiana on a Norfolk Southern Main Line. Norfolk Southern's network is well positioned for future industrial development.

Speaker 4

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 $2,600,000,000 in industry investment That's been completed along Norfolk Southern lines, bringing 3,200 new jobs to the local communities that we serve.

Speaker 4

We continue to invest in 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, we'll continue to land new opportunities across our network. With that, I'll turn it back over to Alan to bring us home.

Speaker 1

Thanks, Ed. Let's turn to Slide 22. As we have 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 2022, 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.

Speaker 1

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 Through 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?

Operator

Thank you. We will now be conducting a question and answer session. As possible. Our first question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.

Speaker 6

Hey, good morning and thanks for taking my question. So Alan, I guess, can you give us an update on lessons learned here as you've reworked your train Make up, I think, through the Q2. And how has that impacted your operational planning going forward? And does that create incremental capacity for you guys if Markets recovered, which I think Mark was alluding to earlier.

Speaker 1

Hey, Brandon, we remade our train makeup Starting in March, and we guided to the fact that we would expect Service to improve as we moved out of the Q2 and into the Q3, coupled with the fact that we're going to get the 2nd track back in East Palace and That's absolutely what we delivered. Our service is on the trajectory that we had guided to and what we're seeing as a result Over the last couple of weeks is real strength in our volumes sequentially and also relative to the rest of the industry. With respect to our updated operating plan and train makeup rules, it gives us an opportunity to create more capacity as we've Increase the utilization of distributed power, which helps our cost structure, helps our service product and helps our capacity for growth.

Speaker 7

Thank you.

Operator

Thank you. Our next question comes from the line of Ken Hoexter with Bank of America. Please proceed with your question.

Speaker 8

Hey, great. Good morning. Just before I get to the question, two clarifications. Mark, you said 1% ARPU gain ex fuel on mix and price. So If mix was positive, are you saying pricing is less than 1% or are you saying intra category mix hides the pricing gain?

Speaker 8

And then second, you mentioned the real estate gain. Did you mention what it was in the quarter? And then my question is, on carload growth. Alan, you mentioned accelerating Growth in the second half of the year, peers are talking about RTMs or industrial production being down slightly. I just want to understand How you're targeting that acceleration in the second half?

Speaker 8

Maybe detail it a little more. Thanks.

Speaker 3

Yes, 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 19,000,000 Absolute in the quarter itself. Go ahead.

Speaker 1

Yes. Ken, and with respect to volumes moving forward, Clearly, our volumes were pressured in the Q2 and in the last 2 months of the Q1 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.

Speaker 2

Ed, do

Speaker 1

you want to give a little bit more color on that?

Speaker 4

Yes. When we look at our volumes compared to the other Class Is over the course 2023, our volumes outperformed the industry average for 9 of the 1st 10 weeks of the year, and we were feeling good. And then as you know, the network slowed and congestion build up. Our performance suffered. But as we started to speed up, our relative performance also has started to recover.

Speaker 4

And over the last 11 weeks, I think this is important, We've outperformed the industry average for 9 of those weeks and the outperformance that we've been experiencing is accelerating, placing us in the top 2 Class 1 railroads were 4 to 5 last weeks. And I will tell you, and I spoke about it in the prepared remarks, There are a few bright spots out there where we're focused 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 new home construction because People with low interest rates are just staying in those houses, so folks who need a home are going out and building a new one. We see some clear Bright spots there.

Speaker 4

And 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.

Speaker 8

Great. Mark, Allen Ed, thank you. Appreciate the time.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your question.

Speaker 7

Thanks, operator. Hi, everyone. Just wondering what inning we are here in terms of the sequential drawdown in intermodal Yield, I assume you've got some new pricing that's being implemented on July 1. You've got more runoff of the storage fees. What's the right way to think about intermodal yields from here?

Speaker 7

And then Mark, there's a lot of like puts and takes on profit cadence from here. On one side, There's a lot of service issues and inefficiencies related to that in the Q2, 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 grow operating income off of the second quarter in the back half? If you can just Kind of give us some of

Speaker 9

the puts and takes there. Thank you.

Speaker 1

Sure. Do you want to take the first question?

Speaker 4

Yes. If you want to let's talk about RPE first, particularly within intermodal. Core pricing remains positive for intermodal. And more importantly, I think I highlighted it during the prepared remarks, 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 RPU within intermodal for sure.

Speaker 4

Again, When we think about supply chain congestion, I think it's pretty much gone. I'd say supply chains are really about as 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 Supply Chain's Index, or excuse me, the Logistics Managers Index, which we pay attention to, noted that warehouse capacity has increased at the fastest It's a challenge and we've seen those storage charges roll off and essentially turn

Speaker 1

You've also seen us take share from truck and the international market.

Speaker 4

Yes. That's what I was referring to with increased IPI shipments. 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.

Speaker 3

Amit, let me go through a little bit of the first half, second half dynamic because there are some changes here for sure. We do expect So modestly higher volumes 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 fuel expense is going to be Less of a headwind than it was in the first half, but we got some sizable tail sorry, sizable headwinds Here in the back half, principally on the RPU side, the fuel surcharge really starts to diminish here and The lag benefit disappears on us.

Speaker 3

So this fuel will be a real negative in the back half certainly to margins. And as Ed mentioned, 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 Q2 of next year. And then of course, if the Futures hold, we're going to have international seaborne coal pricing headwind as well in the RPU side. So That's pretty much the headwind and tailwind equation. So if the volumes come in like we think, a little bit of back half tailwind, we should get some OR improvement from here, and the more the better, because we got a lot of capacity on the railroad right now.

Speaker 7

Thanks a lot guys. Appreciate it.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.

Speaker 5

Hey, thanks. So Mark, you're saying hopefully some OR Mr. Keifer, you're saying hopefully some of our improvement from Q2 into the back half

Speaker 10

of the

Speaker 3

year? Yes. 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're able to bring on to the railroad.

Speaker 1

Look, we were really clear in May that OR would be really pressured in the Q2 because we were going to have 3 months of service disruption as We've delivered on our commitment to improve service throughout the quarter and moving into Q3. That creates more opportunity for volume and it creates a better cost structure We will still have those headwinds that Mark called out, particularly with respect to fuel surcharge and comps On coal pricing. Coal pricing. But the underlying product and our ability to onboard volume at Strong incremental is improving. Yes.

Speaker 5

And so ultimately, I guess, you've given us now a little bit of color on OR And some color on coal RPU, but how should we think about overall RPU when I factor in the fuel headwinds, some of them Maybe continued storage headwind like what's the how much do you think is overall RPU going to be down in Q3? Just that I'll, I think, be helpful.

Speaker 4

This is Ed. When we look at the second half of the year, On the RPU front, reduced storage and fuel surcharge revenues are going to persist. We've talked about that. I talked about that in our prepared remarks. Collectively, those current projections for us for fuel storage and coal pricing is roughly $650,000,000

Speaker 3

Year over year revenue contraction. That's right. So that's the headwind we're swimming against.

Speaker 5

$650,000,000 in what period?

Speaker 3

2nd half versus second half.

Speaker 5

Okay. That's revenue. Thank you.

Operator

Thank you. Our next question comes from the line of Chris Wetherbee with Citigroup. Please proceed with your question.

Speaker 11

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 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 3Q, 4Q?

Speaker 11

And then, Mark, in the past, you talked a little bit about OpEx and maybe putting the profit aside. I know, obviously, there's RPU headwinds on the revenue piece. Is OpEx Kind of flattish from where you were in the Q2? Is there ability to actually improve on that given the network kind of reopening and getting some of that productivity back

Speaker 1

Paul, why don't you address the question on conductor trainees Kraft colleagues?

Speaker 2

Yes. Thanks, Ellen. So as you saw in the in our hiring chart and the stats, we continue to make progress on staffing. And really at this point, We plan to reduce the CT pipeline to around 600 or less, as we continue to focus on attrition and filling in some of those remaining locations. But at this point, with what we've been able to do from a hiring standpoint, we have further leveraged And gain velocity across the network and facilitated having those folks that are at healthy locations sent to some of those hotspots.

Speaker 2

And again, that It is a contributor to the velocity improvements and the service improvements that we've seen here over the past several weeks that we expect to continue Through the latter half of the year.

Speaker 1

And Paul, your guidance on a pipeline of around 600 is more pointed towards the end of the year. Correct. Correct.

Speaker 3

And Chris, with regard to OpEx, I think 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 the munition of those service related costs As we go through the back half of the year, however, don't forget, we've got that 4% wage increase that took effect July 1. So those kind of start to wash each other out. And with regard to some of the other P and L line items, in aggregate, Probably flattish sequentially. We see those kind of holdings.

Speaker 3

So that's why the leverage is there now to take on volume. We believe we've got the capacity to handle a lot of volume without much incremental cost. And really it gets down Facing these RPU headwinds that are going to provide pretty sizable headwind for us on the margin side, $650,000,000 as we just touched on.

Speaker 11

Okay. And average heads are up a little bit in the back half of the year, I think is what I heard.

Speaker 3

I'm sorry, can you repeat that?

Speaker 11

The average headcount is going to be up a little bit sequentially in the back half of the year?

Speaker 3

Yes, correct.

Speaker 4

Okay. Thank you very much. Thank you.

Operator

Thank

Speaker 12

Mark, I thought Slide 7 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 those 2, Let's call them non adjusted impacts to the 2nd quarter results. And as we think about a return to normalization, is 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 Q4? Or do you think that It's going to take all the way till 2024 to say, kind of base revenue and base costs from the entire network.

Speaker 3

Yes. 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 $200,000,000 of revenue behind because of the service disruptions and the shutdown of the line there in East Palestine. So that's kind of on the revenue side. And on the cost side, we were dealing with throwing a lot of costs at trying to accelerate the network, and we've done that And I think by the Q4, most of those costs will be removed from our system. So we talk about probably $40,000,000 to $45,000,000 here in the Q2 of kind of poor service related costs and that will start to unwind here.

Speaker 12

Great. Super helpful. Thanks, Mark.

Speaker 3

Thank you, John.

Operator

Thank you. Our next question comes from the line of Brian Ossenbeck With JPMorgan, please proceed with your question.

Speaker 9

Hey, good morning. Thanks for taking the question. So Maybe just go back to the average comp per employee. Mark, you were talking about the 4% increase for the Craft employees. Can you just give us a sense What that looks like on an all in basis because you've got over time, you've got mix, you've got trainees in there.

Speaker 9

What does it look like in the back half of this year and how does that carry forward into Sure. And then beyond that point, can you just talk more broadly about the cost for paid sick leave, work rule changes and how

Speaker 3

I think I guided earlier in the year to about $35,000 and change each quarter, anticipating that we were going to have this 4% step up Rates in the Q3, but that would be neutralized by the wind down of service related costs. So That guidance pretty much holds. I would if I were you all, I'd be modeling around 35 and change average comp per employee each quarter. Sorry, the second part of that one question was what?

Speaker 4

The work Work rule changes Yes,

Speaker 9

sorry. Yes,

Speaker 3

look, 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 going to have to pay for that with some productivity initiatives in the future and That's what Paul and his team are looking at now. So but clearly some short term headwinds from a lot of what you've seen published.

Speaker 9

Okay. Thank you, Mark.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from the line of Jordan Alger with Goldman Sachs. Please proceed with your question.

Speaker 13

Yes. Hi, good 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 the Q2, you talked about maybe hopefully improving OR with some volume sequentially versus the Q2 OR. But I'm actually curious, is there a given the headwinds you've talked about and maybe even looking into next year, is there a level of volume growth that needs to

Speaker 3

Well, I'll jump in and just say that you go back to our financial framework. Our goal, the one we launched back in December, Conor, we're aiming for mid single digit revenue growth on average in most years and that would imply A few points at least of 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, so that we have op income growth that's greater than the revenue growth. So that's pretty much the model. And I would expect in 2024 that to play out.

Speaker 13

Great. Thank you very much.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

Speaker 13

Thanks. Good morning, everyone. Now that you have a little more time to digest the aftermath of the accident, kind of

Speaker 14

do you have a better sense of when we might know the Final

Speaker 13

kind of financial impact here kind of is that 3Q event, is it 2024 event, is it going to take several years? How does that play out?

Speaker 1

Mark, why don't you address that please?

Speaker 3

Sure. I mean, this is going to take a little bit more time. The way to look at this, Ravi, is 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 Q4. Future periods are going to be impacted by ongoing legal costs and Maybe impacted by other items as well such as fines and penalties, which are currently unknown and frankly we can't estimate.

Speaker 3

So what I would encourage is 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'll continue to monitor this and Keep you all apprised as things change. But right now, the largest part of what we're 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.

Speaker 3

Now I'll take a moment and just say, we've started the process, like I said in my prepared remarks, of Seeking recovery from 3rd parties and we are going to start here in the 3rd quarter, making claims against our insurance Making claims against our insurance policies. So that's going to take some time, to play out. And we're probably talking quarters, not months.

Speaker 13

Understood. Thank you.

Speaker 14

Thank you.

Operator

Thank you. Our next question comes from the line of Justin Long with Stephens Inc. Please proceed with your question.

Speaker 1

Thanks and good morning. We had another Class 1 rail yesterday come out and announced that 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 Southern acquisition closing and how that deal will be funded?

Speaker 3

Yes, thanks. We continued Doing some share repurchasing in the 2nd quarter, similar levels to what we had done in the first. And again, we get back to What our model is and nothing changes. The first thing we do with our returns is reinvest back in the business to drive safety, resiliency, growth, productivity. And this year, that is going to be $2,200,000,000 of CapEx spend.

Speaker 3

After that, we pay a dividend in that 35% to 40% payout ratio range. Sometimes it goes outside of that a little bit, but we'll grow back into it. And then with the remaining excess cash, we've being very mindful of our leverage, we returned that cash to shareholders through the repurchase of shares. This year is a little unique in that we have signaled we're going to do that CSR purchase. The timing of that is also becoming clearer.

Speaker 3

That is likely toward the end of Q1 of next year closing should the citizens vote affirmatively in Cincinnati to go forward. So we will be mindful of that because 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 Then we've seen in the prior couple of years where we were doing $3,000,000,000 a year or more.

Speaker 1

Okay. Thanks.

Speaker 3

Okay, Justin.

Operator

Thank you. Our next question comes from the line of Jeff Kauffman with Vertical Research Partners.

Speaker 15

Thank you very much. A lot of my questions have been answered, but let me ask this one because you threw it out earlier. You talked a little bit about bringing in 1st mile, last mile ahead. Now is not the right time. We're focused on Rehabbing the network and fixing what needs to be fixed.

Speaker 15

But could you talk a little bit about longer term, why this makes a difference and why you're one of the few rails It's actually stepped in that direction.

Speaker 1

Ken, why don't you address that? Sure. I'd be glad to.

Speaker 4

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. 1st and last mile is a critical component of the customer experience and we know There are a few key vectors of value that we're going to be that we have to focus on delivering. Service quality is one of those and first and last mile is a portion of service It's also customer experience. It's also commercial sophistication.

Speaker 4

In all three of those categories, 1st and last mile plays a significant and substantial role. And it's not just in the merchandise business, it's also in our TBT or bulk transfer facilities, it's also with our thoroughbred direct product, it's also with Triple Crown. So We view it as a key component of our future success.

Speaker 1

It's all part of our long term strategy to drive service, productivity and growth.

Speaker 3

We got to do different things if we want to grow. So this is a great example.

Speaker 1

Yes. And we're willing to take a lead role in the industry on that.

Speaker 3

That's right. Okay.

Speaker 13

That's

Speaker 10

my one. Thank you. Thanks guys.

Operator

Thank you. Our next question comes from the line of Tom Wadewitz with UBS.

Speaker 14

So I wanted to ask you, I think you talked a little bit about Maybe what you mean on the volume side to or revenue side to improve OR. But I guess I'm thinking if you look, I don't know, in 24, just let's say beyond the next quarter or 2, it does seem like you identified a pretty big revenue headwind in second half and I don't know that those revenues would come back in terms of storage or coal RPU. And fuel surcharge obviously can be up or down. But I'm just and on the cost side, it doesn't seem like you're going to cut headcount. So is it just all about volume?

Speaker 14

And Should we be optimistic about moving out

Speaker 15

of the

Speaker 14

mid-60s? Or is there an operating ratio? Or Is there a challenge where you're kind of stuck in the mid-60s for a period of time on the operating ratio? It just seems hard to see what's going to move In a big way out of the mid-60s OR other than volume really being a lot better. Thank you.

Speaker 3

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 a peel out from where we are today. And then I think At the same time, Paul and his team in particular are 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 costs and resources to accelerate the network. So now there's a lot of opportunity to take the costs out And start driving productivity again, and that's what Paul and his team are heavily focused on.

Speaker 3

We're not going to give an OR projection here Or the pace at which we're going to improve, there are a lot of levers. And you touched on most of them, RPU being a big piece. We'll see what happens here with coal pricing in the future. That's been a driver. The same thing with fuel that's going to be It's been very supportive fuel to our OR in the first half and it's going to be equally negative now here in the back half.

Speaker 3

So that dynamic could change going forward. So we're not in a position to project where the OR 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 employees to take on volume.

Speaker 14

It just seems like the revenue headwinds are a lot bigger than the $45,000,000 a quarter cost inefficiencies.

Speaker 3

Yes. I mean, we laid them out. There are some revenue RPU 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 there's some share recapture opportunity that's out there and other areas where we can take the volume on. But yes, we're going to have short term headwinds.

Speaker 1

And look, as the service product has stabilized, it gives us the opportunity to continue to iterate our plan and drive productivity and efficiencies into the base So it's not just the elimination of the service recovery costs.

Speaker 13

We're going to

Speaker 1

make the base plan better. And that's exactly what we're doing now. And that's The structure that Paul has built into his organization.

Speaker 14

Great. Thanks for the time.

Speaker 3

Okay. Thanks.

Operator

Thank you. Our next question comes from the line of Allison Poliniak with Wells Fargo. Please proceed with your question.

Speaker 16

Hi, good morning. Just going back to that $2,600,000,000 that you highlighted on industrial development, is there a way to better understand how that converts to a potential volume And I would say similarly with the EV battery plans, per plan, is there kind of an algorithm to think through in terms of the volume opportunity as they come online? Thanks.

Speaker 4

I appreciate the question. I'm not sure I think in terms of algorithms for that stuff. The value of the product that we're delivering varies by the size of the project. And it could be months to manifest volume, it could be years depending on the size of the project. We're encouraged by the EV battery facilities that have located along our lines.

Speaker 4

But let me be also clear, we're encouraged by EV battery production or that are not on our lines because being the largest producer, we serve more auto plants than any other Railroad, we're going to benefit from that offline production as well. So I don't I think when we think through it, it It is a multiyear manifestation of volume over time.

Speaker 1

Yes. I think the salient point is the macro trends in the economy Play to the strengths of our unique franchise. Yes. That's why we have a lot of confidence moving forward.

Operator

Understood. Thank you.

Speaker 12

Thank you, Allison.

Operator

Thank you. Our next question comes from the line of Jason Seidl with TD Cowen. Please proceed with your question.

Speaker 11

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 you think about revenue, what you think about OR, but there's a big swing year over year in other income.

Speaker 11

So just curious about And Alan, any thoughts on potential regulation and maybe the recent steps by the FRA to do a public comment period on trains Size and

Speaker 3

weights. Jason, other income, remember a big driver of other income is the company owned The returns on company owned life insurance investments and during the first half, we had some pretty good compares because Last year in Q1, Q2, we had losses on those company owned life insurance policies. So Now we've swung to returns again, which has historically long term been the more normal. And so the $64,000,000 or so In Q2, which is the year over year compare on company owned life insurance, will probably not be as big in the back half. So I'd get back to more back half numbers like you've seen historically in that $20,000,000 to $30,000,000 a quarter range.

Speaker 1

Very helpful. And Jason, with respect to your question about regulation, I've been fully engaged with our elected officials and our regulators. So Really advancing and offering my full throated endorsement for a lot of the provisions that are in the various bills that are moving Through the House or moving through the Senate, a lot of them make perfect sense to us or just they're commonsensical. I don't see anything out there Right now, that is going to be too onerous on the rail industry's cost structure, which includes railroads or our customers. Good to hear.

Speaker 1

Appreciate it, Alan.

Speaker 3

Thanks, Jason.

Operator

Thank you. Our next question comes from the line of

Speaker 10

Coveries versus spend and some of the issues with East Palestine. I think it would be helpful if you kind of frame what Into 2024 or even if that's how we should look at it given that claims and recoveries will be ongoing and could take years? Thank you.

Speaker 3

Yes. Bascome, it's really because of the timing with EP and the uncertainties around, I had mentioned that the accrued balance that sits there today, dollars 2.87 of cash has gone out. We've got over 800 That we had accrued for, so the remaining $500,000,000 or so 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. It's a matter of when in 2024 they start to come in.

Speaker 3

And we'll get back to again the insurance process where You can't really ask for insurance coverage on costs you've incurred until you actually incur the expense, meaning 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 benefit on the proceeds.

Speaker 10

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?

Speaker 3

I don't want to get into that level of guidance right here. Thanks, Bascome.

Speaker 7

Thank you.

Operator

Thank you. Our next question comes from the line of Ben Nolan with Stifel. Please proceed with your question.

Speaker 17

Yes, thanks. We've heard a little bit about the possibility of seeing some intermodal shifting back to the West Coast from the East Coast given The, hopefully normalization of labor over there. Curious if you guys have seen any initial Sign to that at all or if you see that as a potential risk or not?

Speaker 4

I would say we haven't seen any real signs of it yet, but Let's be clear, we have a network that's built for volume growth from the West as well as from the East, and we can benefit from freight that comes in either coast.

Speaker 9

Okay. I appreciate it.

Speaker 3

Thank you.

Operator

Thank you. Our final question today comes from the line of David Vernon with Bernstein, please proceed with your question.

Speaker 11

Hey, guys. And thanks for putting me in here. So Ed, is there a way to quantify the Share loss in 2Q that had happened from the East Palestine derailment. I'm just trying to get a sense for some How much volume might have moved away that is related to the weaker macro? And then Mark, is there a way to think about, as you look forward to all the things that are potentially out there.

Speaker 11

Obviously, we've accrued for a lot of things. We're going to get some recoveries. If we think about the nets, the good guys versus the bad guys, Is there a way to think about whether the liabilities in this thing is going to net grow or maybe stay constant or maybe shrink a little bit when you think about all the puts and takes out of multiyear view?

Speaker 4

This is Ed. I'll start. There's no doubt we went through a tough stretch there with service that forced some of our actually mentioned $175,000,000 to $200,000,000 in the quarter that we wish we had back. I think that's a fair number. We work pretty closely on that.

Speaker 4

But we also know that our customers recognize the long term benefit 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 looking forward for us doing that. We focused on 2 things during the quarter as we got service back. Number 1, get it back as quickly as possible.

Speaker 4

Number 2, make sure we stayed really close to our customers, so they knew that they could unwind those alternatives and come back to us. I think we're seeing that.

Speaker 1

Yes. Look, that's a central point to our long term strategy. Inconsistent service has consequences and that

Operator

Thank you. That concludes our question and answer session. I'll turn the floor back to Mr. Shaw for any final comments.

Speaker 1

Thank you for joining us this morning, and we'll look forward to further conversations during the Q3.

Operator

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.

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Key Takeaways

  • Norfolk Southern achieved service performance comparable to its best 2019 levels, with railcars cycling faster than any period before 2022 after executing its recovery plan.
  • The company made significant investments under its “Better Way Forward” strategy, including expanding its frontline craft workforce, upgrading locomotives and new sidings, and pioneering a Vice President of First-Mile/Last-Mile to drive productivity and growth.
  • Safety has been strengthened through a partnership with Atkins Nuclear Solutions and direct collaboration with 12 railroad unions, yielding a 12% reduction in injury frequency and a 40% improvement in mainline train accident rates year-to-date.
  • The Q2 results were impacted by the East Palestine derailment, with $416 million in cleanup costs recorded and total 2023 accruals at $803 million, while the company plans to pursue insurance claims and third-party recoveries over the coming quarters.
  • Financially, Q2 revenues fell 8% year-over-year, the adjusted operating ratio was 66.7%, and full-year revenue guidance was revised to at least a 3% decline amid higher capital expenditures for safety, service, and growth.
A.I. generated. May contain errors.
Earnings Conference Call
Norfolk Southern Q2 2023
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