CSX Corporation (NASDAQ:CSX) Q2 2023 Earnings Call Transcript

CSX Corporation (NASDAQ:CSX) Q2 2023 Earnings Call Transcript July 20, 2023

CSX Corporation reports earnings inline with expectations. Reported EPS is $0.49 EPS, expectations were $0.49.

Operator: Good afternoon, and welcome to the CCSX Corporation Second Quarter 2023 Earnings Conference Call. I will now turn the call over to today’s speaker Matthew Korn, Head of Investor Relations. You may begin your conference.

Matthew Korn: Thank you, operator. Hello, everyone, and welcome to our second quarter earnings call. Joining me this afternoon are Joe Hinrichs, President and Chief Executive Officer; Jamie Boychuk, Executive Vice President of Operations; Kevin Boone, Executive Vice President of Sales and Marketing; and Sean Pelkey, Executive Vice President and Chief Financial Officer. In the presentation accompanying this call, you will find our forward-looking disclosure on slide two followed by our non-GAAP disclosure on slide three. And with that, it’s my pleasure to introduce Mr. Joe Hinrichs.

Joe Hinrichs: Thank you, Matthew, and good afternoon, everyone. Thank you for joining our conference call. Our performance over the second quarter met our expectations led by the strong results of our merchandise business. As we had indicated at year-end and again last quarter, we knew that we would have to manage through lower intermodal storage revenue and normalizing export coal prices. We expect the intermodal volume to be soft as imports slowed and destocking activity continued. That said, we also knew that we were gaining momentum with our customers, led by our improved service performance and in our own workplace as our ONE CSX efforts took hold. Our network continues to run well, and our company’s initiatives combined with our employees’ hard work and commitment to making a big difference and helping to set our railroad apart.

There was much more to do, but our results this quarter show signs of the progress we are making as we lay the groundwork for long-term growth and value-creation. Turning to slide five. Let’s review the highlights for the second quarter. We moved over 1.5 million carloads in the second quarter, led by a 3% volume growth in merchandise and 4% growth in coal, and our margins remained strong with an operating ratio below 60%, including the impact of the Quality Carriers’ trucking business. We generated $3.7 billion in revenue, which was 3% lower than the previous year and flat from the first quarter. Operating income decreased 13% year-over-year to $1.5 billion and our earnings per share decreased by 9% to $0.49. When making comparisons to last year, it’s important to remember that our second quarter 2022 results included a $122 million gain, representing $0.04 per share of EPS related to the Commonwealth of Virginia property sale.

All in, this was a solid performance highlighted by great results in our core business. The fact that our team was able to drive 3% merchandise volume growth in such an uncertain macroeconomic market is a testament to what we are able to do when we work together. Now moving on to slide six. Earlier this month, CSX released its new 2022 ESG report, which highlights the tremendous progress that our team has made in moving our company forward. Since I started here last fall, you’ve heard me talk about ONE CSX, about building a supportive and positive culture and about the need to consider all of our stakeholders who are measuring our success as a company. Many of you have asked me, what this really means in practice. What does the railroad look like where its people feel valued and included, where its customers feel appreciated, and where the communities in which it operates you are respected?

I think the picture and the highlight that you see here offer a small view into how we’re making this happen here at CSX. To us, incorporating environmental, social and governance considerations into the priorities of our company goes hand-in-hand with our ONE CSX focus. Adding to the greater sense of purpose that we all share. These are real, authentic actions that we’re taking today. We talk often about our environmental leadership and our clear advantage here over trucks as a core part of our value proposition to our customers and our shareholders. By expanding our use of technology, conducting practical testing of alternative fuels and offering support and encouragement to our suppliers, we continue to make progress. As we reported in our press release last week, we are testing biodiesel blends in locomotives in revenue service.

matthew siddons / Shutterstock.com

Last month, you heard that we are in talks with CPKC to form a joint venture for the development of hydrogen-powered locomotives, which offer encouraging promise as a low emissions fuel solution. What we probably do not talk enough about are all the incredible efforts made by our railroaders, to build up the places in which we live and work. It’s been a priority of ours to increase our company’s positive cultural impact. And I am proud of how quickly the people in CSX have responded. As you see here, our volunteer hours are up substantially. Our CSX-sponsored community events have multiplied. And the number of people who we have been able to help and support has been incredible. I look forward to much more to come. There’s one last item I’d like to mention.

At CSX, safety is our top priority, and that’s why we focus so much on our reported injury and accident rates. Our fundamental goal is to make sure that every one of our employees gets home safely every day. When that does not happen and we lose one of our colleagues as we lost Derek Little last month, it affects us deeply. As a reminder, why we make so much effort on safety and how much more work we need to do. Now let me turn it over to the team.

Jamie Boychuk: Thank you, Joe, and good afternoon, everyone. As Joe just said, we continue to make every effort to enhance our company’s safety performance. As slide eight shows, we made good progress this quarter with both our FRA injury frequency and FRA train accident rate improving sequentially. Our injury rate also improved year-over-year and was the lowest rate for a second quarter that we’ve seen since 2015. Our focus is to ensure that every employee, including new hires who are less familiar, understands and appreciates their part to reinforce our safety-focused culture. Turning to slide nine. Our operating performance held up well over the second quarter and continues to lead the industry. Thanks to the hard work of our railroaders, who execute the operating plan every day.

I’ve seen firsthand the positive response to the efforts being made by our employees to strengthen our culture. Our men and women in the field are valued, included, respected, appreciated and listen to, which helps them feel even more pride in the service they are delivering to our customers. Because of them, we’re able to show how well our scheduled railroading model works, and I am excited as there are more opportunities ahead. Velocity averaged 17.7 miles per hour in the second quarter, slightly lower than last quarter, but up substantially from the same period in 2022. Dwell averaged 9.3 hours, an improvement of over 20%, compared to the same period last year. Intermodal trip plan performance of 96%, increased by 6 percentage points year-over-year, while carload trip plan performance of 84% improved by 25 percentage points.

I’m pleased with the compliments and support we have received from our customers, regulators, and shareholders on our service improvements. Our goal is to keep improving our service and show that we can continue to sustain this over time so we can drive long-term growth for CSX. With that, I will turn it over to Kevin to discuss our sales and marketing performance.

Kevin Boone: Thank you, Jamie. As Joe noted, despite headwinds across many of our markets, the team was able to capitalize on strong year-over-year improvement in service. Importantly, as service has improved, there’s opening up opportunities to discuss new business with our customers where we are seeing in our year-to-date pipeline up 30%. I’m proud of the team and the progress we have made. There remains a lot of work ahead of us as we focus on building our pipeline of growth opportunities. Initiatives including whiteboarding sessions with customers, increasing direct engagement with small and medium-sized shippers, bringing new technology tools to better serve our customers and finally, expanding our reach by leveraging our transload network and collaborating with both with our short-line and Class 1 partners are just a few of the focus areas for the team as we move into the back half of the year.

Turning to slide 11. Our strong merchandise performance continued into the second quarter, with revenue increasing 5% even as our fuel surcharge declined substantially on lower diesel prices. This growth was driven by 3% higher volume, compared to last year and a 1% all-in increase in revenue per unit. As we saw in the first quarter, our customers are seeing improved service levels, which is opening up opportunities and encouraging them to bring more of their business to our network. For the quarter, we saw many of the market trends continue from the start of the year. In automotive, we are seeing more consistent production and we’ve seen our improved service lead to new opportunities and business wins. Minerals benefited from strong construction demand for aggregates in our improving cycle times.

And our metals and equipment business continues to be a bright spot, with volumes up across steel, scrap, and equipment. We’ve been successful in expanding our commercial relationships and translating our service product and to convert new business wins. I’m also pleased that our fertilizer business delivered higher volumes year-over-year, supported by strong domestic shipments of potash and nitrogen. On the other side, chemicals continues to be soft as demand remains challenged across our broad book of business. Forest products. [Technical Difficulty] products faces headwinds in paper and pulpboard. We’ve also seen some slowdown in export grains for ag and food. For the second-half of the year, we expect to build on the successes we’ve had to win more wallet share of our existing customers, while continuing our efforts to attract new customers away from truck.

We expect auto, minerals, and metals markets to remain supportive and will be important contributors to volume growth over the remainder of 2023. We look for destocking activity to wind down in many of the markets we serve including chemicals, so timing there remains uncertain. What’s most important is that our team is not sitting back and waiting for markets to turn. We are pushing forward with our own initiatives. Our business development group has been making great progress with our Select Site program and expanding our pipeline of partner projects. And we’re strategically investing in developing new locations, providing additional transloading capabilities and investing in railcars to drive more business to CSX. Turning to slide 12. Second quarter coal revenue decreased 2% as a 4% volume gain was more than offset by a 6% decline in revenue per unit, driven by lower export coal benchmarks.

We saw continued growth in export volumes due to beneficial cycle times, good performance at our Curtis Bay terminal and a push among our coal customers to move more tonnage into the overseas markets. Domestic utility shipments declined as we expected, as low natural gas prices weighed on coal burn. Though demand in Southern utilities remained favorable. We expect momentum in the export markets to continue over the second-half of the year, with CSX volume supported by new mine capacity and coal producers making opportunistic shipments into the international markets. On the domestic side, we see tougher comparisons versus a strong second-half last year. But the hot summer is providing a helpful tailwind early in this quarter and just recently we are seeing a few customers looking for additional sets.

Of course, as international pricing benchmarks have eased from last year’s record highs, we will see an impact on our revenue per unit into the third quarter. Most of our exports are met coal with the benchmark around $225 per metric ton. We anticipate our third quarter all-in coal RPU will sequentially decline by a mid-teens percentage. Current international benchmark prices remained very healthy and supportive of strong production into the back half of the year. Now turning to slide 13. Second quarter revenue decreased by 18% due to a 10% decline in volume and a 9% reduction in revenue per unit, reflecting the effect of lower fuel surcharge. As in the first quarter, international intermodal drove most of the volume decrease with the business seeing headwinds from declining imports and inventory destocking.

Volumes in the domestic business showed a much more modest decline [Technical Difficulty] by the good progress we continue to make with rail conversions and the team’s efforts to identify new markets and lanes. Our best-in-class Eastern service product continues to position us for truck conversion in the quarters and years ahead. Looking forward, while we and our customers are still looking for a rebound in the international business, pressing ahead with our own initiatives, we brought on a new shipper late in the quarter that recognize the value of our strong service product. And we’re seeing other opportunities in new lanes, growing activity at inland ports. Domestically, we’re encouraged by many opportunities to work more closely with all of our Class 1 partners to target truck conversion.

Just one example of this is the agreement we reached with CPKC just a few weeks ago to create a new interchange in Alabama that will link our customers across the Southeast with key markets in Texas and Mexico. We think there’s much more opportunities for new creative partnerships that can help bring even more business to all of the railroads. And we remain very excited about the opportunities ahead of us. Now I will turn it over to Sean to discuss the financials.

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Sean Pelkey: Thank you, Kevin, and good afternoon. Looking at the second quarter results, revenue was lower by 3% or $116 million, declines in fuel recovery, other revenue, and benchmark-based export coal pricing [Technical Difficulty] benefits from strong merchandise pricing, as well as volume growth across merchandise and export coal. Operating income was down 13% to $1.5 billion, reflecting a $122 million headwind from cycling a gain on the Virginia property transaction. I’ll discuss the expense line items in more detail on the next slide. Interest and other expense was $25 million higher compared to the prior year, and income tax expense decreased by $64 million on lower pre-tax earnings. As a result, EPS fell by $0.05, reflecting a $0.04 impact of lower property gains.

Let’s now turn to the next slide and take a closer look at expenses. Total second quarter expense increased $105 million. Lower fuel price was largely offset by the prior year Virginia gain. While network efficiency improvements resulted in over $20 million of cost savings across labor, PS&O, and rents, it was not enough to overcome more than $100 million of headwinds from inflation and higher depreciation. Turning to the individual line items. Labor and fringe expense increased $57 million, impacted by inflation and increased headcount. Importantly, service improvements are helping us get more employees home sooner, with overtime ratios down nearly 10% and a significant reduction in the number of employees tuck away from home over 24 hours.

As a reminder mid-year union wage rates stepped-up by 4% on July 1, and will be reflected in our second half cost per employee. PS&O expense increased $37 million with inflation and higher repair and maintenance expense, partly offset by savings in intermodal operations and cycling of costs related to the Pan Am acquisition. While we are overhauling and rebuilding more engines than last year, locomotive efficiency was 4% improved in the quarter. Depreciation was up $33 million as a result of last year’s equipment study, as well as a larger asset base. Fuel cost was down $134 million driven by lower gallon price. Equipment and rents was $5 million favorable, reflecting strong improvement in car cycle times with merchandise cycles 13% better than last year.

These efficiency gains more than offset costs from inflation and higher volume, particularly in the automotive market. Finally, as discussed, property gains were $117 million unfavorable in the quarter. Now turning to cash flow and distributions on slide 17. After fully funding infrastructure investments and strategic projects, CSX has generated $1.5 billion of free cash flow year-to-date. This has supported $2.4 billion in shareholder returns, including over $1.9 billion in share repurchases and $450 million of dividends. We were encouraged to receive recent news of a credit ratings upgrade. This move reflects the strong core cash-generating power of CSX through economic cycles, which supports our ongoing commitment to investing in the business and our balanced opportunistic approach to capital return.

Economic profit, as measured by CSX cash earnings, is up over $80 million year-to-date. While intermodal storage revenue declines in export coal headwinds we’ll have a more significant year-over-year impact in the second-half, we remain committed to cultivating and investing in return-seeking projects that see the pipeline of mid and long-term growth and efficiency gains. With that, let me turn it back to Joe for his closing remarks.

Joe Hinrichs: Alright. Thank you, Sean. Now let’s conclude with some comments on our outlook for 2023 as shown on slide 19. First, we reiterate our expectation that revenue ton miles will grow in the low-single digits for the full-year. We remain very happy with the performance of our merchandise business through the first-half of the year and we look for volumes to be supported by continued strength in automotive, minerals and metals and the successes we’ve had in the marketplace. We expect full-year coal volumes to be higher, driven by strong demand for export coal. As we noted last quarter, domestic coal shipments will likely soften as demand is impacted by low natural gas prices. For intermodal, as Kevin said earlier, we have seen modest signs of improvement for domestic intermodal activity starting late in the second quarter, but there are no signs yet of a near-term recovery for the international business.

We’re still benefiting from a favorable pricing environment, though our expectation for $300 million decline in supplemental revenues is unchanged, with most of that year-over-year reduction occurring in the second-half of the year. Lower international met coal benchmark prices will also impact our coal revenue per unit over the remainder of the year. As before, we are making our best efforts to drive efficiency and control costs to offset real inflationary pressures, and we are committed to staying focused on improving service to our customers. And finally, we still estimate capital expenditures at $2.3 billion with a strong focus on innovation and growth. To sum up, I am proud of the progress that the ONE CSX team continues to make. There is no doubt that we face some mixed economic conditions in the near-term.

However, there are so many opportunities opening up for us to win share, expand our markets and achieve profitable growth if we remain focused on safety, service, execution and working together. I am very excited about what is ahead for CSX. Thank you, and we’ll now take your questions.

Matthew Korn: Thank you, Joe. We will now move to our question-and-answer session. In the interest of time and to make sure that everyone has an opportunity, we ask you to all please limit yourselves to one and only one question. Emma, we’re ready to start the process.

Q&A Session

Operator: Thank you. [Operator Instructions] Your first question today comes from the line of Chris Wetherbee with Citigroup. Your line is now open.

Chris Wetherbee: Hey, thanks. Good afternoon, guys. Joe, I guess maybe wanted to start with some thoughts on how you — the second-half of the year I guess, and in particular, how you think about matching resources to the volume and revenue environment that we’re in right now, as you noted you have coal, and you have other revenue headwinds that are greater on a year-over-year basis as we move into the back half of the year. Certainly, volume is still like it’s a little bit uncertain, Joe, as you mentioned around the economic outlook. So how do we think about sort of managing the resources? I know service is coming back. Is it time that headcount starts to decelerate on a sequential basis? Do you think that there is more work to be done there? And conceptually, how you think about that fits in and what it may be means to profitability in the back half of the year?

Joe Hinrichs: Thanks, Chris. It’s Joe. I think at a high level, we’ve noted some of the things that won’t repeat from last year’s second-half as you referenced. So we’re really focused on getting our manpower levels up to continue to sustain the improved customer service levels that we’ve been delivering. And Jamie highlighted the trip plan compliance in the second quarter around 84%. We’ve been in the 80s now pretty regularly since November of last year and that’s really resonating with our customers. We’re watching very carefully what’s happening with the volume. And we have a mixed kind of market out there. And Kevin highlighted, we’ve seen growth in metals and automotive and other parts of our business. Intermodal has been softer as we highlighted.

And chemicals, you know, little down, you know, we’ll see when that turns. But generally speaking, our volume has been holding up on the merchandise side. We’ve been growing merchandise business. So we’re watching the volumes very carefully and making sure that we have the staffing levels to support sustained high levels of customer service. And the reason why it’s so important is that, Kevin and his team have really started to have some really good conversations with our customers. We gained share in the first-half of the year and that picked up momentum in the second quarter. And we’re having very good conversations with our customers now that we’re sustaining these high levels — higher levels of service, and as Jamie noted, we want to continue to improve.

But our focus is really on making sure we have the manpower to be able to sustain that. And also, at the same time, of course, if we see volume reductions further than what we’re seeing right now it will respond accordingly. But right now, the volumes that we’re seeing are supporting this merchandise volume growth and our high levels of service.

Operator: Your next question comes from the line of Jon Chappell with Evercore. Your line is now open.

Jon Chappell: Thank you. Good afternoon. Sean, I wanted to ask you about the productivity improvements. In the first quarter, you said $15 million to $20 million. You said more than $20 million in the second quarter. I think the plan was to eventually get to $30 million. So I guess the question is essentially, do you get to $30 million by the back half of this year as a quarterly run rate? And kind of along the lines of Chris’ question, if the volume environment is a bit softer than you had anticipated six months ago, could that $30 million even become greater as you think about 2H ‘23?

Sean Pelkey: Thanks, Jon, for your question. Yes, your recollection is right in terms of what we said first quarter. So yes, we are building some momentum with $20 million, a little over $20 million of what I would call sort of fluidity-related savings year-over-year. Now just to be clear, we aren’t really counting, sort of, changes in volume in that number up or down if there’s costs related to that. This is sort of independent of that. This is things like cycling the cars faster and reducing costs related to that, reducing overtime, things along those lines. We do have line of sight to that number continuing to increase over the balance of the year, and we should be in that $30 million to $40 million range in the second-half of the year is our plan, especially as we get out of summer here and labor availability starts to pick up, we get some more employees out of training. We feel pretty good about what that’s going to set us up for in the second half of the year.

Operator: Your next question comes from the line of Brandon Oglenski with Barclays. Your line is now open.

Brandon Oglenski: Hey. Good afternoon, and thanks for taking my question. Kevin, I was wondering if you could follow-up on the commentary around merchandise pricing reflecting service and a higher inflationary environment, but maybe contrasting that with the loss coal revenue and intermodal surcharges, if you could?

Kevin Boone: Yes. I mean when you look at our coal market, and particularly the export market, it moves with the benchmark prices. So that’s something that as a swing producer keeps the producers here in the U.S. in the market, and it’s worked very, very well and it’s a great mechanism. We participate, obviously, when the pricing is very good. I mean it remains very, very supportive. We just had extraordinary prices last year that nobody expected would continue. But again, we participated in that. When you look across our — the rest of our portfolio, particularly on the merchandise side, it remains supportive of the inflationary environment out there. And our customers are getting price in the market and they’re not surprised that our ability to go and have those discussions are similar to what they’re having with their customers.

So the alignment is there. Certainly, I think the market would be — people are looking for inflation to come down a little bit, and we’ll see how the market continues. But market from a pricing perspective, both in merchandise and maybe a little bit less so in the spot market on the intermodal side, obviously, that’s been a little bit softer, but still very, very healthy and will carry forward into next year.

Operator: Your next question comes from the line of Scott Group with Wolfe Research. Your line is open.

Scott Group: Hey, thanks. Afternoon, guys. Sorry about my voice. Hopefully, you can hear me. So the coal RPU guidance was helpful. How should we think about the fuel impact in the third quarter? What are the other puts and takes as I think about operating ratio, profit Q2 to Q3? And then just like bigger picture, it feels like there’s still a pretty good gap between underlying pricing and some really elevated inflation. Like, when does that normalize in your mind?

Sean Pelkey: Scott, it’s Sean. Yes, so in terms of Q3 versus Q2, I mean I think step back just a minute and think about what are we ultimately trying to achieve here. We’ve got a service product that’s — it’s well in excess of where it’s been and certainly one of the best, if not the best in the industry. That’s ultimately going to translate into the ability to win business off the highway and we’re seeing those. We’re seeing a number of those opportunities present themselves. Over time, that’s going to have a really positive impact not just on margins, but also on obviously being able to grow the top and bottom line of the company. When we look at the third quarter specifically relative to the second, we’ve got the headwinds that Kevin talked about on coal pricing.

We’ve had positive fuel lag all year long. We’re seeing fuel prices settle a little bit here so that could be a little bit of a headwind into the third quarter. And then as I mentioned, we’ve got the union wage rate increases of 4%. So that will add some costs. In terms of the second-half of your question, the gap between pricing and inflation. We’re seeing mid-single-digit inflation across both labor and fringe and purchase services and other. That’s going to persist here for the balance of the year. We’ve got a clean line of sight into the labor line. And most of the PS&O is essentially set for the year from a rate perspective. I would also say, and Kevin can chime in if there’s additional info, but I think most of the pricing for the year has been done.

We’ll start to get into pricing for next year as we get towards the end of the year. And so far, conversations have been — continue to be very supportive.

Kevin Boone: Yeah, I think that’s right. We’ve seen the pricing reflect the inflationary environment. And there’s multiyear contracts that we’ll still have to touch at the back half of this year that probably need a little bit of catch-up. But beyond that, I think it’s well in line with what the inflationary market is out there, particularly on the merchandise business today.

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

Ken Hoexter: Hey. Great. Good afternoon. So just to understand this environment, Joe or maybe Kevin, as you move into the third quarter, you’re targeting — still targeting low-single-digit revenue ton-mile growth. I guess you’re running about 2% or so year-to-date. So do you think that moves negative based on the current weak volumes that we’re seeing so far right now? And then if we do get that weak environment that we’re talking about, can you still improve operating ratio as we move into the third quarter if you’re looking at revenue stay above cost of inflation? Thanks.

Kevin Boone: Yes. I think, Ken, you’ll remember, I think as you move into the back half of the year and as you enter into the fourth quarter, we’re also going to lap a lot of easier comps, whether it’s the international intermodal market or some of the markets that we saw. Some order softness begin in September and really carry through the fourth quarter. So I would say things will probably trend positively through the quarter, which will be helpful from a revenue — RTM growth perspective. Coal is a dynamic market right now. Look, two weeks, three weeks ago before this hot summer started probably a little bit lower outlook for domestic coal business. But just recently, we’re getting a lot more interest and a lot more inbounds on what we can do given some of the heatwaves we’re having.

In fact, I think we got a heat warning here in Jacksonville this afternoon. So things have been hot. Obviously, that’s supportive of that market. And so things can change — are very dynamic and can change quickly. The destocking, I think, I mentioned it in my prepared remarks. We’ve seen destocking for a while in some of these markets. I don’t — I can’t call the month or the quarter of when that stops, but there’s many markets right now where we’re underrunning I think, the demand that’s out there in the business. So once that normalizes to the underlying demand in the economy, I think that’s an opportunity for us, too. And I’m hopeful that as we move into the fourth quarter, we’ll see some of those dynamics play out. And then as Joe pointed out, there’s — the team has been doing a fantastic job.

And some of the efforts and some of the collaboration that we’ve had with Jamie and his team on the operations side is resulting in wins and those start to layer in as we move through the year and into next year, and you’ll start to see that in our business as well.

Sean Pelkey: Yes. And Ken, just on the second part of your question, I think the commentary you heard from Kevin suggests we’re not calling a pullback in volumes. But to the extent that the macro presents something like that, there’s things that we can do, there’s levers that we can pull. And certainly, we would look to do that but not to jeopardize the ability to continue to gain momentum and gain share off of the truck, which is the ultimate goal here to kind of grow the pie and grow our profitability.

Operator: Your next question comes from the line of Brian Ossenbeck with J.P. Morgan. Your line is now open.

Brian Ossenbeck: Hey, thanks. Good afternoon. So maybe just on the topic of truckload conversion, it’s been mentioned several times on the call. Obviously, it’s a big opportunity. But can you give us any context in terms of the wins you’re getting or you have line of sight to? Would you be able to quantify that at some point in time because clearly, making the long-term decision to go after that and sounds like you’re getting some — but it’s hard to say what relative size that could be? And then, Sean, if you could just clarify cost per employee that we should expect for the next quarter? I know payments go up or the wages go up another 4%, but you got mix over time, a few other things in there as well. So it would be helpful if you can clarify that, too. Thank you.

Kevin Boone: Yes. I think in terms of numbers, we’ll probably put a finer point on the truck conversion opportunity over the next three years at some time in the future. There’s a huge focus by the team to really look at our pipeline and measure it and focus on those customers where there’s an opportunity. And some customers have a lot more opportunities than others and making sure we have the resources up against those customers to really drive that conversion. So a lot of activity. We have a lot of new tools internally that we’re focused on in terms of measuring that. So our data is getting better and better every day, and there’s a lot of momentum. And as I mentioned, our pipeline, as we measure it on a year-over-year basis, is up significantly, up 30%.

On a dollar volume perspective, it’s up even more than that. So a lot of momentum building. Obviously, the trucking market is not the most receptive market to compete against right now. Hopefully, there’s some optimism that’s firming up here, and that will even drive more opportunities as we work with customers over the next few months to drive more opportunities. And we’re upwards of 25 whiteboarding sessions year-to-date, and those are driving a lot of opportunities. They don’t necessarily come to fruition tomorrow. But over the next couple of quarters, we think those are going to translate into a lot of opportunities to shift share from truck as well. So we’re — teams are very, very excited. I don’t think we’ve had this much of momentum in terms of the things that we can control going forward.

It’s just some of these markets obviously are against us right now. Over to you, Sean.

Sean Pelkey: Yeah. Thanks. And in terms of cost per employee, it should be fairly stable other than the 4% wage increase on the union piece. I think there are some opportunities to drive some efficiencies there. So we hope to do better than a 4% increase from the first-half to the second-half, but we’ll certainly feel the impact of higher wages.

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

Justin Long: Thanks. I wanted to ask about intermodal, because there’s a big divergence between the domestic intermodal and international intermodal volume trends. And I was wondering if you could share how those numbers compared in the second quarter. And looking into the back half, around your comment about the domestic intermodal market gaining momentum. Is that a function of demand getting better or your expectation for business wins starting to kick in? Thanks.

Kevin Boone: Yes. I think when you look at the second quarter, think about the international market being down in that high-teens range. We probably, from a bottom perspective, peak that down in that mid-20s, and it’s improved slightly from there. So our exit rate is a little bit better than what we saw middle of the quarter. What we saw through the quarter on the domestic side is sequential improvement month-over-month or on a year-over-year basis each month as we get to move through the quarter. So that gives us optimism there. The team has done, quite frankly, a fantastic job of introducing some new lanes, working with some of our Class 1 partners to do that and identify new business. And some of those things are really playing out.

Some of our partners have done really, really well in the market despite some of the, obviously, headwinds there. So working with them, identifying markets where we have some opportunities. And in these kind of markets, it gives you more flexibility to go out there and look at things, look at your network, identify opportunities, try things out that work — may work and really go after it. So that’s what the team has been using the softness in the market to go and do and set us up for growth as the market rebounds. And I think you’re starting to see that in the numbers here.

Operator: Your next question comes from the line of Tom Wadewitz with UBS. Your line is now open.

Tom Wadewitz: Yes. Great. Good afternoon. Appreciate it. I know you’ve got a lot of questions, Kevin, on volume. And maybe there’s not — it’s tough not to have a clear crystal ball in this type of environment. But I guess, how do you think about the kind of — you’ve got good momentum with the service, good discussions with customers. You’re talking about the pipeline is good. If we see some improvement get beyond inventory reduction, just see a bit of improvement in demand, do you think you’re going to see maybe a bigger cyclical swing up and maybe more evidence of some of that truck conversion coming through? Or, I guess I’m just trying to think about — we know it’s a tough rate backdrop, but what is — how do these things translate when you see some improvement in markets? Is it mid-single digit volumes higher? How do you think about that potential framework maybe looking at a little ways?

Kevin Boone: Yes. I probably won’t put numbers around it, but there’s a reason we’re hiring. There’s — we see all the things that we can control internally, setting us up nicely for when the markets rebound. And yes, I think the combination of markets returning at least to — in some cases, just the current demand levels is going to create a lot of leverage in our business to do that. And I think you’ll see some of these businesses where we’re having discussions around truck conversion as the market firms up, more willing to move that freight back over to rail or move it to rail for the first time. So it’s — the pipeline takes a while to build up. It’s been — as Joe was pointing out earlier, it’s been about nine months since we’ve seen that rail improvement. And the customers are reacting to it, some sooner than others. But yeah, that’s the idea of all these investments, obviously, will help us participate when that cyclical upside starts to occur.

Operator: Your next question comes from the line of Fadi Chamoun with BMO Capital Markets. Your line is open.

Fadi Chamoun: Yes. Thank you. My question on the service level, like obviously, you have done a great job in rebuilding the service and doing the — a comprehensive work on building the culture to sustain that longer term. But as we know, like some of the service issues we saw in the last two or three years were all rail related. You had obviously a lot of friction coming to you from outside of your own network. I’m just wondering, how are you kind of thinking about some of these problems that are affecting your service from outside your network. Some of these partnerships that Kevin talked about, try to kind of iron out some of these friction areas that you see in the supply chain? Or are there opportunities to kind of build the service level that can be sustained even as demand comes back, which historically has been a challenge to service levels?

Joe Hinrichs: Yes. Thanks for the question. This is Joe. You’re right. Over the last several years, supply chain across the globe was challenged, and we certainly felt the effects of some of that. We’ve got some benefits from that on the supplemental revenue side of things because things were going up in storage. But generally speaking, from a customer standpoint, it definitely impacted everyone. And as we’ve noted in the past, around 40% of what we moved on the carload side touches another rail provider. So interchanges are important and the overall service levels of the partners we have across the Class I rails is really important. If you think about going forward, the ports aren’t congested as much as they were, and we don’t have a lot of the network all gummed up in the intermodal facilities and et cetera.

So we should be able to run more fluidly when the market comes back on the intermodal side especially. So I think from a customer perspective, the things that have calmed down help. And as our Class 1 rail partners continue to improve their service, the collective service that we give to the customer holistically will improve as well, which — that’s an opportunity for the whole industry going forward. That’s the way we’re thinking about it. We can control our piece of it, and we want to keep getting better and more repeatable and more predictable and also working with our Class I rail partners to do the same. At the same time, the other parts of the business have also freed up — so as Kevin was alluding to, when that market comes back, we’ll have the manpower levels, and we’ll have the fluidity in our network and the system overall should be able to handle it in a better way, which should be better for the overall economy.

Operator: Your next question comes from the line of Amit Mehrotra with Deutsche Bank. Your line is now open.

Amit Mehrotra: Hey, guys. Thanks for taking the question. Kevin, can you just talk about the direction of travel for non-coal yield? I just would have expected a little bit of a better performance in the second quarter sequentially. I know there was a few headwinds that’s pretty severe incrementally, that fuel headwind kind of moderates in 3Q. So just wondering what the direction of travel on that is. And then Sean, you made some good progress on PS&O costs in the quarter relative to, I guess, that insurance gain adjusted first quarter. I know you’ve got some like leases that are expiring around intermodal container storage jars and things like that in the back half. What’s the right way to think about PS&O coming down in the back half relative to what you did in the second quarter? Thanks.

Kevin Boone: Yes. Obviously, putting coal aside, obviously, that we’ve talked about on the international side. When you look at yield broadly, there’s always mix, right? And when you look at our merchandise business, in general, one of the markets we’ve highlighted is obviously under cyclical pressure right now is the chemical market, which typically has a higher RPU. So that’s weighed on the overall benefit you’ve seen from the merchandise side, and there’s a lot of moving parts within it. But if you look at what we were able to achieve within the individual markets is quite healthy I think despite some of the fuel surcharge headwinds that you saw. The intermodal market obviously is unique, given some of the challenges on the truck and what we have to do there, particularly on the spot market.

But again, fuel surcharge is a much larger impact there. And absent that, you saw a flattish-type RPU, and that was mainly impacted by some of our longer-term contracts, obviously had positive rate. But on the flip side, some of the spot markets saw some significant downgrade along with the truck. But the market held in, obviously, a lot better than some of the trucking rates out there and what the markets do there. But overall, I was very pleased in some of the NPA results as we measure it or some of the highest results that we’ve seen in a long time, if you look broadly across the markets.

Sean Pelkey: And Amit, your question on PS&O, I’m always hesitant to predict that line, because there’s a number of different puts and takes within it that can impact the quarter. I will say that we are very — we’re focused on cost control and we’re making sure that we’ve got only the costs that are necessary in order to move the volume to the extent that intermodal volumes pick up a little bit, that will have an impact on PS&O costs. But outside of volume-related expenses, I would fully expect that we’d be able to, kind of, hold the line on the improvement that you saw in the second quarter in PS&O going forward. And if you look at it on a year-over-year basis for the second-half, that means we’ll probably be able to absorb most of the inflationary impact in the second half, notwithstanding any sort of volume-related impacts that we might see.

Operator: Your next question comes from the line of David Vernon with Sanford Bernstein. Your line is now open.

David Vernon: Good afternoon, guys. Thanks for the call and thanks for taking the question. So Kevin, just to kind of dig into the mid-teens guidance for RPU sequentially. Does that kind of bring us to mark-to-market for $225? And then how do we think about the sensitivity? Can we extrapolate that sensitivity going forward if we’re going to expect sort of benchmark pricing to either go up or down? Is that a good way to think about the sensitivity on further price changes? Because $225 was still, call it, $75 above the long-run average in the prior decade.

Kevin Boone: Yes, I think that’s fair. Obviously, there’s bottoms, right, and there’s — we protect ourselves both on the bottom and then on the top end. We don’t participate in some of the extreme stream cases, but I think that’s fair. $225 is kind of embedded in what we’re coming into the quarter. We’ve seen a little bit of positive uplift in that so even as recently as the last couple of days. So we’ll see where that trends. But we’ve seen a lot of stability, if not a little slight uptick in that market here recently, and we’ll see what the fourth quarter brings.

Operator: Your next question comes from the line of Jordan Alliger with Goldman Sachs. Your line is now open.

Paul Stoddard: Hi. This is Paul Stoddard on for Jordan. I guess with the recent agreement on the West Coast for the Long shoremen, there’s some anticipation that there could be some more freight being diverted back to the West Coast. I guess how are you thinking about that in terms of international intermodal long-term? And do you think that’s going to be offset by domestic intermodal? Thanks.

Kevin Boone: I think the long-term trend, if you just go to Charleston, you go to Savannah and you look at all the investments being made, there’s a long-term growth opportunity on the East Coast and you’ll continue to see our growth in the East Coast, which we’ll continue to serve and benefit from. Some stability on the West Coast is going to be helpful. As you know, a lot of our international business still comes across the West through Chicago and other interchange points. And unfortunately, a lot of that volume given some of the congestion on the West was either trucked, and we didn’t see that volume. So as that — we should benefit from a recovery there. So I don’t see it as necessarily taking share away from what we’re doing in the East, more as something that — obviously, if the rails in the West begin to perform better on a year-over-year basis will benefit the Eastern network and some of that traffic coming to us.

Operator: Your next question comes from the line of Allison Poliniak with Wells Fargo. Your line is now open.

Allison Poliniak: Hi, good evening. Just want to go back to Brian’s question on modal conversion. When you talk to customers that aren’t quite ready to convert yet, is it simply price that’s holding them back? Or is there something from a service perspective that they’re looking for you to provide that’s just not quite there yet? Just any thoughts on that. Thanks.

Kevin Boone: Look, I think the most important thing for a customer is reliability, right? And in some customers’ eyes, they want to see more of that reliability. They like what they see today. We’ve got to continue to perform and have those conversations. And sometimes it’s lane-by-lane. It’s carload-by-carload where we get that confidence from a customer. And so we’re in the very early innings of this, and we feel the acceleration from first quarter to second quarter, and I expect those conversations to pick up even more in the third and fourth quarters as we continue to perform. Sharing what we’re doing on the hiring side is incredibly helpful. Sharing with them what we plan to do to make our network more resilient, winning their confidence, but that’s the number one issue.

It’s not price. 99% of the time, we have a pricing advantage versus our truck competitor. So that’s the opportunity for us. We have the environmental advantages. So we have all these things, we’ve just got to get the reliability and prove that the reliability is sustainable.

Operator: [Operator Instructions] Your next question comes from the line of Walter Spracklin with RBC Capital Markets. Your line is open.

Walter Spracklin: Thanks very much, operator. I just wanted to shift focus from — the pipeline looks really good, Kevin, and presumably that’s merchandise base mainly. But looking into 2024 on some of your bulk areas and in particular, ag and coal, the EIA has just revised downward its forecast for next year by quite a bit? And then on the ag side, it looks like there’s some severe drought conditions forming that’s going to impact the current growing season. So looking into 2024, I mean that suggests that we could be bracing for some down double digit volume growth in those two categories. Is there any offsets there that you would flag for next year that would offset some of those fairly negative forecast for those two particular commodities?

Kevin Boone: Well, really hot summer certainly doesn’t hurt and that’s what we’re in the middle of. Obviously, from a coal perspective and you’re referencing mainly the domestic side, that’s obviously dependent on the weather conditions and the weather I think is a surprise from a heat perspective to the upside here over the last few weeks. And we’re seeing that with a lot of our customers running full out here and replenishing some of the inventory levels. And so we’ll see how the winter plays out. I think it’s really, really early in July to call 2024. That seems a bit premature to me. We see a very healthy export market as well. Obviously, that’s driven by global macro conditions. But we have new supply coming online that will ramp up next year.

That supply is going to land in the market. It’s very competitive in the market, and we expect to participate in it. Many of the mines that we serve are going to be in the market almost no matter what conditions. So we see the volume there sustainable. On the ag side, again, I followed these markets for a long time. I think July is a little bit premature as well. It has been hot out there. We’ll see how the market firms up here, but there’s a lot of moving parts. We’re seeing a little bit of weakness here in the third quarter, but we see some good indications into the fourth quarter. So we’ll see how that trends, and we’ll watch the crop conditions as you are to see how that moves into the back half of the year. Obviously, we don’t have as large of a franchise on that side as some of the other railroads, particularly in the West from an export perspective.

So a little less exposure.

Operator: Your next question comes from the line of Jason Seidl with TD Cowen. Your line is open.

Elliot Alper: Great. Thank you. This is Elliot Alper on for Jason. On the international intermodal side, last quarter, you talked about how some of your larger customers were expecting a pickup in the back half of the year. So I guess, what have your customers said that has changed over the past three months that has resulted in no inflection yet? Maybe there’s been any change in view into peak season? Thanks.

Kevin Boone: I don’t — I wouldn’t read any of our comments that there’s been any type of inflection down. We’re just — I don’t think there’s — we’re seeing in real-time an inflection up in the market. And I mentioned earlier, in the fourth quarter, we obviously start to lap a lot easier comps on a year-over-year basis. So I think from a overall growth perspective, fourth quarter will be a much easier comp than what we’ve seen throughout the year. And hopefully, that momentum will carry into next year. But there’s no indications that the market is necessarily picking up. I don’t — I think we bottomed from that perspective. The question is how quickly the market recovers. And that will be heavily relying on the consumer and how that pans out into the holiday season going forward.

Operator: Ladies and gentlemen, this concludes our Q&A session for today and today’s conference call. Thank you for attending. You may now disconnect.