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Text: A full transcript and download will be posted after the call.
It is now my pleasure to introduce Norfolk Southern's Chairman, President and CEO, Jim Squires.
Building upon our momentum to start the year, our team delivered another record-setting quarter, as dramatic improvement in both revenue and volume up 34% and 25% respectively outpaced an 11% growth in expense and while the year-over-year improvement is aided by easier comps from last year's economic shut down, our performance in the quarter also improved sequentially in a number of ways as shown on slide 4.
Our results includes second quarter records for net income and earnings per share and all-time records for operating income and operating ratio, which was 58.3% this quarter.
We accomplished a lot this quarter and I am most pleased with our PSR progress during the past several months, we continued to get more productive face our challenges head-on and seize the opportunities we are creating.
In the second quarter, we saw the benefits of a structurally lower operating cost base coupled with an operation that successfully absorbed increased volumes in the network.
Turning to the operating metrics on Slide 6 you can clearly see the operating leverage generated in the quarter.
Leverage that flow directly to the bottom line.
Our operating discipline enabled us to handle a 25% year-over-year volume increase with 8% fewer people in our workforce and a 1% decrease in active locomotives.
This success shows our improvements in train size reflecting our goal of absorbing more business into our existing operating network wherever possible and further driving productivity.
These gains were achieved in part by the increased deployment of distributed power and more blending of previously separate traffic types on the same train.
We will continue to unlock train size increases through targeted siding extensions on key routes where train length is currently limited.
Terminal capacity enhancements, which we've achieved through more efficient operating practices will also be a key factor in absorbing and processing growth on these larger trains.
Increased train size promotes better fuel efficiency and our progress this quarter reflects our commitment to closing the fuel efficiency gap with our peers.
On Slide 7, you can see in the second quarter, we showed sequential improvement in terminal dwell and train velocity after we got through the severe winter weather in the first quarter.
However, our progress was uneven and we lost ground in June in part due to several discrete but geographically impactful operating disruptions.
We aren't satisfied with our service levels and we are working extremely hard to seize the opportunity PSR presents to recover faster from disruptions.
As the graph show, we resumed our improvement in July.
We are committed to continuing to improve service levels and running a faster railroad, not just because a faster railroad is a lower cost railroad, but also because speed generates capacity for us to take on additional traffic within our existing train network.
I'll move to Slide 8; during the quarter we strive to deliver a consistent service product even with significant volume changes by focusing on the consistency and productivity of our yard and local operations.
We are teaching and equipping our field managers to better measure the work our yard and local crews do and answer some important questions; does the number of assignments working match the car volumes flowing through a terminal or territory?
Are we getting full value out of each resource in our yards?
What's the right balance of over time cost?
Where are there further automation or process opportunities to help us reduce support costs, including clerical staff and chemical [Phonetic] presence.
We are implementing technology to provide better and more timely data to answer these questions, which helps us reduce direct operating cost and improved service consistency.
In several locations, we've renewed our focus on more efficient remote control operations, which have been facilitated by the changing nature of the work over the last year.
Local operations scheduled and properly sized to volumes, enable us to be more predictable to our customers and move cars quickly.
Having a higher balance of crews assigned to road train service, while creating capacity within the terminal through process enhancements makes us nimble in responding to market changes and reducing our fixed costs.
Local service is at the core of our service product and these changes are designed to improve that product.
So far, we have reduced the cost-per-yard in local crude 7% versus last year and expect additional progress as the year continues.
In a moment, Mark will discuss the benefits of reduced head count and employee activity levels in constraining overall compensation expense as we absorb volume.
Our focus on yard and local productivity has played a pivotal role in driving these benefits.
We pursue targeted initiatives such as these with an eye toward the next generation of modern railroading, which we are bringing to life today.
We continue to empower our workforce to the delivery of mobility solutions and have distributed 8,000 smartphones to our T&E employees to facilitate improved reporting and to streamline the process of keeping trains moving.
In the third quarter, we will begin rolling out a next generation local train reporting application to improve our visibility and customer service for the first and last mile.
We are also in the final months of deployment of our current phase of the mobile track authority application that facilitates more efficient coordination between engineering and dispatching functions for right of way maintenance activities.
We are at a very exciting time for our company and industry, in which we have ample opportunities to drive customer and shareholder value through both operational improvements and technology, a powerful formula.
Earlier, I mentioned the role the mechanical team has played in our PSR success so I thought it would be useful to explain their crucial role on Slide 9; PSR railroads Norfolk Southern included end up needing fewer locomotives.
What our mechanical department has done is to take that initial Annie [Phonetic] and use it strategically to call the worst performing units and to make our locomotive fleet more homogeneous.
Those changes unlock repair productivity.
Think about the benefits of repairing newer and fewer locomotives, which drove down the number of units out of service for repair.
That started a virtuous cycle of improved reliability with 175% improvement in the days between unscheduled events to a shop versus pre-PSR levels, meaning that when units do go into the shop our craftsman can spend more time on preventive maintenance instead of triaging issues.
This cycle repeats itself and ultimately supports the efficient movement of trains and serving our customers.
Fewer, more reliable units also require fewer resources.
So, we need fewer servicing facilities and have fewer people maintaining locomotives.
This is just an example -- a big example of Norfolk Southern's PSR transformation.
These changes are purposely aligned with our overall fleet strategy including investments in our fewer but better units through our DC to AC conversion, energy management solutions and predictive analytic tools for maintenance planning and failure prevention.
When taken as a whole, the benefits of this strategy flow through our materials, fuel and compensation expense lines while ensuring we have a robust fleet capable of supporting profitable growth.
You can see on Slide 11 that we are approaching pre-pandemic revenue levels; however, the composition of our business has changed dramatically due to the secular trends in the overall economy that were accelerated by the pandemic.
Norfolk Southern is positioned at the forefront of these shifts due to the unique advantages of our powerful consumer oriented franchise and the diverse industrial markets we serve.
The progress we have delivered amid dynamic business conditions underscores the value we provide to the markets we serve.
Norfolk Southern's network directly connects to the majority of consumption and manufacturing in the United States and is a vital resource for maintaining the flow of goods to support the economy.
We are building on the inherent value of our network by working to provide our customers with the digital logistics solutions they need to compete and grow in an evolving market.
The sustainability advantages of the Norfolk Southern franchise deliver a competitive advantage, provide customers with solutions to their carbon offset goals and are an accelerant to growth.
In the second quarter of 2021, we successfully capitalized on opportunities by leveraging productivity enhancements and collaborating with our customers.
As a result, second quarter revenue in our non-energy markets exceeded pre-pandemic levels by 4%.
Growth this quarter was driven by consumer facing and industrial segments, which helped to offset sustained headwinds in our energy markets.
Revenue in our energy related markets returned to just over two-thirds of pre-pandemic levels in the second quarter of 2021.
Our market position enabled a quick recovery and consumer and industrial markets almost fully offsetting the 50% decline in our energy revenue, despite the sharp decrease in this historically profitable segment, we reduced operating ratio, levering the strength of our unique franchise to target segments of the $800 billion truck and logistics markets with a sharp focus on productivity.
Turning to Slide 12, our quarterly volume and revenue improved significantly from pandemic lows in all three business units, reflecting our ability to capitalize and build on the momentum of improving economic conditions.
Total revenue for the quarter was $2.8 billion, up 34% year-over-year on 25% volume improvement.
Rising fuel prices and price gains drove a 7% improvement in revenue per unit, led by our intermodal franchise, which delivered record-breaking revenue per unit and revenue per unit less fuel.
Sequentially, volume and revenue improvement in all three business units over the first quarter, in line with the accelerating economic recovery.
Beginning with our merchandise segment, both volume and revenue improved 25% versus the second quarter of 2020 driven primarily by recovery from COVID-19 related shutdowns in the prior period.
While automotive continued to face headwinds associated with the semiconductor chip shortage, shipments in the second quarter were up 122% year-over-year against easy comps associated with near complete shutdown of vehicle production in the second quarter of last year.
Our steel franchise also delivered strong growth this quarter, up 67% as record level steel prices and elevated demand fuel production activity.
Combined gains in automotive and steel volume represented roughly 63% of total merchandise growth for the quarter.
Revenue per unit was flat, while revenue per unit, excluding fuel declined slightly driven by mix headwinds in chemicals and automotive.
Turning to intermodal, our powerful franchise delivered record-breaking revenue, revenue per unit and revenue per unit less fuel for the quarter.
The second quarter of 2021 marks the 18th consecutive quarter of year-over-year growth in revenue per unit, excluding fuel for our intermodal franchise.
Strong consumer demand and tightness in the trucking sector drove growth for our domestic service product.
Domestic shipments were up 17% year-over-year in the second quarter and up 4% from the same period in 2019.
International shipments were also strong in the second quarter improving 26% year-over-year on sustained high import demand but were down 3% from the same period in 2019.
Revenue per unit gains were driven by increased statutory [Phonetic] revenue, higher fuel surcharge revenue and price gains.
Approximately 50% of the revenue per unit gain was driven by higher container storage time on terminal due to supply chain recovery challenges.
Lastly, our coal segment experienced some bright spots in the second quarter due to higher demand levels driven by global economic recovery and weather events.
Coal shipments improved 55% year-over-year with strength in both the export and utility markets.
Revenue per unit decreased slightly due primarily to negative mix experienced in our export markets where growth was driven by strength in the lower RPU export thermal market.
Moving to our outlook on Slide 13.
We expect the current economic momentum to continue through the end of the year and are raising our guidance for full-year revenue growth to approximately 12% year-over-year.
The overall economy continues to surprise to the upside with forecast for 2021 GDP growth now at around 7% and approximately 5% for 2022.
Industrial production is forecasted to increase 6% in 2021 and north of 3% in 2022.
Increased manufacturing coupled with record low retail inventories, high savings rates and increased energy consumption, all set the stage for continued growth in the second half of the year.
Merchandise growth will be led by strength in steel markets as low business inventory to sales ratios and sustained demand for durable goods drives manufacturing activity in the second half.
We are well positioned to capture opportunities associated with current strength in the steel markets as our network serves more integrated steel mills than any other railroad in North America.
Merchandise energy markets will benefit from increased travel and commuting activities as businesses continue to reopen and virus restrictions are lifted.
Pulp board and plastics volumes are also expected to increase as personal consumption drives demand for packaging.
Merchandise gains will be partially offset by a year-over-year decline in automotive shipments in the third quarter, due to planned production downtime associated with the semiconductor shortage.
Demand for international trade to support recovering global economies is expected to lead second half growth in our intermodal franchise.
Domestic intermodal demand will continue to improve as well with consumer spending and e-commerce forecasts strengthening through the end of the year and ongoing capacity constraints in the trucking sector, driving more opportunity for highway to rail conversions.
Our coal franchise will continue to capitalize on near-term opportunities to support global energy demand and steel production.
Volume in the second half of 2021 is expected to improve year-over-year, driven by export markets benefiting from high seaborne coal prices making US coals more competitive in the global market.
Demand for domestic met to support growing steel production activity is also likely to produce year-over-year growth.
Gains in these markets will be partially offset by expected year-over-year declines in utility volume as this market deals of unit retirements, coal supply and planned maintenance outages.
Volatility is an ever-present risk in the coal market, so we are closely monitoring geopolitical trade tensions and coal production, both of which have a potential to influence results.
Overall, we expect economic conditions to be favorable for Norfolk Southern growth through the end of 2021.
We are confident in our ability to leverage the strengths of our unique franchise and continue to drive revenue and margin growth.
On Slide 15, you see the reconciliation of our Q2 reported operating ratio and earnings per share versus 2020.
The operating ratio of 58.3% represents a 1240 basis point improvement.
We had $67 million of property gains in the quarter, of which there was one major transaction that closed at the end of the quarter and resulted in a $55 million gain.
We view this single transaction is incremental to our normal yearly operating property gain guidance of $30 million to $40 million and it alone represents 100 basis points of the operating ratio improvement this quarter.
Earnings per share at $3.28 was $1.75 higher than prior year, aside from the $0.17 goodness from the property gain there was a state tax law change that resulted in a favorable adjustment to our deferred taxes of $0.09.
Moving to Slide 16, Alan walked you through the drivers of the 34% increase in revenues, including the 25% growth in volumes.
At the same time, we contained growth in operating expenses to 11% as we harvested additional benefits from workforce and asset productivity.
The volume growth coupled with the productivity drove strong incremental margins again this quarter resulting in an operating ratio that was a record low 58.3% improving 1240 basis points year-over-year and 320 basis points sequentially versus Q1, including the 200 basis point tailwind from the major property gained.
Our operating income at $1.167 billion in the quarter is another record, up $557 million or 91% year-over-year and we generated free cash flow of $1.47 billion through 6 months also a record, and that represents an increase of $447 million or 44% versus the same 6 months last year.
Moving now to a drill down of operating expense performance on Slide 17, you will see that operating expenses increased $157 million or 11% and fuel was the biggest driver of the increase with price driving expenses up $83 million.
Usage increased due to higher volumes, which was partially offset by another quarter of fuel efficiency gains, a 4% improvement in the quarter.
The increase in purchase services and rents has driven by volumes, although we managed to keep the increase in these categories, well below the volume growth rates.
Comp and Ben is up 6% with savings from headcount being down 8% year-over-year, offsetting increases in pay rates and over time.
Higher incentive compensation in the quarter was $39 million reflecting the improved outlook for the year and lower accrual rates of last year.
The big item in the materials and other column is the favorable compare on gains from property sales, in Q2 and that was $67 million in the quarter versus only $2 million last year.
Turning to Slide 18, you will see that other income net of $35 million is $14 million or 29% unfavorable year-over-year due primarily to lower net returns on our company owned life insurance investments.
Our effective tax rate in the quarter was only 21%, lower than we typically model and that was primarily from the benefit associated with the state tax law change.
Net income increased by 109%, while earnings per share grew 114% supported by the nearly 3.4 million shares we repurchased in the quarter.
Wrapping up now with our free cash flow on Slide 19, and as I mentioned free cash flow was a record for the 6 months of 2021 at $1.47 billion buoyed by very strong operating cash generation and relatively modest property additions of $627 million thus far in the year and that translates to a free cash flow conversion of 99% through 6 months although, we still expect property additions to ramp up in the balance of the year and hit our $1.6 billion guidance number.
When we spoke last quarter, I took the opportunity to share our company's long-standing commitment to sustainability; along those lines I'm excited to report two brand new milestones in our journey.
Earlier this quarter, we became the first North American Class 1 railroad to issue a green bond, launching 500 million in green bonds to fund sustainable investments to reduce our carbon emissions and partner with customers to do the same.
As outlined in our Green Financing Framework, potential projects range from improving locomotive fuel efficiency to fostering truck to rail conversions, powering company operations with clean energy to increasing the use of energy efficient buildings and technology and supporting reforestation projects that restore natural landscapes and offset carbon emissions.
In addition to our green bonds, we achieved another significant milestone earlier this month with the approval of our science-based target.
Our commitment to reduce emissions intensity by 42% in the next 15 years.
These two steps are a critical part of our shared commitment to sustainability with our investors, customers, partners and communities underscoring our resolve to be an even bigger part of the solution.
Before we open the call to Q&A, I'll take a moment to provide our updated outlook based on the current economic environment.
As Alan mentioned, we are even more confident about growth for the balance of this year and we now expect revenue to be up approximately 12% year-over-year.
Strength in our consumer oriented and manufacturing markets will drive the majority of the growth and the near-term upside in coal markets will provide more of a lift this year than previously expected though the market remains challenged in the long term.
We are also succeeding in driving productivity into our operations and as a result we got onto our 60% run rate here in the second quarter.
We expect to maintain this OR level for the balance of the year, which translates to at least 400 basis points of OR improvement for the full year versus our adjusted 2020 result, and we'll build upon this momentum for more improvements in 2022 and long-term sustained value for our shareholders and customers.

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qtrly railway operating revenues of $2.8 billion increased 34%.
qtrly railway operating ratio was 58.3%, an all-time record.

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