CSX Q3 2021 Earnings Report

CSX EPS Results

• Actual EPS: $0.43
• Consensus EPS: $0.38
• Beat/Miss: Beat by +$0.05
• One Year Ago EPS: $0.32

CSX Revenue Results

• Actual Revenue: $3.29 billion
• Expected Revenue: $3.06 billion
• Beat/Miss: Beat by +$229.68 million
• YoY Revenue Growth: +24.30%

CSX Announcement Details

• Quarter: Q3 2021
• Date: 10/19/2021
• Time: After Market Closes
• Conference Call Date: Tuesday, October 19, 2021
• Conference Call Time: 8:00PM ET

CSX (NASDAQ:CSX) (NASDAQ: CSX) is a transportation company that operates one of the largest rail networks in the eastern United States. Through its CSX Transportation subsidiary, the company provides rail freight transportation and logistics services for manufacturers, distributors, utilities, agricultural businesses and other commercial customers.

CSX transports a broad range of products, including chemicals, agricultural and food products, minerals, forest products, metals, automobiles and consumer goods. It also moves coal and other energy-related commodities, and provides intermodal services that combine rail transportation with trucking. The company supports its freight operations with terminals, transfer facilities and other logistics assets.

CSX’s rail network serves major population centers, industrial regions and ports across the eastern United States, with connections to parts of Canada and Mexico through partner railroads and intermodal networks. The company traces its history to the 1980 merger of Chessie System and Seaboard Coast Line Industries, which created CSX Corporation and brought together several major railroad systems.

CSX Q3 2021 Earnings Call Transcript

Key Takeaways

• In Q3, CSX delivered 24% revenue growth and 20% operating income growth year over year, achieving a record 56.4% operating ratio.
• Persistent supply chain disruptions—port congestion, equipment and labor shortages, and long lead times—drove CSX to add container yards, drayage services, automated equipment and network capacity investments.
• Despite streamlined recruiting and a 300% increase in the hiring pipeline, ongoing labor shortages and COVID-related absences limited headcount growth and constrained service fluidity.
• Coal revenue jumped 39% on 16% higher volumes supported by stronger utility demand and benchmark pricing, while intermodal revenue rose 14% despite domestic chassis and container shortages.
• Year-to-date free cash flow before dividends rose nearly 50% to $2.9 billion, enabling $2.3 billion in buybacks and $600 million in dividends, as CSX maintains double-digit revenue growth and high-end capex guidance.

Presentation

[Operator]

Good afternoon. My name is Emma, I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 2021 CSX Corporation Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Bill Slater, Head of Investor Relations, you may begin your conference.

[Bill Slater, Head of Investor Relations at CSX]

Thank you, and good afternoon, everyone. Joining me on today's call are Jim Foote, President and Chief Executive Officer, Kevin Boone, Executive Vice President of Sales and Marketing, Jamie Boychuk, Executive Vice President of Operations, and Sean Pelkey, Acting Chief Financial Officer. On slide two is our forward-looking disclosure, followed by our non-GAAP disclosure on slide three. With that, it's my pleasure to introduce President and Chief Executive Officer, Jim Foote.

[Jim Foote, President and CEO at CSX]

Great. Thanks, Bill, and thank you to all who are joining us today for the call. I want to begin by thanking all of CSX's employees for their extraordinary efforts to help our customers navigate the strained global supply chain. Across virtually every industry, there are challenges presented by extended lead times, port congestion, shortages of labor and key materials, and lack of storage capacity. While the current operating environment is challenging, we are not sitting idle. We are designing new solutions to help reduce congestion, adding container yards and drayage to keep intermodal terminals fluid. We are investing in both people and network capacity to ensure CSX is able to reliably meet customer needs today, and for years to come.

[Jim Foote, President and CEO at CSX]

In a few minutes, Kevin will go through the revenue numbers and discuss some of the steps we are taking to provide new service offerings to our customers to help them overcome these challenges. Jamie will provide an update of our hiring initiatives as well as actions we are taking to keep our network fluid. Let's first turn to the presentation and begin on slide four with an overview of our third quarter results. Operating income increased 26% to $1.44 billion. Earnings per share increased 34% to $0.43. The operating ratio improved by 50 basis points to 56.4. These figures include the results of Quality Carriers, which did not have a significant impact on operating income, but increased third quarter operating ratio by approximately 250 basis points, excluding transaction and integration expenses. I'll now kick it over to Kevin.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Thank you, Jim. Turning to slide five. Third quarter revenue increased 24% year-over-year, with growth across all major lines of business. The inclusion of Quality Carriers revenue represented roughly 8 percentage points of the total increase. Supply chain challenges, including a lack of labor and equipment, continue to impact almost every market we serve, driving volatility in freight flows and uneven volumes. Merchandise revenue increased 6% on 2% lower volumes, as higher revenue across all other markets was offset by declines in auto, driven by the ongoing semiconductor shortages. The industrial and construction-related markets, such as metals and equipment, forest products, and minerals, all showed strong year-over-year volume growth. In addition, our core chemicals business grew, but was partially offset by declines in crude oil and other energy-related markets.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Intermodal revenue increased 14% on 4% higher volumes due to increased international shipments as a result of strong demand, inventory replenishment, and growth in rail volumes from East Coast ports. The domestic side was more challenged, as multiple supply-side constraints, including container and chassis shortages, have resulted in the inability to meet the strong demand. Coal revenue increased 39% on 16% higher volumes, with growth across all end markets. Export coal revenue increased from the combination of higher demand and higher export benchmark prices. Other revenue increased primarily due to higher intermodal storage and equipment usage due to the broader supply chain disruptions from truck driver shortages, chassis availability, and a lack of warehouse capacity. Turning to slide six. This is an extraordinary time. As customers and global supply chain face challenges we have never experienced before.

[Kevin Boone, EVP of Sales and Marketing at CSX]

From trucks to chassis, to ports to containers, lack of truck drivers to labor challenges at the warehouse and production facilities, we are seeing shortages everywhere. The entire CSX team has been highly focused on delivering new, innovative solutions and partnering with customers to address the supply chain challenges by driving more volume to the railroad. Across the network, we have accelerated investments to create new capacity. To address the truck driver shortages, we have added 13 new overflow container yards, implemented new steel wheel options for West Coast cargo, and added transload sites that offer customers additional options to move their freight at a lower cost. To address the port congestion and container shortages, we have added new solutions to accelerate repositioning of containers and utilized port-to-port lanes to alleviate marine terminal congestion.

[Kevin Boone, EVP of Sales and Marketing at CSX]

We are working closely with partners, including GPA, to utilize additional inland rail yards to help reduce congestion at the port. We have also been aggressively expanding our customer solutions team to further supplement the significant investments we are making in customer-facing technology. Our team is working diligently to create new solutions and options for shippers with supply chain disruptions unlikely to improve in the near term. Finally, we are starting to see early signs of customers making long-term investment decisions to reinvest in onshore production and supply chain solutions. To address these customer needs, we continue to develop and invest in new CSX Select Sites that offer a shovel-ready, CSX-served solution to meet customer requirements. With that, I will hand it over to Jamie to discuss operations.

[Jamie Boychuk, EVP of Operations at CSX]

Thank you, Kevin. As noted, our teams are working closely together to find new ways to overcome the supply chain disruptions and provide new solutions for our customers. In addition to the ongoing supply challenges, this past quarter was further impacted by a rise in COVID mark-offs due to the Delta variant. At peak, we had several hundred employees marked off, including regional concentrations, that required us to adjust our network plan in real time to get customers their freight. Despite these challenges, we were able to maintain network performance compared to the prior quarter, and we expect the initiatives we have underway to drive improved fluidity going forward. Kevin touched on many of the things we're doing to help reduce congestion at the ports and keep containers moving, and I want to thank my intermodal team for the exceptional work they are doing to accomplish these goals.

[Jamie Boychuk, EVP of Operations at CSX]

These efforts are highlighted by the nearly 90% intermodal trip plan compliance they continue to deliver in a challenging environment. We entered the year focused on hiring the people required to respond to the rising demand, and I'm proud of how our team has been able to think creatively and act decisively to overcome the challenges presented by the tight labor market. Over the course of the year, we have redesigned our recruiting process to eliminate unnecessary steps and significantly shorten the time from application to offer. We have also implemented new recruiting tools and referral programs that are improving our application through different conversion rates and better identifying highly qualified candidates. These efforts have successfully increased the size and frequency of our conductor classes and provided strong ongoing hire visibility by expanding our new hire pipeline almost 300% since July.

[Jamie Boychuk, EVP of Operations at CSX]

We are also increasing intermodal headcount and supplemental labor to keep the terminals fluid and allow us to continue moving containers for our customers. While these hiring initiatives are underway, we're taking steps to increase the availability of our existing team workforce. We have implemented new attendance-based initiative programs, which allow us to better utilize our existing headcount to move more freight for our customers. We are also making upgrades to our network to increase throughput and create additional capacity. We're installing more automated equipment at our hump yards. We are converting intermodal terminals to grounded facilities in order to increase capacity, and we are expanding our investment in autonomous cranes to increase intermodal terminal throughput. While we still have sufficient line of road capacity, we are strategically investing in growth by extending sidings in select locations across the network.

[Jamie Boychuk, EVP of Operations at CSX]

These siding investments will allow us to continue to refine our train plan and provide growth capacity for years to come. Every action we take is focused on network reliability. That begins and ends with running a balanced train plan to minimize delay and maximize network performance. Running a scheduled network ensures assets are in the right place at the right time. We will continue to maintain network balance and the principles of scheduled railroading as we add resources to meet current demand. These principles have allowed us to keep the intermodal network open and running well this year. We are focused on continuing the strong performance as we enter into peak season. Turning to slide eight.

[Jamie Boychuk, EVP of Operations at CSX]

Maintaining a safe operation is the foundation to the success of any other operating goal we want to pursue, and we remain committed to being the safest railroad. In the third quarter, personal injury rate improved sequentially, and ongoing safety initiatives also drove a decrease in injury severity. While train accident rate increased slightly from last quarter's record result, accidents rates have improved year-over-year. Focus for the remainder of the year will be critical rule compliance and reducing human factor accidents. We are leveraging the approximate 9,000 tablets distributed to field employees to more productively deliver these messages. Not only do the tablets allow real-time communication of key safety information, but we are also able to more effectively combine electronic and in-person communications to increase the impact of our training programs and drive lasting changes in the behavior that will better protect our employees.

[Jamie Boychuk, EVP of Operations at CSX]

I'll now turn the call over to Sean for the financials.

[Sean Pelkey, Acting CFO at CSX]

Thank you, Jamie, and good afternoon. Looking at the income statement on slide nine, operating income grew nearly $300 million or 26%. Revenue was up 24%, reflecting gains across all major markets, higher fuel prices, and the impact of Quality Carriers. The operating ratio of 56.4% is a third quarter record for CSX, as we focus on operating efficiently and growing the business. As a reminder, this includes an impact of approximately 250 basis points from the ongoing operations of quality. Looking below the line, interest and other expense was $16 million favorable to last year due to a lower weighted average coupon and lower average debt balances, as well as favorable pension impacts. Income tax expense was up on higher pre-tax earnings. The effective tax rate for the quarter was 24.3%.

[Sean Pelkey, Acting CFO at CSX]

Looking at expenses in more detail on the next slide, total costs increased $349 million or 23% in the quarter. Including transaction-related expenses, approximately $200 million of the increase was driven by Quality Carriers. Higher locomotive fuel prices were also a significant factor, up about $90 million versus last year. Partially offsetting these items, real estate gains were $56 million higher. Non-fuel inflation remained steady versus last quarter at around 3%. As I mentioned last time, we have some lagging contracts that may drive higher inflation going into next year. As Jamie discussed, we continue to focus on hiring and retaining train and engine employees. While headcount was roughly flat sequentially, excluding the addition of Quality Carriers, the conductor count was up and was offset by reductions in other areas of the business. As a result, we experienced $16 million more in hiring and retention costs versus last year.

[Sean Pelkey, Acting CFO at CSX]

You'll note that we have renamed the prior MS&O line to Purchased Services and Other. The base expenses are identical to the prior MS&O category, but the new description better reflects the costs in this line post-acquisition. Increased costs on this line reflect the addition of Quality, as well as higher intermodal terminal and locomotive expense. Depreciation was up on a higher asset base that also includes the acquisition impact. Finally, we are proud to report another all-time record for fuel efficiency in the quarter. This reflects continued focus and investment by CSX, demonstrating our commitment to sustainability and the ongoing environmental advantage of rail. Looking into the fourth quarter, we typically see a seasonal increase in operating expense due to weather, lower capitalized labor, as well as holidays and vacations.

[Sean Pelkey, Acting CFO at CSX]

That trend should continue this year, in addition to expected headwinds from higher incentive compensation and lower sequential gains on property sales in the fourth quarter. Peak season expenses are also likely to be higher than normal as a result of ongoing supply chain disruptions. Now, turning to cash flow on slide 11. With operating income up 34% on a year-to-date basis, free cash flow before dividends this year is $2.9 billion, up nearly 50%. Free cash flow conversion on net income is exceeding 100% year-to-date, and we expect it to remain near this level on a full year basis. The company's cash balance of $2.2 billion is beginning to normalize. The lower balance reflects the acquisition in the quarter and a step-up in distributions to shareholders. We expect cash to continue to normalize over time.

[Sean Pelkey, Acting CFO at CSX]

After fully funding capital investments in our core infrastructure, year-to-date shareholder returns have exceeded $2.9 billion, including approximately $2.3 billion in buybacks and over $600 million in dividends. We will continue to be balanced and opportunistic in our buyback approach. We remain committed to returning excess cash to our shareholders. With that, let me turn it back to Jim for his closing remarks.

[Jim Foote, President and CEO at CSX]

Great. Thank you, Sean. Concluding with slide 12, we are maintaining a full-year outlook for double-digit revenue growth before the impact from Quality Carriers. We expect capital expenditures to be at the top end of our initial $1.7 billion-$1.8 billion range due to materials cost inflation, the capacity investments we just reviewed, and the inclusion of Quality Carriers' capital spending. I'll conclude my remarks the same way I began. We are committed to helping our customers overcome the current supply chain challenges. As you heard today, our entire team is aligned around this goal, and we will continue to act. We have a strong hiring pipeline, and we will hire until we have staffed the network to match demand. We expect to hire above attrition throughout the rest of this year and into next year. Economic demand remains strong, and CSX will help customers capture that demand.

[Jim Foote, President and CEO at CSX]

Everything we do begins with a commitment to providing customers a high-quality service. We will build on the positive momentum from actions taken to date. We will continue putting resources in place to drive growth, and we will provide customers with creative new offerings that make CSX a more meaningful part of the customer supply chain. Back to you, Bill.

[Bill Slater, Head of Investor Relations at CSX]

Thank you, Jim. In the interest of time, I would ask everyone to please limit themselves to one question. With that, we will now take questions.

[Operator]

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Ken Hoexter. Your line is open.

[Ken Hoexter, Analyst at Bank of America]

Great. Good afternoon. Congrats on some really solid results in a tough environment. Great to see. Maybe just a follow-up, either Jim or Sean, just talking about your thoughts on pricing. I know you were kind of running through some of the categories there. Maybe how much you can still address and some of the opportunities to catch this rising market. Obviously, coal up 20%. It seems like you're touching some of that maybe even faster than thought, or there's different kind of moves. Maybe just delve into the pricing outlook. Thanks.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Hey, Ken, I'll take a shot at this. Kevin. I think it's clear that, cost inflation over the last year, expectations have risen and are rising in the next year. This is not surprising to our customers. They're facing the same cost inflation pressures that we see, and what we've strived to do is be transparent around that in our conversations with customers. Fourth quarter and first quarter are our heavy renewal periods for us, so we'll be having those discussions. The exciting part, though, as we get into a higher inflation environment, is really the value proposition we offer. When a customer is looking to offset some of that cost inflation, rail is such a great alternative to ship more of their volumes over to the rail.

[Kevin Boone, EVP of Sales and Marketing at CSX]

You add on top of that the persistent driver shortages that we're likely to see well into next year and probably the years ahead. The value proposition is there. On top of that, the environmental discussions that we're having increasingly with customers is really resonating with those. It's no surprise cost inflation is higher than what we saw last year. It'll be a higher cost inflation environment than what we've probably seen in the last number of years, and we've got to have conversations with our customers around that.

[Ken Hoexter, Analyst at Bank of America]

I guess Just to follow up, any detailed thoughts on kind of the trend of pure pricing, pace of acceleration, or any level of that detail?

[Kevin Boone, EVP of Sales and Marketing at CSX]

Well, we get to touch, as I mentioned, contracts into the fourth and first quarter. That's a heavy renewal period. We'll continue to have those discussions. I think I'll probably leave it at that.

[Ken Hoexter, Analyst at Bank of America]

All right. Thank you very much, Kevin.

[Operator]

Your next question comes from the line of Amit Mehrotra. Your line is unmuted.

[Amit Mehrotra, Analyst at Deutsche Bank]

Thank you, operator. Hi, everybody. Kevin, can you just update us on the Quality Carriers acquisition, the status of the revenue opportunity you're seeing converting some of those into chemical carloads, and just when we may see kind of a more meaningful uplift? Obviously, that's a great offset to intermodal carloads, which are growing. It seems like it's a great idiosyncratic opportunity, if you could just give us a little bit of update there. Any initial thoughts on margins or performance next year? Obviously, you've got a big pricing cycle ahead of you. Any willingness to opine about what the opportunity is from an OR perspective next year would be highly appreciated. Thanks.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Maybe I'll let Sean take the OR question, but I don't think we're giving guidance today on next year. On the Quality Carriers, as you'll remember, that really is focused on our chemical franchise, and the customer reception has been overwhelmingly positive in a market where supply is constrained. Our customers are looking for more options to move their freight. Randy and his team, combined with our TRANSFLO team, have found a number of options, and we're moving freight today. Now that we're doing it in a way where it's thoughtful and calculated, and that the customer's seeing a good service on that product, and we'll continue to build momentum in the market. I think everything that we thought before we made the acquisition is coming true.

[Kevin Boone, EVP of Sales and Marketing at CSX]

The only thing I will say is, from an equipment standpoint, obviously with things tight right now, the equipment backlog is going to take a little bit longer in the next year to really ramp that up when we think about some of the ISO Tank solutions that we're contemplating out there. Other than that, everything is full speed ahead. I would say there's customers that we believe would take a lot longer to adopt that have been first to adopt, which is exciting for us. Market leaders in the industry. Their adoption, I think, is going to really set the tone for this to really take off into the market.

[Kevin Boone, EVP of Sales and Marketing at CSX]

The other thing that I think is positive, it shows other partners that we have that we're capable of doing this, of using the TRANSFLO solution in unique ways. We don't always have to do it ourselves. We would love partners to continue to bring freight and through all of our different capabilities that we have. I think that momentum is starting to be seen in the market as well.

[Amit Mehrotra, Analyst at Deutsche Bank]

Sean, do you want to talk about the OR? Maybe you can offer guidance, but maybe another way to ask it is, there's obviously a lag on this coal revenue or coal opportunity. Just wondering, are we going to see more uplift in coal yields in the fourth quarter as some of that lag gets caught up? Just talk to us maybe about the cadence, if you don't want to answer the OR question next year.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Clearly on the export coal side, you've seen some favorability in the prices there, and as we mentioned before, our price is tied to the benchmarks, and you will see some favorability sequentially in the fourth quarter versus third quarter. It's a strong market. We continue to see favorability in the next year. How long it holds up at these levels? It probably won't hold here, but these are extremely elevated levels that will probably carry into next year and hopefully create some favorability there. Everybody's trying to produce more coal, and we're trying to move more of it today. At the mine, there's been some struggles here in the third quarter, as you could see, with some of the production hiccups that some of the producers have had.

[Kevin Boone, EVP of Sales and Marketing at CSX]

We're working through that as diligently as we can and really ramping up our ability to serve those customers.

[Amit Mehrotra, Analyst at Deutsche Bank]

Okay. Thank you very much. Appreciate the time.

[Operator]

Your next question comes from the line of Tom Wadewitz. Your line is unmuted.

[Tom Wadewitz, Analyst at UBS]

Yeah. Good afternoon. I think this is probably for you, Kevin, but maybe for others also. How do you think about the impact of capacity constraints on volumes? You think intermodal would've been meaningfully stronger? How much optimism do you have as you look forward that maybe into 2022, that capacity constraints get alleviated quickly? How does that kind of inform your perspective on growth looking to next year? Is it reasonable to expect easing of constraints and a pretty good acceleration? I guess it's primarily around intermodal, but you may have capacity constraints in other areas as well. Thank you.

[Jim Foote, President and CEO at CSX]

Hey, Tom. It's Jim. Let me take a shot. I would say, yeah, we're clearly constrained. There was more business out there this quarter. There has been more business out there throughout this year that we could not handle. The primary reason for that is our inability, like everyone else in the world right now, to ramp up our workforce, coming out of the steep declines of the early phases of the pandemic. As Jamie talked about, we are now starting to see the fruits of all of our hard work for the last nine months or more and are beginning to bring on more people and actually deploy those people into the field, so we're able to operate a little bit better.

[Jim Foote, President and CEO at CSX]

We fully expect that that trend will continue as we go forward, unless some other crazy curve ball gets thrown at us, and be in a much better position as we exit this year and move into next year and hopefully be able to take advantage of what seems to be a continuation of strong demand for transportation services into 2022, and now some people are even saying 2023.

[Tom Wadewitz, Analyst at UBS]

Do you think a lot of that's in your control, or is it hard to have visibility given the warehouse labor, drayage labor, other pieces?

[Jim Foote, President and CEO at CSX]

My first and number one priority is getting enough CSX employees in the trains, principally conductors on the train, so we can operate more fluidly and get back to some of the performance metrics that we were putting up pre-pandemic in the end of 2019 and the beginning of 2020. The fluidity, the dwell, the on-time performance, the customer service metrics that we put out there, the trip plan compliance numbers, those numbers are all down. It's principally a result of our having an extremely difficult time getting people to come to work for us. It's taken a complete, I would say, re-engineering of the hiring process, a complete review of everything that we do when we onboard employees for us to get to this point. This has been extremely difficult, and we're no different than every business, at least in the U.S.

[Jim Foote, President and CEO at CSX]

Every business, every hospital, every school, everybody is struggling with the same phenomena of trying to get people to come to work. I am confident that we have done everything we can do right now. Are seeing that numbers are increasing in terms of the number of employees that we can put into our training programs and begin to qualify them to go to work. Like I said, unless something else comes along that disrupts that process, I hope we're going to be in a lot better shape at the end of this year and the beginning of next year than we have been over the last nine months.

[Tom Wadewitz, Analyst at UBS]

Great. Thanks for the insights, Jim.

[Operator]

Your next question comes from the line of Justin Long.

[Justin Long, Analyst at Stephens]

Thanks, and good afternoon. Sean, I think you called out a few sequential headwinds to OpEx in the fourth quarter. I believe it was incentive comp, lower gains on sale, and then some peak season expense. Any way you can put a finer point around those three items to just help us understand the order of magnitude here in the next quarter?

[Sean Pelkey, Acting CFO at CSX]

Yeah. Thanks, Justin. You got the items right. Higher incentive comp, lower gains on property sales, and then just some additional costs related to the supply chain. If you put all those together, you're probably looking about a couple of pennies over and above what we would normally see from the third quarter to the fourth quarter.

[Justin Long, Analyst at Stephens]

Okay. Very helpful. Any thoughts on other revenue as well? I know it was pretty elevated and took a decent step up here sequentially ex Quality, thoughts on that into the fourth quarter and maybe into next year.

[Sean Pelkey, Acting CFO at CSX]

If you look just at the pure other revenue line, not considering the trucking revenue line, which trucking revenue should be pretty consistent quarter-to-quarter. Really the big driver, as Kevin said there, is the intermodal storage and premise use charges as well as demurrage. That's a direct result of what's going on in the supply chain that we've been talking about here. As things start to improve, the other revenue line will come down. Here we sit in October, we're probably in about the same place as we were in Q3, and we'll see where it goes from here.

[Justin Long, Analyst at Stephens]

Okay. I appreciate the time. Thanks.

[Operator]

Your next question comes from the line of Scott Group. Your line is open.

[Scott Group, Analyst at Wolfe Research]

Hey, thanks. Afternoon, guys. Just back on headcount. If you can get all the people that you'd like to get, I guess two thoughts. One, it sounds like you want to be above attrition directionally. What kind of percentage increases in headcount are you thinking about? Is there a way to think about if you add back 5% to headcount, what do you think that means to volume growth and things like that? Do you still think you can grow volume in excess of headcount? Just to understand the spreads there. Thanks. Thank you.

[Sean Pelkey, Acting CFO at CSX]

Yeah, Scott. What we're looking on a sequential basis is modest increases in headcount, right? We're bringing on, trying to fill classes of 40 every week, and then getting those folks trained up and out into the field, right? You're not going to see dramatic increases in headcount. I think it's also fair to assume that we've got capacity still on our existing trains and capacity on the network. We are hiring for growth, but it doesn't need to be one for one.

[Scott Group, Analyst at Wolfe Research]

Okay. I probably didn't ask that so well, but do you think next year's a year where you could grow volume in excess of headcount?

[Sean Pelkey, Acting CFO at CSX]

I don't see any reason why that wouldn't be the target.

[Scott Group, Analyst at Wolfe Research]

All right. Thank you, guys. Appreciate it.

[Sean Pelkey, Acting CFO at CSX]

Thank you.

[Operator]

Your next question comes from the line of Brandon Oglenski. Your line is open.

[Brandon Oglenski, Analyst at Barclays]

Hey, guys. It's Brandon. I just want to ask a quick one about the fourth quarter cost commentary. I don't know if this was directly asked, does that mean that it's going to be hard to show OR improvement in the near term? I guess longer term, if I can sneak a two-part question in. Kevin, what are some of the structural things that you think you can leverage with the headcount, kind of building off of Scott's question there?

[Sean Pelkey, Acting CFO at CSX]

Yeah. Just on the OR question, we're not going to give OR guidance, but I think it's fair to assume sequentially, given some of the cost pressures as well as just the normal seasonality, we'll probably see an OR that's a little bit higher in the fourth quarter than the third quarter.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Brandon, I guess the question was what can we do with more headcount?

[Brandon Oglenski, Analyst at Barclays]

Yeah.

[Kevin Boone, EVP of Sales and Marketing at CSX]

Strategically, we're going to move a lot more freight. When we talk to customers right now, they're looking for capacity, and they're trying to offset a lot of cost inflation, too. The environment couldn't be any better for us to go out and sell the product we have. We're going to move more freight, and we're going to get more wallet share with the customer. It's a perfect environment for us.

[Brandon Oglenski, Analyst at Barclays]

All right. Thanks, Kevin. Thanks, Sean.

[Operator]

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

[Brian Ossenbeck, Analyst at JPMorgan]

Hey, thanks for taking the question. Jim, I just wanted to ask a bigger picture question about just capacity and interplay with the regulators in D.C. We'll see what your peers put out there later this week and next week, but it looks like you have a lot of capacity solutions here that you're ramping up on your own. Do you think you need additional help on that for some of your supply chain partners? Maybe just some perspective on what you can do on your own versus what you sort of need help with. Just contrasting that with the, obviously, the big other revenue you just mentioned. Clearly, the demurrage is a cost for everybody at this point. There have been some fairly pointed comments out of the STB about growing and focusing maybe less on OR than on growth.

[Brian Ossenbeck, Analyst at JPMorgan]

Maybe you can address all that in terms of adding capacity, if you need help, and what the regulators you think will take away from all this. Thank you.

[Jim Foote, President and CEO at CSX]

I think Kevin did a very good job of outlining all of the activities that we've been undertaking here over the last six months or so to do on our own without any prodding to improve and increase capacity. We were way ahead of the curve in Chicago, the biggest terminal for us in terms of intermodal capacity, expanding our 59th Street facility. We bought that property two years ago. We had another yard right down the street which was ready to go, cranes available. We've always tried to be somewhat visionary in trying to determine where the growth would be and make sure that we were properly positioned. Some of these new initiatives, like Kevin talked about moving traffic inland from Savannah into a facility in Atlanta. We had a yard available there. Wasn't an intermodal yard. We created an intermodal yard.

[Jim Foote, President and CEO at CSX]

We're taking the steps that we think are appropriate and necessary in order to make sure that our railroad continues to operate more fluid and provide better service all the time. That's always been the case. That'll always be the case. Whether that's mainline track that moves merchandise business or whatever it is, we're always being thoughtful in our planning process to make sure that we have the capacity available to handle traffic growth as it comes on. The lucky fact is that we, over the last four years, by changing the methodologies we use to run the railroad, have freed up an enormous amount of capacity across the rail network just simply by running the trains in a more reliable and efficient manner. We don't need to make big investments in the railroad in order to handle future growth.

[Jim Foote, President and CEO at CSX]

We've got locomotives in storage. We're ready to go. Had thought, I believe it was on a year-end conference call in January where I called out the fact that we were going to be hiring. I fully believed, inasmuch as at that point in time, we had about 300 of our train and engine service employees off on COVID, that we would just simply do what we'd always done. We'd hire 500 employees. The 300 employees would come back from off sick, and we'd be rocking and rolling, and we'd be moving freight. No one ever gave me a heads up that says, oh, by the way, when you want to hire somebody, nobody's going to want to work for you. Plus, all the people that you had furloughed as the railroad, the traffic had declined so dramatically.

[Jim Foote, President and CEO at CSX]

It was so many more than was usual when we called them back and said, do you want to come back to work? They said, no, I've decided to go do something else. I've changed my lifestyle. I'm going to go enjoy the scenery on the Jersey Coast, or whatever it might be. This is not a phenomenon that is unique to CSX. This is a phenomenon that nobody saw coming. It is a phenomenon that everybody in the supply chain, whether you're a trucker, whether you're a steamship company, whether you're a port, whether you're a warehouse operator, whatever you do, this is a phenomenon that is impacting everyone, and everyone is trying to deal with what is now the new norm. We've had to change everything the way we think about it, but have done that. As we always do, we adapted.

[Jim Foote, President and CEO at CSX]

We recognized the situation, we adapted, and we made changes. That's why we're reasonably confident that we'll be in better shape as we move forward this year and in pretty good shape as we move into next year. I don't need any help from the government in order to figure out what I'm supposed to do. I just don't want to make sure the government does something that screws it up worse.

[Brian Ossenbeck, Analyst at JPMorgan]

Understood. Thanks, Jim. If I could sneak one quick one in. All the stuff on page six, do you think that would be permanent going into the future, these things you had pulled forward from prior plans? Do you think this is more of a case of reacting to kind of what we see here? Thank you.

[Jim Foote, President and CEO at CSX]

Well, I think what we're doing is we're responding to the situation. It's simple as that. We can think, we can plan, we can do all kinds of things. Unfortunately, I think we've had more black swan events in the last two years than most people would experience in a lifetime. As I said, what's the next thing? I started off my remarks saying how proud I was of our employees. All of this going on, all of these challenges, all of these changes, all of these demands, all of these people saying, first of all, geez, the entire supply chain issue was as a result of the railroads. Oh my God, the railroads have screwed this thing up. Well, as time went on, everybody figured out it's not really the railroads. We don't own the warehouses where this stuff goes.

[Jim Foote, President and CEO at CSX]

We don't have the trucks that bring it there. If I need to buy a truck and bring it there, I'll bring it there and I'll put the box in the warehouse parking lot. It'd be somebody else's problem. Most of the issues associated with everything that is talked about, the railroads are doing an extremely good job. Their employees have been critical workers throughout the entire pandemic, have been out there working, have not been home in the basement, have been complying with all the requirements and making sure that the economy keeps going. The railroad guys, not just CSX, but the entire railroad industry, has done a phenomenal job under unbelievably difficult circumstances.

[Brian Ossenbeck, Analyst at JPMorgan]

Thank you, Jim. Appreciate it.

[Operator]

Our next question comes from the line of Chris Wetherbee. Your line is open.

[Chris Wetherbee, Analyst at Citi]

Hey. Thanks. Good afternoon, guys. Jim, I think you mentioned on the call that the Quality impact is more than 200 basis points on the operating ratio, I guess it sort of struck me that you guys are running sort of the core rail business at an operating ratio I really haven't seen before. I guess in the context, I understand the pricing environment, particularly on the accessorial side, is certainly elevated, and that probably has some impact on how we should be thinking about operating ratio. Maybe big picture as we think forward, you are growing volume arguably better than your peers. Pricing is going to be a cycle here for a period of time, and you're talking about bringing some folks back, but service is good.

[Chris Wetherbee, Analyst at Citi]

Can we talk a little bit about maybe we need to think about a new way to think about OR over the long run? I guess I just want to make sure I understand what this business is capable of in terms of incremental margins and the ability to take on some of this new freight and these new opportunities, what seems to be very, very good margins going forward.

[Jim Foote, President and CEO at CSX]

Yep, you did the math. Yeah, that was excluding some of the transaction costs and some other things, too. It's pretty simple math. Yeah, the railroad is running efficiently. When we stretch, as Oliver said this a million times, it's not about OR. This is not about how low can we go? How many heads can we take out? When we run the railroad good, when we stretch, like we're doing right now, and the reason we're stretching is because we're trying every single hour of every single day to move our customers' freight. When you do that, and you focus on getting it there as quickly as you can and as efficiently as you can, it results in, unfortunately not a perfect service product, but a very good service product in difficult times. You do it efficiently.

[Jim Foote, President and CEO at CSX]

As a result of that, the score adds up that says, you got a low operating ratio. That's not the goal. That's just a result. Yeah, we rung up a pretty good number. I would have preferred to do a lot more business, as we said we could have. We try to do every single day. We try to move more freight. Kevin is out there right now constantly trying to figure out how he can provide solutions to our customers. Our goal here is to move more freight. That's what we do. We move freight. The more freight we move, the more revenue you pour in the top, the more efficiently you operate. It's simple as that. It's just math. You want to worry about what the operating ratio was?

[Jim Foote, President and CEO at CSX]

Think about what the operating ratio could be for the railroad industry if it were able to grow more than it's historically grown. You can start talking about what the operating ratios might be. Stop thinking about how much cost you can take out.

[Chris Wetherbee, Analyst at Citi]

Okay. That's a helpful color. Thanks very much. Appreciate it.

[Operator]

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

[Bascome Majors, Analyst at Susquehanna]

Yeah. Thanks for taking my question. Jim, as you alluded to earlier, you've been talking about hiring to support growth since January. Certainly doubled down on that in July, and it's been a big topic today. At this point, it doesn't feel like your U.S. competitors are talking as much about labor and some of the challenges there that they're having as you are today. Maybe while that's a messaging difference rather than a fundamental difference, you got a letter from the STB on Monday about CSX service specifically. Can you help us understand, is there something different with your situation with labor versus your other public peers in the U.S.? Is it a messaging difference? Just anything to help us unscramble this would be helpful. Thank you.

[Jim Foote, President and CEO at CSX]

Yeah, well, I'm trying to unscramble it for myself. Yeah. I've said from the very beginning of this year that we had a challenge in terms of hiring. We needed to hire. I thought we would be able to hire like we always had. We aren't able to hire like we always have. I've said that now for three quarters. Yet my metrics, as I've reported to the STB in terms of all of the railroads, whether it be velocity, whether it be Dwell, my service metrics are continuing to lead in most areas. The railroad here is still running better than most. During that period of time where we were finding out that a lot of people wanted to make career choices and leave the company that we hadn't expected, we were having the difficulties that everybody else was having, during that period of time.

[Jim Foote, President and CEO at CSX]

We were the epicenter of the world in terms of the pandemic here in Jacksonville. I think we got probably hit during that period of time a little more severely. The states of Florida, Georgia, Alabama, Louisiana, Tennessee, Mississippi, have had a little more rough time, and I'm not calling out any reasons why that might be. That's just the facts. While we have been saying publicly we are hiring as fast, aggressively, anyone right now that will want to come and work here during the midst of the worst of the pandemic in the world ongoing in our service territory. Yeah, guess what? I got a letter. Well, the STB takes in complaints from customers, and they relay them to me. We'll respond. They're just doing their job. We'll respond.

[Jim Foote, President and CEO at CSX]

I found it a little unfortunate that under the circumstances of everything we're doing, based upon what our overall service metrics show our performance to be, based upon how the STB measures us in terms of how we operate, that we got the letter. I'm a big boy, I've been around. We'll deal with it. We'll respond. We'll work with the regulator and our customers to try and address any customer issues. The letter's posted. If you can figure out who the customer is that's having a problem from the letter, I don't know why they just don't call me. I tell every customer I meet, I give them my business card, I give them my cell phone number. I say, if you got an issue, give me a call. Jamie Boychuk's the same way. I wish they'd just call me if there's a challenge.

[Bascome Majors, Analyst at Susquehanna]

Thanks for the candid response, Jim.

[Operator]

Your next call comes from the line of Jon Chappell. Your line is open.

[Jon Chappell, Analyst at Evercore ISI]

Good afternoon. The theme of the earnings season's been pricing power. Obviously there's things like accessorials that are helping intermodal, your whole core business has been kind of reset a bit higher on the revenue per carload front. The question is, what's the stickiness of some of these pricing increases that have gone in? Where does the total portfolio sit on a contractual basis as we think about maybe the ability to push pricing higher this quarter or two?

[Kevin Boone, EVP of Sales and Marketing at CSX]

Yeah. Look, I've gotten a couple pricing questions already. I'm going to stick to the script for the most part. It's a discussion we're having with our customers. We're being transparent around the cost pressures that we face, that we expect to cover those costs. We also want to talk about volume growth with our customers, wallet share, and all those other things. We do have parts of our business that you're well aware of, coal, which moves with the benchmark prices. We have seen some favorability there. We participate when our customers are participating in a good market, obviously when those markets come down, we participate on the other side as well. Intermodal businesses, some other parts of our business are tied directly to inflation metrics, those have moved up.

[Kevin Boone, EVP of Sales and Marketing at CSX]

We'll see some favorability in those parts of our business that are tied to those indices, and those will continue to probably flow through into the fourth quarter and the next year. We'll have some momentum there. Obviously this is probably our expectations for inflation in the next year are higher than the previous year, last year. We'll have those discussions and price accordingly. I'll probably leave it at that.

[Jon Chappell, Analyst at Evercore ISI]

Thanks, Kevin.

[Operator]

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

[Jason Seidl, Analyst at TD Cowen]

Thank you, operator. Afternoon, gentlemen. Congratulations on that impressive OR. I wanted to drill down a little bit on a comment you made about some onshoring production due to sort of supply chain issues. Is that sort of a one-off customer? Is this a trend you're seeing? Also, are you having customers coming to you telling you that they might change sort of how they run their inventories in the future?

[Kevin Boone, EVP of Sales and Marketing at CSX]

Absolutely. I can think of multiple industries right now, and you've seen some announcements from some large producers out there that are making incremental investments in U.S. production. I think they're looking at the volatility and how costly it is to get freight from overseas. Labor is less of a component in some of these production facilities than it's ever been, so that labor differential moving in here to U.S. just doesn't matter as much. It's more about having availability to the inventory, and the onshore phenomenon, I hope it has legs here.

[Kevin Boone, EVP of Sales and Marketing at CSX]

We're seeing the early signs of that. You've seen some big announcements. I hope we'll see some further announcements coming forward. We talked about this with the energy renaissance here a number of years ago when we had cheap energy with gas and oil and the fracking. That never materialized. I think this time, in my opinion, could be different. I think all the things are starting to align for our customers and others to reconsider where they want to have production and more balanced, so they don't run into the same issues that they're having currently.

[Jason Seidl, Analyst at TD Cowen]

In terms of total inventories carried, are you seeing a change there as well?

[Kevin Boone, EVP of Sales and Marketing at CSX]

I certainly think there's more customers are reevaluating forward-positioning inventory levels. We're having those discussions around our transload products. They don't need next-day shipping or things like that, but they're forward-positioning those things so they can make sure that their production facilities remain up and running. That's very important. All these factors are, I think, playing into investments that we'll see customers make over the next couple of years.

[Jason Seidl, Analyst at TD Cowen]

Kevin, I appreciate the color, and gentlemen, thanks for the time as always.

[Operator]

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

[Ben Nolan, Analyst at Stifel]

Hey, thanks guys, I appreciate you fitting me in here. We talked a lot about labor and some of the issues that are impacting there, but just thinking about maybe the opportunity to actually get a little bit more volume through, and specifically, we talked about coal, but curious what your customers are talking about with respect to further ramp-up there and also on the intermodal side, we've seen steamships diverting cargoes away from Savannah, for instance, to get into Jacksonville or other places on the East Coast, trying to fit more volume through the system. I guess the question is how capable are you of accommodating some of those things?

[Kevin Boone, EVP of Sales and Marketing at CSX]

Well, look, you've seen the East Coast ports outgrow the West Coast ports for the last number of years. That's going to continue ongoing. Savannah's making significant investments. All the ports that we operate into are making investments to be able to handle that. We're well-positioned, whether it's Savannah, Charleston, Jacksonville, Tampa, all of those locations are areas where we have the ability to serve. We're ready to take on that volume. We've made some investments. Our intermodal network continues to be the best network in the East operationally. There's no question around that. You just look at the service metrics, look at the growth. We've been able to handle that better than anybody else, and we'll continue to leverage that product into the market.

[Ben Nolan, Analyst at Stifel]

Sure. There's no near-term inhibitant to being able to put more volume through some of the network then, I guess is the question?

[Jim Foote, President and CEO at CSX]

We talked about all the capacity.

[Ben Nolan, Analyst at Stifel]

Yeah.

[Jim Foote, President and CEO at CSX]

Clearly, we have the rail capacity. We're well-positioned with all of the ports. Again, it's not just the international steamship companies that are coming. It's plastics, imports, exports. There's a lot of merchandise business, bulk business that we move through these ports as well. Yeah, we're working with them through the transload facilities, either our own facilities or partnering with people who are building big transload facilities along the coast to be able to handle the capacity. We clearly, as I said earlier, have 30% of room on the railroad to handle the traffic without making any more big investments.

[Ben Nolan, Analyst at Stifel]

All right. Thanks a lot, guys.

[Operator]

Our next question comes from the line of Jeff Kauffman. Your line is open.

[Jeff Kauffman, Analyst at Vertical Research]

Hey, thanks for squeezing me in, and congratulations. Just some questions for Kevin. I'm trying to get used to my model with Quality Carriers in it here. Your non-locomotive fuel expense was up about $38 million year-on-year. How much of that was attributable to the inclusion of Quality?

[Sean Pelkey, Acting CFO at CSX]

Just a little over $20 million.

[Jeff Kauffman, Analyst at Vertical Research]

Okay. Just one other net, the depreciation, that was up about $19 million sequentially. About how much of that would have been attributable to Quality?

[Sean Pelkey, Acting CFO at CSX]

Jeff, it's Sean again. Yeah, about half of that is related to Quality. We'll see that impact carry forward.

[Jeff Kauffman, Analyst at Vertical Research]

Okay. That's all I have. Congratulations. Terrific quarter. Thank you.

[Operator]

There are no further questions at this time, and this concludes today's conference call. Thank you for attending. You may now disconnect.

Participants

Executives

• Bill Slater, Head of Investor Relations
• Jamie Boychuk, EVP of Operations
• Jim Foote, President and CEO
• Kevin Boone, EVP of Sales and Marketing
• Sean Pelkey, Acting CFO

Analysts

• Amit Mehrotra, Analyst at Deutsche Bank
• Bascome Majors, Analyst at Susquehanna
• Ben Nolan, Analyst at Stifel
• Brandon Oglenski, Analyst at Barclays
• Brian Ossenbeck, Analyst at JPMorgan
• Chris Wetherbee, Analyst at Citi
• Jason Seidl, Analyst at TD Cowen
• Jeff Kauffman, Analyst at Vertical Research
• Jon Chappell, Analyst at Evercore ISI
• Justin Long, Analyst at Stephens
• Ken Hoexter, Analyst at Bank of America
• Scott Group, Analyst at Wolfe Research
• Tom Wadewitz, Analyst at UBS