CSX Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 19, 2022

There are 13 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2022 CSX Corporation Earnings Call. After the speakers' remarks, there will be a question and answer session. Followed by the number 1 on your telephone keypad.

Operator

Thank you. It is now my pleasure to turn today's call over to Mr. Matthew Korn, Head of Investor Relations. Please go ahead.

Speaker 1

Thank you, operator. Good afternoon, everyone, and welcome to our Q2 call. Joining me on today's call are Jim Foote, our President and Chief Executive Officer Kevin Boone, our Executive Vice President of Sales and Marketing Jeremy Boycek, Executive Vice President of Operations and Sean Pelkey, Executive Vice President and Chief Financial Officer. In our presentation, you will find our forward looking disclosure on Slide 2, followed by our non GAAP disclosures. And with that, it will be my pleasure to introduce our President and Chief Executive Officer, Jim Fint.

Speaker 1

Thank you, Matthew, and thank you, everyone, for joining us today. I'll start by expressing my thanks to all of CSX's employees for their hard work during another quarter of tough operating conditions. And I am very pleased to welcome everyone from Pan Am who joined the CSX team in June. We look forward to working together to build new single line service across our combined network. Our second quarter results were solid as we continue to benefit from strong customer demand and firm pricing.

Speaker 1

But our ability to hire and retain new workers, which is vital to improving our service and growing the business remains challenged. We are not alone in facing this problem. The labor market is tight. Prospective recruits have many job options and the pandemic has had a profound effect on employees' work and lifestyle preferences. Our hiring process has been steady but slow.

Speaker 1

We will not let up in our efforts to grow our engineer and conduct our headcount and improve network fluidity to pre pandemic levels. Since the time of our last earnings call, uncertainty and volatility have clearly increased in the financial markets and in parts of the economy. Inflationary pressures have moved higher and interest rates have risen. We're staying diligent by keeping in close touch with our customers, monitoring our order rates and constantly updating our forecasts. But what remains constant is that right now, as we have seen this entire year, there is more demand for rail service in what we are able to satisfy.

Speaker 1

The efforts we are making now to grow our workforce and add capacity to our network by not just the status by current demand. We are investing because we see plentiful long term opportunities for Rail, driven by customer demand for more fuel efficient, environmentally friendly transportation options and growth in domestic manufacturing. We're excited about our potential, but to realize it, we must focus on near term execution. Our entire team is aligned in our goals, and I look forward to keeping you updated in our progress in the quarters ahead. Turning to our presentation, let's start with Slide 4, which highlights our to Q2 key financial results.

Speaker 1

We moved nearly 1,600,000 carloads in the quarter and generated over to $3,800,000,000 in revenue. Operating income was $1,700,000,000 which includes a $122,000,000 gain from our Virginia real estate sale. Recall that in the Q2 of 2021, we recognized a much larger $349,000,000 gain from this transaction. Earnings per share increased 4% to $0.54 a share, which also includes a smaller contribution from the Virginia sale compared to a year ago. And Our operating ratio was 55.4%, which includes a 320 basis point tailwind from the Virginia real estate game, but also includes combined headwinds of roughly 4.50 basis from the impact of quality carriers, higher fuel prices and Pan Am acquisition costs.

Speaker 1

I'll now turn it over to Kevin, Jamie and Sean for details.

Speaker 2

Thank you, Jim. Turning to Slide 5. 2nd quarter revenue increased 28% year over year with revenue growth across merchandise, cold and intermodal. Overall volumes were flat where we saw strong demand across many of our markets limited by resource constraints across the supply chain. Merchandise revenue increased 10% on flat volume driven by price and higher fuel surcharge revenue.

Speaker 2

Looking at some of the highlights. We are encouraged by strength in automotive market where revenues rose 24% on a 10% increase in volume. There are clear signs from auto manufacturers that semiconductor challenges are easing. Our Minerals business benefited from improved shipments of aggregates and salt, while our Ag and Food segment saw growth from ethanol in Export Grains. Less favorable was our fertilizer business, where volumes and revenues declined year over year on reduced phosphate shipments.

Speaker 2

Volatile fertilizer prices combined with some production issues impacted volumes in the quarter. Borr's products, along with metals and equipment, saw positive revenue growth offset by modest declines in volumes, mainly driven by resource constraints. Intermodal revenue increased 18% on 1% higher volume as growth in the international business was partially offset by lower domestic shipments, driven by continued equipment challenges through the quarter. Intermodal demand remains strong and customers continue to recognize our industry leading service product in a challenged market. Coal revenue increased 54% on 3% lower volume.

Speaker 2

As we have discussed, Coal demand remains strong across our domestic and international markets. Volumes have been constrained by production issues at the mine, to infrastructure constraints at the port, including courier to stay and general manpower shortages, including crews. We still expect volumes to improve through the year as some of these constraints moderate. Other revenue increased primarily due to higher intermodal storage in equipment usage. Although macro uncertainty is clearly elevated as we enter into the second half, We still see positive drivers favoring rail, including environmental benefits as customers prioritize ESG, to lack of truck capacity with driver shortages, onshoring of industrial production and inflation that will all benefit our growth opportunities.

Speaker 2

Currently, we are still seeing demand in many markets limited by the global shortage of labor. We believe this will continue to benefit Rail's value proposition and the opportunity to increase mobile share over time. Going forward, we remain committed to making the investments needed to serve our customers and helping them grow their business. I will now turn it over to Jamie to discuss operations.

Speaker 3

Thanks, Kevin. Safety remains our top priority at CSX and operating safely is critical foundation to achieving any of our operating goals. We work hard to instill to a culture of safety across our railroad, and this begins with the moment that our employees enter our training facility. And focus not only on teaching employees the right way to work, but creating an environment that facilitates ongoing coaching and education around our safety protocols. This is particularly important for the almost 700 new T and E employees that have completed training year to date.

Speaker 3

That coaching does not end with a training program. We have created new programs to significantly increase touch points with managers to ensure new employees are protecting both themselves and their fellow railroaders. These efforts have helped drive another strong quarter of safety results. In the Q2, injury rate increased modestly from the near record levels in the Q1, but remained flat year over year. Train accidents ticked up slightly from the prior quarter, but continued their positive trend as we focused on to minimizing human factor accidents through proactive employee communications.

Speaker 3

Turning to Slide 7. We remain committed to delivering strong service, and we are taking action to improve network performance. We are seeing signs of this improved performance in our local service measures. This is our 2nd consecutive quarter of improved results and our best since exiting the pandemic downturn in 2020. We continue to actively coordinate with customers to further improve these metrics and are encouraged that we are seeing some of the largest improvement in some of the areas that we are most challenged entering the year.

Speaker 3

Our intermodal trip line performance remains strong and crossed back above the 90% threshold this quarter. Looking forward, we continue to focus on keeping terminals open and fluid during the ongoing supply chain constraints. We expect merchandise performance to improve throughout the second half of the year as network fluidity increases. To offset the impact of crew shortages. We have added additional assets to the network to better meet our customer commitments.

Speaker 3

As employees mark up, who will be able to refine the network plan to reduce congestion, shorten transit times and improve reliability. Now turning to Slide 8 and our ongoing hiring initiatives. We continue to have a strong hiring pipeline that averaged over 500 trainees in the Q2. This pipeline will allow us to continue filling classes as we work towards our headcount targets. For the 2nd consecutive quarter, over 300 inductors qualified and total active T and E increased to nearly 6,700 employees.

Speaker 3

We expect this number to increase sequentially throughout the second half as our newly qualified more than offset attrition. In addition to focusing on hiring, We are also working to minimize attrition. These initiatives will help us with our new hires throughout their early years of their career, including a recent agreement that will lift the pay for newly qualified conductors. As I said last quarter, this will all take time, for we know that to deliver on service, we must have the right level of resources and that starts with our people. I'll now hand over to Sean to review our financial results.

Operator

Thank you, Jamie, and good afternoon. In the face of these challenging labor market conditions as well as ongoing supply chain issues. CFX delivered over $800,000,000 in revenue growth with gains across all major markets. Expenses were also up over $800,000,000 and as a result, reported operating income increased 1%. However, as I will explain in more detail on the next slide, costs were heavily impacted by lower real estate gains, the addition of quality carriers, to A and M transaction costs and higher fuel.

Operator

Interest expense was $10,000,000 favorable to the prior year, while other income improved $6,000,000 The effective tax rate for the quarter was 24.4%. Turning to the next slide. Total costs increased $813,000,000 Nearly $500,000,000 of the higher expense was due to the inclusion of quality carriers, lower gains on property dispositions and Pan Am acquisition costs. Real estate gains were driven by the Virginia transaction with a $122,000,000 impact this quarter versus $349,000,000 in the prior year. This represents our last significant gain from Virginia and we expect to receive the remaining $125,000,000 of cash proceeds in the 4th quarter.

Operator

Higher fuel prices were also a significant factor with fuel expense up over $200,000,000 excluding the quality impact. Not surprisingly, inflation is running above historical levels. And the $56,000,000 on this slide represents inflation across labor, to purchase services and rents. All other expenses increased by $50,000,000 with approximately $20,000,000 higher depreciation, about $10,000,000 lower incentive compensation expense and nearly $40,000,000 of higher operating costs. This $40,000,000 reflects increased hiring and retention,

Speaker 2

the impact of a larger active locomotive fleet,

Operator

to intermodal terminal costs from supply chain disruptions and slower car cycle times. As service levels normalize in the coming quarters, We would expect the opportunity set on the expense side to come first from these operating categories. Now

Speaker 3

turning to cash

Operator

flow on Slide 11. On a year to date basis, free cash flow before dividends is down by approximately $125,000,000 that's up about $75,000,000 when adjusting for proceeds from the Virginia transaction in the prior year. Capital spending is up nearly $60,000,000 and for the full year, we still expect to invest approximately $2,000,000,000 in our network. This ensures safety and reliability with roughly 80% of these investments going to the core infrastructure in a growing amount being allocated to strategic and return based projects. After fully funding capital demands, Year to date shareholder returns have exceeded $2,900,000,000 including over $2,500,000,000 in buybacks and over $400,000,000 in dividends.

Operator

This brings our cash and short term investment balance down to a more normalized $800,000,000 And as we go forward, We will remain both balanced and opportunistic in our commitment to return excess cash to our shareholders. With that, let me turn it back to Jim for his closing remarks.

Speaker 1

Great. Thanks, Sean. Let's conclude on Slide 12 with our outlook for the year. Having benefited from high export coal prices over the first half of the year and with fuel prices still elevated, We continue to expect double digit revenue and operating income growth for the full year. As I mentioned in my opening remarks, our customer demand for rail freight remains greater than what we're currently able to supply.

Speaker 1

Export coal benchmarks have moderated over the last couple of months, but our guidance who had already anticipated a correction over the second half of the year. Consistent with our commentary all year, We believe that increasing our train and engine employee headcount is the key factor necessary for improved service and network performance and our hiring efforts will continue. Our aim is still to reach an active transportation headcount of 7,000 as soon as possible. As Sean said, full year capital expenditures are planned at approximately $2,000,000,000 which is also unchanged, as is our commitment to return excess capital to our shareholders. As we stressed last quarter, we are moving forward, but real progress takes time and is often challenging and gradual.

Speaker 1

There is plenty left to do, but the whole CSX family is committed to delivering on our goals, supporting our customers and growing this company. Thank you, and I'll turn it back to Matthew. Thank you, Jim. Now as we start Q and A, in the interest of time, I'd ask that everyone please limit yourselves to 1 and just one question. And with that, operator, we will now take

Speaker 4

questions.

Operator

Your first question comes from Scott Group with Wolfe Research. Your line is open.

Speaker 5

Hey, thanks. If I look headcounts down sequentially excluding Pan Am, and you guys were the 1st rail to Talk about ramping up hiring, but perhaps maybe struggling the most. Curious, why do you think that is? And then Maybe just separately for Kevin, any thoughts on just guidance on other revenue and coal RPU in the 3rd quarter. Thank you.

Speaker 1

Well, I'll take hi, Scott. I'll take the first part of your question about the hiring. And yes, I don't know if we're struggling more than everybody else or not. I think everybody's struggling. We've hired over the last 2 years since we started talking about this to issue, which we saw coming again a couple of years ago, 2,000 employees and our numbers have been going backwards.

Speaker 1

So the question has been not really as much as our ability to put employees into the pipeline and get them through the process, for a much, much higher attrition rate than we had expected from our current workforce and to a significantly higher attrition rate from the new people that we brought on. Unfortunately, after we get them through to the classroom training part and the on the job training part and they actually go to work in the outdoor operating environment. Who've seen a significantly higher attrition rate than what we had ever normally experienced more than what we had anticipated. So I think as we a couple of us, Jamie and myself, Sean had mentioned during here, we've done a lot of work in terms of focusing on attrition now, in terms of what we can do from a compensation standpoint to make sure that we keep the employees that we invest in. And so I think that is the I think that's the issue.

Speaker 1

I also what I We had a target out there of 7,000 people. And based upon where we stand today with the number of people that who should be qualifying over the next 2 to 3 months. We certainly hope when we put that target out there, our employee The employee number of employees off at that time was around 20 or so daily with COVID. It's now north of 80 to 90. So we hope that number comes down.

Speaker 1

And if those two factors come through as we expect and as we plan, We'll get that 7,000 number, it's achievable by the end of the Q3.

Speaker 2

Yes. And then on the coal RPU, look, obviously, the met coal prices have come down as everybody's seen. Our expectation right now given where things are is probably you'll look at the RPU in line with what we saw in the Q1, so a little bit down from the Q2. And then on the other revenue line, supplemental other revenue, probably something flattish versus this quarter outside of the market changing dramatically, which we don't see right

Speaker 5

Thank you, guys. Appreciate it.

Operator

Your next question is from the line of Bascome Majors from Susquehanna. Your line is open.

Speaker 6

Thanks for taking my question. Sean, There's obviously some uncertainty as to what the actual union wage increases from 2020 forward will ultimately be. Can you talk about how CSX has managed that uncertainty with its accruals so far? And if the actual wage increases were to come in different than your to expectations. When do you true that up retroactively

Speaker 1

and communicate it to us prospectively? Thanks.

Operator

Yes, Bascome, I can speak to that. So when we look at the union wage issue, we have been accruing for increased wages ever since the expiration of the last contract. When we do get to a settlement, we'll take a look back at that and see if an adjustment is necessary. If it is, we would take that all at once. And it's probably also worth noting that We've been accruing for back wages, which means that when we do get to a settlement, the employees who've been working with us for several years and not getting wage increases We'll likely get back pay, so there will be a cash impact around the time of whenever that settlement occurs.

Speaker 6

In that accrual, in this period where we don't have certainty, has that been consistent with historic rail

Operator

Yes, Bascome, I'm not at liberty to give any specific insight in terms of what we CSX are accruing that's sort of based on our best guess of where the negotiations come out.

Speaker 6

Thank you.

Operator

Your next question is from the line of Tom Wadewitz with UBS. Your line is

Speaker 7

open. Yes, good afternoon. I guess, I want to go back to the headcount question a little bit and the network operation. You have made some progress on active T and E headcount. And yet at the same time, it seems like the velocity metrics really haven't necessarily reflected that.

Speaker 7

So I was wondering if you could offer thoughts maybe why that would be the case. And then also just like level of confidence that 7,000 is the right number. Is that pretty good visibility? I mean, you talked about end of Q3. If you achieve that, Should we expect to see stronger volume and just a lot of confidence that that's really the right number and you don't need to go beyond that?

Speaker 3

Thanks, Tom. I'll first touch on our number. We feel quite comfortable that 7,000 gets us to a pre pandemic level, which is where we were, but that doesn't mean we're stopping at 7,000. We're going to continue to hire, obviously for growth that Kevin had mentioned that is still out there, that is untapped really. So 7,000 is a number that we feel comfortable, that gets us to our metrics and our trains, less train delay and everything else is going out on the main line and other So we're comfortable with that number for that reason, but we're not stopping there.

Speaker 3

I want to make that clear. We still got to make sure that we continue to hire for to growth over the next year or 2. With respect to the numbers, you're right, we have seen an increase in our T and E quarter over quarter if I look at my averages. And look at every week, we've got 20 to 30 folks to our qualifying in the conductor ranks, which in different areas is making a difference for us and helping us. But the last few months have really been to a high peak for vacation for us.

Speaker 3

So seasonably, our availability for our employees are usually 84%, 85%. But over the past couple of months, because of the seasonality of vacation, our availability really has dropped about 80% to 81 So every one percentage point equals somewhere close to 70 employees. So if you start Backing that out and thinking about what that means for the network, we're all feeling that vacation crunch and we're going to be into that until probably Labor Day into September when the vacation start to back off. So that's part of the reason why you're seeing numbers climbing, but yet our velocity in other

Speaker 1

Tom, it's Jim too. And we've learned a lot over the last 18 months in terms about what the current state of affairs are when it comes to hiring and the difficulties associated with that, which were not there historically. And so there's a lot of at the end of this quarter, Are we going to know what our attrition or what our true long term attrition rates are going to be? Will we know are we going to be in a situation where we get hit with another surge of some variant and we have another couple of 100 employees off at any given time. So we're trying to get back to the number that we put out publicly as what we had in 2019, when the end of 2019, early 2020 when the railroad really running at record performance.

Speaker 1

And so that's kind of the starting point for us to have better visibility as to what we should really do going forward.

Speaker 7

Great. Thanks for the perspective.

Operator

Your next question is from the line of David Vernon with Bernstein. Your line is open.

Speaker 5

Hey, guys. Thanks for the time. So the last two quarters, you've been running whatever high single digits in of employees and training relative to your active T and A account. I'm just wondering, after we get past this more employees would be better than fewer, what's the right number do you think long term to be thinking about in terms of employees in training relative to the active headcount. I'm just assuming that you're incurring some additional expense having a bunch of 7.5% of your active teeny count on the payroll, but not necessarily hauling freight.

Speaker 5

I'm just trying

Speaker 4

to figure out how the

Speaker 5

best way to normalize that. So any thoughts on that, Sean, would be really helpful.

Speaker 1

David, let me answer that. It's kind of consistent with what I just said a few moments ago. We're going to have to learn our way through this as we get into the end of this year and beginning of next year to have a better understanding of what these attrition rates are. It's been somewhat of a Surprise to all of us, the number of people that have dropped out after, again, going through all of the classroom training, all of the on the job training, and then working a few months in deciding that they don't like railroading as a profession. And so these are all new things for us.

Speaker 1

So One thing we know, we can easily manage down just simply by taking advantage of attrition if that's what's necessary. What we do know, it's a lot more what we have experienced anyway In the recent times here, it's a lot more difficult for us to manage up. So in the short term, We're going to learn about what we need to do differently and how we need to do it. And until that point in time, we're going to do everything we can to not run short.

Speaker 5

Okay. So I guess that it's probably too early to figure out what that number should settle at. But I guess If you think about kind of the what you're hearing from the folks that are bouncing out pretty quickly, is there some qualitative sort of assessment Can you share with us in terms of the rationale for why some of these folks are leaving what has historically been a pretty attractive job? Well,

Speaker 1

we're trying to do analysis of every different type to try and figure out Why? So we don't make so if we can identify factors we don't bring people in because there's a lot of cost and time and effort associated with training somebody. So we're trying to do to the psychological union that whatever analytics we can do to try and help us better have a better understanding of the profile of worker that we need to hire upfront. And this is just new for us and but we're learning and we'll get it figured out and then we'll be able to better manage on a more consistent basis the headcount.

Speaker 5

All right. Thanks very much for the time guys.

Operator

Your next question is from the line of Chris Wetherbee with Citi. Your line is

Speaker 4

open. Hey, thanks. Good afternoon. Maybe could you help us

Speaker 8

a little bit with your expectations around volume in the second half of the year and sort of how you that that might play out. And then I guess maybe a little bit bigger picture. I think there's just a general sense that there's more demand out there than you guys are able to capture. So as you see operating performance and headcount improve, there's the ability to sort of lean into that. Can you sort of help us with your confidence around and levels in the back half, what you're hearing from the customer?

Speaker 8

Are you seeing anything slow down? So just kind of curious about generally speaking the volume and Dynamics as you go into the back half of the year.

Speaker 2

Hey, Chris, this is Kevin. As I mentioned and Jim mentioned it, I think a couple of times, Demand continues to outstrip supply chain. We're not alone. It's the supply chain in general and we're part of that supply chain with the crude issue that we're having. Right now, if you look at the back half of the year, when you look on just a purely comp basis, we have easy comps on the auto business and we clearly have seen that production start to pick up here.

Speaker 2

So we're encouraged what's happening there. We've had some disruption on the coal side of the business. We think that will continue to improve in the back half of the year. So there's some things that just from a comparison point of view get better as we move into the back half of the year. And then as the crews come online, we'll go and chase those opportunities that we know are out there in terms of market share.

Speaker 2

And then the existing opportunities that we know that are out there in terms of order fill rates, things like that, that we're highly focused on as a team and see the opportunity going forward. So Nothing's really changed from the last quarter when we see a pretty robust environment, but we're not we're also keeping an eye on what's going on. The housing markets had some pressure out there, but we have exposure there, but there's other areas where quite frankly, there's a lot of inventory restocking that still needs to happen.

Speaker 8

Okay. So if operations get better, then volume goes up. I think it's as simple as that as far as you guys are concerned, right?

Speaker 2

Yes, that's our view given the demand environment that we're seeing right now.

Speaker 8

Got it. Thank you very much.

Operator

Your next question is from the line of Ari Rosa with Credit Suisse. Your line is open.

Speaker 9

Hey, good afternoon guys and congrats on a solid result here. Jim, I was hoping I could just get your reaction to the announcement of a Presidential Emergency Board in relation to the negotiations with the union. Do you see any risk around your ability to achieve margin targets based on that appointment or based on these negotiations. And

Speaker 3

alternatively, do you

Speaker 9

think that maybe some of these attrition issues could be solved if there's a resolution to some of these labor negotiations standstill that you've been facing.

Speaker 1

Well, we're glad that the emergency board was appointed. It's unfortunate, as I've said quite often that it took so long to for us to get to this point. But the wall has worked for a long, long time and we're hopeful that The emergency board puts out a recommendation. It's a win win for both sides. Do we hope that once the labor issue is resolved and our employees are not happy that they didn't get erased for 2.5 years, let me tell you that.

Speaker 1

They tell me that all the time. And so we're hopeful that once this is resolved and we're expecting that they'll get a very Federal rates, that that will help with morale and that might help with the retention. And then final, you know, the board are seasoned veterans of dealing with labor for issues and they are going to make a recommendation based upon the inputs and hearing from both sides. And as I said, I hope it comes out that it's a reasonable win win solution. And if that's the case, We're certainly able to accommodate that in our economics going forward.

Speaker 9

Understood. Okay. Thank you.

Operator

Your next question is from the line of Jon Chappell with Evercore

Speaker 10

Jamie, when we look at the weekly metrics, obviously, we've already addressed moving in the wrong direction, yet your intermodal trip plan performance back to 90%. Your volumes, which I'm sure you're disappointed with, but probably not as as some others or maybe what the metrics would be indicating. Can you speak a little bit to that apparent disconnect where velocity dwell moving one way, volumes to rebounding another. And if you get to that velocity dwell that you're targeting with the right resources, how much free capacity that would free up for your network?

Speaker 3

John, look, it's a great question. It comes down to the hard work of those operating folks on the ground, right from the union folks who are working day in and day out for us that are working more than they ever have filling in some of those gaps, but the operating team is just doing a fantastic job from the network side to the guys out in the field making tough decisions. And in this environment, look at intermodal has a priority on our railroad. We make sure that the intermodal Trains get across within their schedule to the best that we can. We're in an environment where we have concerns to make sure that Chickens get fed and the utility and the lights stay on.

Speaker 3

So There's times when we actually have to prioritize some of our bulk traffic, which we would never have done before because normally bulk traffic goes to a stockpile. So when you are prioritizing different flows of traffic that you never really had before and it goes against a little bit of your principles of making sure you take care of that merchandise traffic. At times, The merchandise traffic might take a 24 hour delay or something across the network getting from terminal to terminal. So that's where you're seeing some of those areas where we're just not moving as quick as we could and some of the congestion that's out there. So Yeah, you're absolutely right that when we can get back to a little bit normalized workforce with respect to being able to move every train and not having to make those tough decisions on this week.

Speaker 3

We're worried about the lights in the Southern Carolina area or we're worried about the chickens down in Alabama or different areas. Yes, you're going to start to see that to move better and the capacity. Back in 2019, we talked about it

Speaker 1

a lot. We have a

Speaker 3

lot of capacity on this network. We have a great network. We have more than enough assets out there. As a matter of fact, I've always said and I stand by it that hiring the folks that we are and any expenses that come along with that, we're going to be pull that out through assets. So, we're quite confident that we're making the right moves that we can today in order to try to keep everybody happy.

Speaker 3

But the one metric I did talk about is that the customer metric, if you want to call it that 1st mile, last mile metric, which It's something we're watching to continue to improve that we're showing up at the customers. They may get merchandise customers may have a 24 hour delay in transit time, But when we're actually showing up when we say we're going to be there and the cars we say we're going to bring in are coming in, that's making a difference to those customers. And that's something that we're continuing to work on to be able to give the customers a better experience than what they're feeling. So don't, you know, the metrics that are out there, you're right, they're not the the way we want them to be. I wouldn't be fooled completely by how you read into some of those metrics because we're running the railroad differently.

Speaker 3

And my final comment really on this is the hardworking folks who are out there running this operation are doing a fantastic job with the tools

Speaker 1

Yes, this is Jim. Just a follow-up to what Jamie said, where the railroad was running in 2019, which was at record phenomenal rates in terms of ability, velocity, dwell, etcetera. At that point in time, we always kind of talked about the fact that without doing much to the rail network. We had an additional 25% to 30% of capacity available that we had freed up over the prior 2 years with the changes that we've made. And during the last two and a half years, 20 2021.

Speaker 1

We did not slow down on our capital program. We continue to invest in the railroad. We continue to extend siding, all because it just makes the we're preparing for normalcy to return, plus it creates a lot of efficiency across the network. So we're in great shape to handle whatever traffic comes to us whenever we get we only have one restriction on us right now and it's crews and we're doing everything we can possibly do to hire as many people as we can.

Speaker 10

All right. That's very helpful. Thanks, Jamie. Thanks, Jamie.

Operator

Your next question is from the line of Justin Long with Stephens. Your line is open.

Speaker 11

Thanks. I know previously you had talked about volumes this year outpacing GDP growth. I was curious if that's still your expectation. And Sean, last quarter, you gave some color on your expectations and for operating expenses ex fuel on a sequential basis. I was curious if you could do that again for the Q3, especially with Pan Am being layered in.

Speaker 2

Hey, Justin. It's Kevin. Nothing's really changed with our outlook. Obviously, the GDP numbers are moving around quite a bit, but that's a lot has changed since the beginning of the year. Clearly, inflation has moved up a lot more than what people believe coming into the year.

Speaker 2

And so we've that's probably been more reflected in price. And then on the volume side, You know, probably not as quick of a recovery from a supply chain as we anticipated, but still given the favorable comparisons that we have in the back half of the year, we to growth.

Operator

Yes. Justin, on the second part of the question around OpEx, I think it's fair to assume that OpEx is going to OpEx is going to be fairly stable quarter over quarter. We will begin accruing for higher wages, the compounding impact of higher wages that would reset at midyear, so you should see a little bit of an increase sequentially in the labor line. And to your Pan Am question, recognize on a fully integrated basis. It's about 1% of revenue or a little less than that figure.

Operator

The Operating ratio on that business today is a little worse than our average and then spread the costs similar to our current spread and that'll probably get you there in terms of the Pan Am impact. But everything else relatively stable and the hope would be as crews continue to mark up and become available towards the latter part of next quarter as the vacation peak subsides. The network begins spinning, we begin to take some of those, $40,000,000 or so of costs out.

Speaker 11

Okay. That's helpful. I appreciate the time.

Operator

Your next question is from the line of Amit Mehrotra with Deutsche Bank. Your line is open.

Speaker 11

Thanks, operator. Hi, everybody. Kevin, I just wanted to ask about yields in the back

Speaker 3

half of the year relative to

Speaker 11

where they were in the Q2. There's a few puts and takes. I mean, obviously, fuel is moderating off of a very high level. So Maybe that's a little bit of a debit to yield, but then we're obviously still in a high inflationary environment. So maybe there's some pricing opportunity.

Speaker 11

So Understand mix is going to be what it is. So if we can just kind of hold that to the side for a minute, could you just talk about maybe how you think back half yields would be relative to what you did in the second quarter. And then Sean, that was really helpful on the cost to comment non fuel costs. I guess with fuel moderating, that optically releases some pressure on the OR. So would you kind of expect to the OR to continue kind of sliding down in the back half of the year, obviously not as big of a jump improvement from 1Q to 2Q, but Would you expect kind of the sliding down of OR in the

Speaker 3

back half of the year as well? Thank you.

Speaker 2

Hey, on the yields, I think you covered one of them, obviously, the fuel surcharge and there's a bit of a lag there as we move from Q2 and Q3. So I can move around quite a bit, but you understand how that works and we'll adjust as that moves around a bit on the diesel prices. The other one that I covered earlier was really on the export coal pricing. What we're seeing today is obviously some moderation off the really, really High prices, the environment is still really, really good for us. We would take these price levels any day.

Speaker 2

It's just that they're coming off the stream levels. So we'll see some moderation there. Outside of that, clearly, when we're having contract negotiations with our customers, they understand the high inflation environment we're dealing with today. And obviously, on the labor side and other parts of our business, and we're having to recapture that value in those discussions. So as things reprice, We're making sure we stay in line with what's happening out there in the market and what we're having to pay expense wise.

Speaker 2

So we probably will see some underlying momentum there as well. But outside of that, nothing really changes into the back half of the year.

Operator

Yes. And just adding to that in terms of The operating ratio, I think the two things that are sort of non core or less out less inside our control, we had about $5,000,000 of real estate gains last year. We're obviously always working on potential deals, but we'll see whether we have a similar number that materialize in the second half. And then fuel, if prices tail down and continue to go down, we'll have that favorable lag benefit that will help the OR. But if you set both of those items aside, we have sequential volumes gains into the second half of the year and expenses are relatively flat excluding to A and M and the wage increase impact.

Operator

And I think it would be fair to assume that we'll continue to have some good momentum on the margin side.

Speaker 11

Right. Okay, very good. Thanks for the help. Appreciate it.

Operator

Your next question is from the line of Brian Ossenbeck with JPMorgan. Your line is open.

Speaker 10

Hey, thanks. Good afternoon. I just wanted to go back to the comments on Jim, I think you made a comment about offering a little bit more incentives or compensation for some of the folks that are coming on to the network. Are Are there any other things you can do to kind of pare down that rate of attrition with other things or you do have to wait on the official agreement to get settled and what do you think that might be? And then for Jamie, are there any other things you would consider?

Speaker 10

We saw 1 of the Western rails put an embargo, which is pretty disruptive, but it seemed to get them in a little bit of relief. Is that something that you would consider at this point or would that be unnecessary?

Speaker 1

Well, we work in a unionized environment and we're not able to do too much without an agreement with the unions, including increasing their pay, but we have tried many options and we'll continue to work to do whatever we can to try and change to the work environment so that people feel like they really want to work here, simple as that. And so it's an ongoing process like everything is. And So, we don't have any silver bullets. We're making it up to a large degree as we go along because these are All uncertain times and experiences that we've never had before, including myself. I've been doing this all my life.

Speaker 1

But we'll continue to innovate. We'll continue to come up with ideas and try to make this the place where Everybody wants to work. In terms of embargoes, in my opinion, an embargo is pretty draconian step that one would not take without a lot, a lot, a lot, a lot of forethought. And so we would only do embargoes if it was absolutely, absolutely necessary. And that's my position on it and that's where we're going to stay.

Speaker 10

And then timing of the labor resolution, do you have any ideas on that or is

Speaker 1

it still too early to tell? Timing in terms of the outcome of the current negotiations? Yes. Sometime in the next So we're going to be done in the next 60 days is Mike. Well, I mean, you're in the second you got 3 30 day cooling off periods.

Speaker 1

You got one is Fire 1 encompasses the period of time where the emergency board hears, meets and my belief is They are not going to delay that, so they will be done in a little less than 30 days, 28 days or whatever time is left for that. And then after that, there's another 30 day cooling off period where the parties will meet and either accept the recommendations of the emergency board. And if history plays, it shows us what the outcome will likely be, if the parties don't agree, the government to step in and impose the findings on the parties. So it will be done.

Speaker 10

All right. Thank you, Jim. Appreciate it.

Operator

Your next question is from the line of Walter to Bracklin with RBC Capital Markets. Your line is open.

Speaker 6

Yes. Thanks very much. Good afternoon. I guess you've Had a chance to have at least an early look at and assessment of quality and had a sense of how it's fitting in with your network. And my question, I guess, from an acquisition standpoint strategically, do you think, Jim, you need more of that type of business.

Speaker 6

Are you impressed enough by what you've seen with quality that You would ask for or you'd look for more opportunities like that in the, call it, trucking space or the specialized trucking space? Or do you think What you got with quality is enough and you're happy with what you have and focused on more organic opportunities going forward?

Speaker 1

Well, first of all, we're extremely impressed with quality carriers. They're a great company. They have great people. They do a great job. They're industry leaders, And that's what piqued our interest when they became available.

Speaker 1

But that's not The only reason that we pursued that, it was the fact that it aligned so well with our existing core business in New Era than what comes first is our existing core business. So I don't see us necessarily going out and doing something along the lines of another quality of that size, unless it met those same criteria. And if it met those same criteria, then of course, we'd be interested We're going to continue to try and expand our footprint through everything we've talked about on the to Transflo and on the reloads and on the warehousing and everything we can do in those spaces that brings greater to the core rail network to our customers. So often in times, we don't go all the way to the door. Where there's a gap.

Speaker 1

And so whatever we can do to try and fill that gap between connecting the core railroad to to a bigger base of customers and that's what intrigues us and we'll continue to pursue that.

Speaker 10

I appreciate that color, Jim. Thank you.

Operator

Your next question is from the line of Ken Hoexter with Bank of America. Your line is open.

Speaker 4

Great. Good evening. Jim and team, I guess, on time performance down at 50%, originations down 62% last seen since well before PSR rollout at CSX and I think even before Hunter got there in 2017. So you don't think that this starts to affect your ability to win business on to the railroad with the service levels here? And I guess, If Kevin, you're talking about the demand is there and you're turning it away, maybe talk about where your is that localized your specific parts of the network where it's harder to hire, where you're seeing some of that push away.

Speaker 4

And then Jim, can you just clarify the lift? You mentioned lift pay for newly qualified conductors, but you just said To Brian, you said you can't do things without the union agreement. Maybe you can just clarify what you meant by that statement then.

Speaker 1

Well, that means what I said. We obviously got a labor we obviously got the labor leadership to agree that we could pay their employees more. And so we couldn't just do that. I guess I would be concerned that we had slipped back to the points before to to the metrics, our operating performance metrics. Before we've done so much Hard work over 2017, 2018 2019 in order to get this company running at spectacular rates.

Speaker 1

It's kind of hard to believe that with our measurements that we are we're still doing an extremely good job under very difficult circumstances. It's clearly not like everybody else in the world is doing Fantastic and everybody is running at 100 percent on time and we're running at 62. This is an issue that affects everybody in the logistics chain. This affects the truckers, this affects the steam ship companies, this affects the terminal operators, this affects everybody. Everybody's slowed down, everybody's struggling.

Speaker 1

And it's not just the railroad industry. As I was saying earlier today, I don't think Heathrow They thought they'd have to put an embargo because they can't handle air traffic through the facility. So it's a global phenomena. We're continuing to improve. As we said, we're continuing to do better.

Speaker 1

I can tell one thing that we're the only railroad that I know of in North America that never shut a terminal because we were congested. So because we were intensely focused on the fact that everybody wanted to e commerce and we're going to make sure we're there for the country when they needed us. So I'm very proud of the job this year that everybody did. So our other metrics, clearly, our velocity has stabilized. Our dwell has stabilized.

Speaker 1

We're beginning to turn the corner. I said we're going to get to 60 to 7,000 employees when we said we would. And that's the plan and that's what CSX He's always done here the last four and a half years and that's what we're going to do this time.

Speaker 4

Great. Thanks, Jim. Appreciate it.

Operator

Your next question is from the line of Jason Seidl with Cowen. Your line is open.

Speaker 3

Thanks, operator. Good afternoon, gentlemen. I wanted to just to clarify a little bit on the operating ratio. You talked about some of the puts and takes going forward. Obviously, the Pan Am costs aren't going to continue into the second half of the year.

Speaker 3

Just how much of that 450 basis point headwind was Pan Am in the quarter?

Operator

Yes, Jason, about 50 basis points was Pan Am.

Speaker 1

Okay. Just 50 basis points

Speaker 3

for Pan Am. And then if I could just follow-up really quick. I mean, you talked about how much demand sort of pent up demand for rail that there is. And then if we just assume that you do start improving even more on the operational Is it really intermodal, and maybe boxcar that a lot of these gains are going to jump out in terms of where you can open up and take on business?

Speaker 2

Well, I think it goes beyond just the intermodal and boxcar. You think about the coal network and look, some of this is on the coal mines and to some of the export facilities that have had a lot of issues as well. So it's we're part of that puzzle piece with the crew issue on that side of the business. But I would say it's limited just the boxcar and intermodal. When I think about some of the other markets like auto and we're playing a little bit of catch up there as well.

Speaker 2

So there's opportunities across almost every market that we serve today.

Speaker 3

Fair enough. Appreciate the time as always.

Operator

Your next question is from the line of Ben Nolan with Stifel. Your line is open.

Speaker 11

Yes, thanks. Hi, guys. I had a sort of a big picture question just given all of the uncertainty and with respect to the As you guys have mentioned, if we do move into a little bit more of a challenging environment or a recession, Do you think that the railroad is positioned any differently than it had been historically or not? And if so, how would that be?

Speaker 1

Good pictures. Everybody looks at me to answer that question. Well, I guess by good picture, I mean, it would from an economy standpoint because I don't know what the next thing they can throw at us that we haven't seen in the last two 2.5 years here. So I think the railroads are in CSX The segment of the railroad industry in general is well positioned right now with everything that's going on in terms of issues associated with Congestion, issues associated with highway congestion, issues concerning The environment, more and more and more customers every single day are asking us about what it is we can do for them to help them with their ESG targets. My Experience in the railroad business is when you the if there is to a bigger downturn or a downturn in the economy to the extent that our service gets back to where the reliability we had pre pandemic.

Speaker 1

We're a great option for companies when they need to reduce their costs and they need to reduce their transportation spend and people who are making decisions based on, I don't care what it costs to get it there, just get it there. I'm willing to pay 25 times the historical average rate to move a container from A to B. What they want to do is save money. Well, that's where our That's where we really get to play more in the game, because we're always substantially cheaper than a truck. So everything winds up for us to be, but It's all based upon our ability to get the number of employees in here that we need so that we can prove to the customer that we're to Reliable, as Kevin just said, it's across the board.

Speaker 1

People have historically always moved grain by rail or trucking it. People the supply chains are completely back to where we were and we'll continue to grow share principally by competing with And beginning to convert more and more traffic off the highway all the time.

Speaker 11

All right. Appreciate it. Thanks. Thanks for that. Thanks.

Operator

Your next question is from the line of Eric Morgan with Barclays. Your line is open.

Speaker 11

Hi, thanks for taking my question. I just wanted to ask about capacity of the network outside labor. I think you used Can you talk about how much additional capacity has been freed up by PSR? And Looking at things now, does that kind of still exist today or are there bottlenecks that you think need to be resolved with additional capital once your labor situation is on better footing.

Speaker 3

Eric, it's Purely labor is what's, you know, people is what's holding us back. Our network is, as you know, if anything, our network has improved over the Past 3 years, as you heard Jim, we've put just as much high rail and ballast in as we have. We've done siding extensions in areas. We've invested And we've got more locomotives than we need. We're really in a great spot if we had the folks that we need to move to business.

Speaker 3

So Our terminals, as a matter of fact, 90% of our home terminals are running very well. Our flat switching terminals are running well. Where we get congestion a little bit bottlenecked is different crew change points where we don't have crews to keep those trains moving or we got to to decision on which train moves quicker than a different train. So, I'm very confident that the network is better than probably what it was in 2019 and we're ready to go once we got the folks trained up.

Speaker 11

Thank you.

Operator

Your next question is from the line of Jordan Elliger with Goldman Sachs. Your line is open.

Speaker 12

Yes. Just sort of following up a little on that last operational Related question. I mean, you guys are seem to be pretty close or moving closer on the headcount front. And I know the network, you say, is in good shape, but And it's just a matter of getting those extra employees, but is there anything that needs to be done like reconfiguring schedules? I mean, I know you mentioned you're making decisions on which figuring schedules.

Speaker 12

I mean, I know you mentioned you're making decisions on which trains to run. I mean, is there any wider scale Changes either the intermodal network, the carload network needed in addition to the employees or simply that. And then when you hit that 7,000 target, I How quickly does all this volume and service react? I mean, it just doesn't seem that we're that far away. I'm just trying to understand How that gap in the service, how it reacts and how quickly it will react?

Speaker 12

Thanks.

Speaker 3

Jordan, it's Where we're sitting right now with respect to our terminals and everything else, We are in much better shape than we have been in a long time. So we design we review and analyze the railroad every single day, every single week. As a matter of fact, I made an org change just a month ago or so that service design reports directly to me so that I can work closer with them so we can continue to design things every day. When I say we make a decision, it's the unscheduled network from coal and grain that has become a much higher priority than it ever has been. And that unscheduled network is where those decisions come in with the crew availability.

Speaker 3

And of course, Kevin and I and our teams are working all the time to make sure that when there's a location that that is short and rain and needs to feed chickens or anything else, we'll make sure we get it there. It's a just on time service and it never was before. The same thing with coal for the Southern Utilities. This was all stockpile and it's turned into just on time service. So that's changed for us and it's very difficult for us to schedule Unit trains not knowing when they're going to be released or come out.

Speaker 1

Yes, Jordan, it's Jim too. We're grinding here every day and we're doing all of this with hand to mouth and trying to make sure that we serve every customer that we possibly can the best we can. And yes, our velocity is down, our dwell is up, but we're still more carloads in the Q2 of this year than we did in 2019 when we were running lights out. So it's not like, oh my God, look at these guys, their velocity is down 21%, Glad their volumes must be down 21%. We're still moving more freight than we did.

Speaker 1

So, yeah, that's why we're confident that when we get Boeing's back to where we get the velocity back to where they were and things are and Key from a customer standpoint is reliability. That's why velocity dwell 1st mile, last mile. That's why all these metrics are so important because this is what the customer looks to determine whether or not they're going to ship by rail or truck. When we get that back, that's where we have a reasonably solid to a base to believe that the volumes will grow in the second half and continue to grow into the future, but we're moving more freight this

Speaker 12

Yes. It's interesting on the unit train and just in time comment actually. I'm curious though, does that mean that there are issues separate from what you as a rail could do and more related to the Customer on this whole just in time thing that may make it a challenge or not?

Speaker 1

Well, Kevin might want to weigh in, but as I said, it's everybody in the supply chain when we're talking about moving coal trains from a mine to a utility or from a mine to an export terminal. It's not just a railroad. We need everybody in the supply chain to work when you're talking about moving international boxes from a port into a warehouse on the south side of Chicago. We need the terminal to work, we need the railroad to work, we need to the Inland terminal to work. You need to have chassis there.

Speaker 1

You need to have truckers there. You need to have somebody there that can unload the box when it gets to the warehouse and get it off the Chassis and get it back. There are a zillion moving parts. We play a role in that in many respects. And each one of those key elements in the supply chain is challenged.

Speaker 1

So we need to get better. Everybody needs to get better. And you get a sense generally that things are gradually improving. And again, you see it You see that in every industry that is not working properly because of the issues associated with the shortage of employees.

Speaker 12

Thanks so much.

Operator

Your next question is from the line of Jeff Kauffman with Vertical Research Partners. Your line is open.

Speaker 3

Thank you very much and thanks for taking my question. Jim, I'd like to go big picture on you here. You talked about, okay, if we could just get to 7 1,000 and get our trains where we need to be. Everything comes down quickly, we start running well. And then you said, well, it's not really that Right, because we've got shippers that need to accommodate.

Speaker 3

We've got ports that need to accommodate. I guess my thought is If you had all the crew you needed tomorrow or a year from now, right, you pick your target, how long Would it take you to get the network running the way you want to run it? And then I guess on the tail end of that, the world's changed in the last year. Has your thought about what kind of Returns this business can generate changed at all as part of that macro.

Speaker 1

Big picture question. Thanks a lot, Jeff, for following up with an easy one. It's helpful. Now as I said before, I think the railroad industry is extremely well positioned not just for the short term, for the long term with everything that's going on in the world globally, United States, you name it, re to the customer's goods going forward. And so if we're more relevant, if we provide a better service and we're a key component that should be good for our margins, not bad for our margins.

Speaker 1

Who are much more sought after product service as opposed to just a transportation commodity. So that's good. Can I fix the global hunger? No. Can I solve the pandemic?

Speaker 1

No. Can I fix CSX in this team? Do I have a 100% confidence in the people that work for CSX to get this railroad back and running the way it was and then even better? Yes. So I can't fix the chassis shortage problems.

Speaker 1

I can't fix I can't invest in coal mines. I can't move this. I can't move that. Well, that will all correct itself over time and we will be a much bigger participant in that. And like I said, I think you've got a great future ahead of us.

Speaker 3

Okay. Thank you very much.

Operator

There are no further questions at this time. Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now disconnect.

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Earnings Conference Call
CSX Q2 2022
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