Good morning and welcome to the Kansas City Southern Second Quarter 2021 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask Please note this event is being recorded. It is now my pleasure to introduce you to Ashley Thorne, Vice President, Investor Relations for Kansas City Southern.
Thank you, Jason. Good morning and thank you for joining Kansas City Southern's 2nd quarter 2021 earnings call. Before we begin, I want to remind you that this presentation contains Statements within the meaning of the Securities Exchange Act as amended. Actual results could materially differ from those anticipated by such Forward looking statements as a result of a number of factors or combination of factors, including, but not limited to, the risks identified in our annual report on Form 10 ks for the year ended December 31, 2020 and in other reports filed by us with the SEC. Forward looking Statements reflect the information only as of the date they are made.
KCS does not undertake any obligation to update any forward looking statements to And with that, it is now my pleasure to introduce Kansas City Southern's President and CEO, Pat Ottensmeier.
Okay. Thank you, Ashley, and good morning, everyone. Thank you for joining us for our Q2 2021 earnings presentation. I'll start on Slide 4. We're going to change the format a bit this morning and Mike Upchurch And I will go through a brief presentation.
I'm told that this is a record for us in terms of brevity of our formal Remarks, but given the assumption that there will likely be a lot of questions related to matters Other than our quarterly earnings, we're going to change the format, go through the prepared material Fairly quickly and expand the time for Q and A. The only other comment that I'll make on this The slide is we have included Adam Goddard. Adam is our Chief Legal Officer, given the fact that we have a proxy statement out And shareholders' meeting set for August 19, ask Adam to join us in the event there are any technical or specific questions related Moving on to Slide 5, I am going to start with 3 slides just to touch on and speak about the proposed merger with Canadian National. Obviously, most of you have heard this before, but given the timeline for events going forward, specifically The KSU Special Stockholders Meeting, which is now set for August 19, I wanted to And just a few minutes and reiterate some of the more significant characteristics and benefits of this transaction. So again, just looking at some of the highlighted comments here on this slide, we believe this is a pro competitive deal and will deliver more choices, more single line service options to shippers than exist currently.
There has been a commitment to keep all gateways open on commercially reasonable terms and provide greater price transparency, Specifically through Rule 11 rates to those gateways to satisfy any potential Competitive concerns that might arise. This merger, this combination is driven by growth and That is focused on consolidation or eliminating options or facilities. It is all about growth. And as you see in some of the appendix material, we have been blessed with a Very strong and widespread support for the merger, over 1700 close to 1800 letters now supporting the transaction. We are confident that the voting trust that we are proposing meets the STV Requirements for insulation from control and the public interest requirements and specifically the Financial viability of both Canadian National and KCS during the voting trust period.
Moving on to Slide 6, this is a very brief timeline path to completion. You can see the first items on the left are completed. The next milestone, as I mentioned a few minutes ago, is the August 19 special meeting of Kansas City Southern Stockholders And the proxy material has been circulated. We will fall back and refer to that proxy A statement on a number of questions and we'll be happy to explain anything that's in that proxy Further, as far as other milestones, these are really expectations. As you know, the Surface Transportation Board will take whatever time they need and we respect that requirement As far as the completion of their review and a determination regarding the voting trust, Our expectation is that, that will come in the second half of this year.
And then beyond that, again, it is our expectation That a decision on the merger would be the second half of twenty twenty two and of course the voting trust would remain in place until we have full SVB approval. And then wrapping up the merger discussion on Slide 7, Just reiterating again, this combination is pro competitive and we believe will yield significant public benefits. Some of those benefits are stated on this slide. I won't read them. And then importantly, the CN KCS filings on July 6 in response to Public comments and opposition to the merger, we think are very strong and powerful And are available on our website as well as the website for our transaction, which is connectedcontinent.com.
And the voting trust approval, which is the stage that we're in now, We are very confident that the voting trust satisfies the requirements for independence and And public interest and the financial viability of both CN and KCS Yes, during the voting trust period is assured. Moving on just to now to a few slides on the quarter. 2nd quarter revenue increased by 37% from the previous year. Gross ton miles up 30%, volumes up, I believe, 21%, I'm sorry, 31%. Obviously, the headline here is easy comps as a result The COVID collapse in business that occurred in the Q2 of 2020.
Our results were clouded by the accounting treatment of the $700,000,000 A termination fee for the Canadian Pacific transaction, Mike Upchurch will get into some of those details later. I would like to draw your attention for purposes of our really representation Our underlying performance to the adjusted numbers shown on this slide, 2nd quarter adjusted operating ratio of 61.4%, which was a 380 basis point improvement versus last year And adjusted diluted earnings per share of $2.06 which was a 79% improvement from last year, again, on an adjusted basis. Moving on to Slide 9, our outlook. There are a couple of changes To this slide from what you saw in January April, revenue growth, we're confirming our guidance from previous quarters of double digit revenue growth in 2021 for the full year. Operating ratio, we are Changing our full year operating ratio guidance to about 60%, approximately 60 percent for the full year.
That is revised from 57.5% guidance that we had provided earlier. The headlines to that revision are a number of factors that you all are very aware of in general. The chip shortages that have affected the auto industry and certainly our automotive business As has been affected by that, as evidences recently as earlier this week, we have been informed of 3 new planned plant outages in Mexico. Mike Nantz is here to answer any questions about Without that in greater detail, but as you all know that ship shortage that's really plagued many industries across North America has been
a bit of a moving target and
difficult to predict how long that's going to target and difficult to predict how long that's going to last. In addition to that, in our case, there have been Disruptions in the flow of refined products into Mexico due to some regulatory developments and other factors that are More unique to Kansas City Southern that have affected both our performance and our outlook for the full year Those developments have created some additional congestion in addition to other factors. So there is a bit of an increase in congestion related costs. And then in addition to those factors, the Extended impact on the expense side of our business related to the polar vortex and other delayed plant openings, all contribute to our revised guidance here in operating ratio for the full year And Mike Upchurch will provide more color regarding the path to our 2022 guidance in a few minutes. Earnings per share, we have made a slight revision to our guidance there for the full year at approximately $9 a share in 2021 Versus in the prior two quarters, our guidance was greater than $9 a share.
So a slight revision to That guide and then beyond that, our longer term EPS guidance as well as our capital expenditure and free cash flow guidance remains unchanged from the previous two quarters. Moving on to Slide 10, key operating metrics, which this chart had a little more green on it, but Again, there's some explanations that go behind the numbers. Looking at train velocity and terminal dwell, Those numbers are considerably below and worse than a year ago for the Q2. But remember, What had happened a year ago with the rapid Downturn in business volumes during the Q2 of 2020, a good way to think of that is There weren't many cars on the freeway at this time last year. So our speed and our dwell were at very high levels.
This year, our volumes recovered and we had other issues to deal with, including some of the Weather related issues and the regulatory developments in refined products that I mentioned a couple of minutes So our network was much busier and these statistics reflect a combination of those factors in the Q2 of 2020. I'll draw your attention to the 4 boxes in yellow at Bottom of this page that are highlighted and these are some of the things that we have done intentionally To support the service recovery as well as the increase in volume and outlook that we have for the rest of the year, We have proactively brought additional power online, leading to a 39% increase in active locomotives. We have also proactively added crew starts and hired additional crews in the transportation and mechanical areas, Leading to the year over year headcount increases that you see on this slide. Again, all of this is to support Our service recovery and to be prepared for volume growth we see for the rest of the year and beyond. And then finally on Slide 11, you can see the impact that some of those moves Have resulted in, in terms of the additional resources and other initiatives And the impact they're having on our most recent velocity and dwell trends, which are very encouraging, I called out a number of things on this slide, including the Monterrey team engagement effort And the Sanchez team engagement effort, I would encourage someone to ask a question of John Orr Later about what's behind that and some of the things that we are doing and John and his team are doing to really heighten the focus and accountability on our performance measures.
A lot of those are built around infrastructure and aligning processes, org structures and resources for a more precise service delivery product. So with that, I will turn the presentation over to Mike Upturk.
Thanks, Pat, and good morning, everyone. I'm going to start my comments on the quarter here. I'll cover revenue and volumes in a little bit more detail in the next Slide that you can see revenue grew 37% on 31% volume growth. Our reported operating ratio of 100 and 57.6 percent does include $721,000,000 of merger costs we incurred during the 2nd quarter, Including the break fee of $700,000,000 we paid when we officially terminated the merger agreement with Canadian Pacific on May 21. As you might remember, CN paid us $700,000,000 to reimburse us for this break fee, But because there are certain potential repayment obligations, we have recorded the CN reimbursement as a liability on the balance sheet.
Once shareholders vote for the merger, the break fee received from CN will no longer be reimbursable and accordingly, we would record to income The $700,000,000 reimbursement effectively offsetting the break fee that we paid to CP in the 2nd quarter. So you have the expense in the 2nd quarter, the offsetting income we would expect to be recorded in the 3rd quarter. And as Pat mentioned, our shareholder vote is currently August 19. Excluding merger costs, adjusted OR was 61.4%, A 380 basis point improvement over prior year. We did incur several headwinds during the quarter, which I will discuss in more detail on the expense slide, but generally included an approximately 200 basis point Headwinds from network congestion, including higher overtime and re crews, car hire increases from elongated cycle times and incremental costs from resources we put in place to improve our service and support our future growth.
We also recorded 120 basis point one time non recurring contract dispute during the quarter. Our reported diluted EPS was a loss of $4.17 However, adjusted For FX and the previously mentioned merger costs, our adjusted diluted earnings per share was $2.06 up 79% from a year ago. And then finally, we had about a 40 basis point headwind from fuel surcharge lag or price increases create a negative lag before we can recover those in our fuel surcharge So turning to the next slide, let me cover revenue. Revenue for the quarter was up 37% On a volume increase of 31%. Excluding fuel prices and foreign exchange, revenue was up 30%.
All business segments saw year over year volume and revenue growth. And let me address the negative mix you see in the revenue per unit table On the top right of this slide, we did see core pricing gains in the quarter. However, lower revenue per unit segments Like energy, saw growth rates creating higher growth rates creating some negative mix in the quarter. We've been very pleased with the revenue growth so far this year and our results continue to be on track with our guidance Established earlier this year, despite what happened with polar vortex in the Q1, The auto chip shortage that has severely impacted auto production across the entire globe And increased regulations in Mexico related to the importation of refined products. Our franchise has shown remarkable resiliency Despite some of these exogenous factors that have suppressed some of our growth potential, but again, we expect to lead the industry Growth during 2Q.
Cross border volumes grew 42% and revenues 53%. Star performers for us in cross border was intermodal growth revenue at 49% And Mexican Energy Reform grew 121%. Core pricing and contract renewals were essentially in line with 1st quarter, but we are clearly seeing inflationary pressures that will need to be addressed going forward. As we look into the back half of 'twenty one, we would expect the auto chip shortage to continue to negatively impact our growth With a strong bounce back late in the year and into 'twenty two as auto demand continues to be extremely high And dealer inventories at all time lows. We also begin shipping Western Canadian crude Into the new Port Arthur crew terminal in the second half of July and we would expect that terminal will gradually ramp up whereby we will be moving approximately 15 to 20 trains per month by the end of the third quarter, So a fairly rapid acceleration of volumes.
Turning to expenses on the next slide. Adjusted operating expenses increased 29%, some of that due to comps relating to the pandemic from a year ago As we saw significantly higher volumes, but we also saw higher fuel prices, foreign exchange impact And significant cost increases as a result of network congestion. As Pat mentioned, we're clearly not operating as well as we expect And saw productivity decline during the quarter as we in service new locomotives and added headcount to stabilize our service and prepare for what we believe to be substantial increases in volume starting here in the Q3. Key expense drivers were Fuel expense increased 19%, dollars 13,000,000 from volume and GTM increases, $16,000,000 increase to expense from foreign exchange, which of course is largely offset in revenue $10,000,000 from higher overtime and higher REIT crews as we deployed additional Transportation Resources to Stabilize Service. Headcount declined 1% year over year, but grew 2% sequentially, still well below the 5% sequential volume increase that we saw from 1Q to 2Q.
We also had a $9,000,000 expense from a one time contract dispute, dollars 6,000,000 increase in materials and parts Due to a larger locomotive fleet and the GTM growth that we saw year over year, dollars 6,000,000 in increased equipment rents, which is split roughly equally due to volume and car cycle times, $6,000,000 from wage and benefit inflation and $4,000,000 from higher year over year incentive comp due to the fact that we greatly reduced our incentive comp expense during the pandemic in 2Q a year ago. As we look into the second half, we do expect better productivity and we will be extremely focused on better execution The PSR principles Sami has instilled at KCS over the past 2 years. As a reminder, we have successfully reduced expenses By an annual run rate of approximately $150,000,000 going into 2022 As a result of these PSR initiatives and continue to target $250,000,000 run rate now by 2023. One cost increase to inform you about in the second half of twenty twenty one We've discussed this at length in prior quarters, but we do now expect an approximate $8,000,000 of incremental compensation expense related to the profit sharing from the passage of the labor reform in Mexico.
However, going into 2022, we would expect any expense increases associated with the new labor law to be negligible. So let me wrap up with a little perspective on our outlook for the rest of the year and 2022. We expect the demand environment to hold up quite well as key macroeconomic factors, Feedback from our customers and new business opportunities continue to give us confidence in delivering superior growth And that's despite all the challenges around the vortex and chip issues, etcetera, that we've mentioned. During the first half of the year, we had a couple of challenges, but essentially are on plan, on guidance with We provided early in the year and we think that that revenue outlook is certainly supportive of some of the Supply chain challenges we're seeing across the board and pent up demand that's being built for vehicles, appliances, household goods And a variety of raw materials as we look at a variety of economic factors going into the rest of the year and into 2022, We really believe we're going to see tremendous top line growth that we think going into 'twenty two will allow us to deliver Somewhere in the range of 150 to 200 basis point improvement to the operating ratio.
And then turning to cost side, we can clearly Execute better than we have and consistent with our PSR success in 2019 2020. We recently deployed some incremental resources, namely locomotives and transportation FTE to improve our network fluidity And prepare for continued growth in our business. This improvement in congestion Plus favorable expense comparisons relative to the unplanned costs around the Mexican labor reform And the one time contract dispute that I mentioned should allow us to achieve another 150 basis points to 200 basis points So, collectively, you'll see our guide continues to believe we've got some substantial opportunities to improve So with that, I'll turn the call back to Pat for final remarks.
Okay. Just a couple of comments before we open the line up For questions, we've got the as I mentioned, the entire executive team here happy to answer any questions about performance, our outlook for business, our outlook for operating efficiencies and those types of questions. Ashley advises me that we get a lot of questions about additional details, background and other things That we will not be able to answer the proxy statement is available And while we are happy to provide any clarification on certain things in the proxy leading up to the shareholder vote, But a lot of questions that I know are out there, we are just going to rely on the proxy disclosure So you might want to steer away from those kind of questions if you only have limited time. And then in that vein as well, I know there's a lot of question about the likelihood of various outcomes And responses from the STB, we will also not be in a position to But as I also mentioned, the SDB will take whatever time they deem is necessary to make a full and evaluation before making that decision and we're just not going to speculate on timing or outcomes beyond that.
So With those sort of warnings, I suppose, we'll happy to answer open the line up for questions.
We will now begin the question and answer session. Due to the number of participants On this morning's call, management will limit you to one question and one follow-up question. At this time, we will pause momentarily to assemble our roster. Our first question comes from Jon Chappell from Evercore ISI. Please go ahead.
Thank you. Good morning, everybody.
Good morning.
Maybe this doesn't matter in a month based on what the STB says, but if I can focus On the fundamentals and the operations, a little bit here. And maybe at Pat's encouragement, I'll go to Jon Orr first. There's a lot of optimism about the back half of the year in the guidance. I mean to get to the OR number for the full year, you need about 300 basis points improvement. To get to the EPS number, you need $5 after $4 in the first half of the year.
Yet, there's a lot of challenges still out there, whether The planned outages in the auto plants in Mexico, the reduction of flows in New Mexico, the refined products. Maybe speak to us a little bit about the Some of your KPIs and your service metrics that gives you the confidence that you'll have that fluidity and that service
Yes. Thank you. You're absolutely right. We have a lot of momentum and we have a lot of challenges, but this team It's certainly up to those challenges. I guess there's a couple of fronts.
1st and foremost is the field activity and the engagement in the field. And second is the network structure that and the organizational structure that's better aligned for process improvement and asset management and accountability. And that's what supports the effectiveness of our service, the use of our plant and the plan itself. And so as part of that, we have gone through a network reorganization with our network Vice President both accountable for the planned development and the planned execution. And we've in that, we've improved our service visibility and awareness at all levels, including the new delivery of asset levers that we can now see in order to create more resiliency and more precise fit for both our capacity and our resources.
So, it's sort of the it's the architecture that we've developed underneath our service plan to support it and create a balance of strategic and tactical deployment of assets. The velocity is one of the key drivers that everyone on the team, whether it's Mike Nats, Sami Famy or myself, Really focusing on a daily basis and that willingness to get into the weeds and drive performance with the team is It's showing the results. And if you look at where we see network performance improving and the impacts of the initiatives that are taking hold, Our velocity is improving. In fact, our velocity today is in line with the 3 to 4 year average, Taking the outlier of the comp of the COVID year out of the equation, US is recovering at a quicker pace. We are very comfortable at where the pace is and the Half were on and I see that returning to close to the challenging number of a COVID target through Q3.
Mexico velocity is showing the rate trends. We still have some headwinds with COVID recovery not being as complete as it is in the U. S. So, we still deal with those realities today. But with the initiatives that we focused in Monterrey and Sanchez, where we brought our Team engagement to bear, where it was we take an integrated multifunctional team to decongest Significant yards like Monterey, which is primarily a service yard, so that we can implement our View or implement better customer service and the effectiveness.
And not only do we roll up our sleeves and work 24 hours a day, 7 days a week to create a better plan and create better visibility, but we're also addressing The skills development of the local teams and the network support to build the organizational structure and create that better asset alignment and service visibility. And it comes down to the accountability that we're driving across All of our departments. In the case of Monterey and Sanchez, the heightened focus Drive how Mexico goes and drives our ability to cross border. One of the key indices that I really looked at was our green performance because it is really an end to end market for us. So a market segment that has handoffs with other railways, it spans most of the length of our network and it has a really good sense of where our end to end supply chain capability looks like.
Those numbers for grain in the last 2 months have picked up tremendously and we're Closing in on some record performance and even benchmarking against some of the best times from a capacity and fluidity perspective. So I would say it's the reorganization and the architecture that supports growth. It is the heightened accountability and visibility and leading indicators, the support and education of our frontline and entire management staff. And at the same time, we are underpinning everything with our safety values and our customer service values. So, that's what gives me a lot of confidence that we're on the right path and the leading indicators that we look at every day are pointing in that direction.
Hey, John, just real quickly. I mean, clearly, we have an assumption here we're going to work our way out of some of the congestion and lower our operating costs. But don't forget that the first half of the year was pretty challenging with polar vortex and chip issues and we're still sticking with our guidance for the Full year on the top line implying that we're going to have a really terrific back half of the year from a revenue perspective, Including new business from this Port Arthur crude terminal. So that top line is certainly going to help significantly here.
Right.
Super helpful answer, John. I almost feel bad asking a follow-up, but I know anyone else on this call would ask one. So, Mike, since I have you, you guys have been talking about The refined product opportunity in New Mexico and the huge numbers you put around it for quarter upon quarter, but now we have this new regulatory issue and The congestion it's causing, is there any way to frame either the lost revenue or the cost impact Of these regulatory issues in New Mexico and also kind of the duration, how long you think this lasts?
Well, I think it's a temporary situation, John. Let me kind of back up to the macro environment here. The bottom line is 2 thirds of Mexico's demand has to be imported and most of that's coming from the U. S. And there's nobody better positioned And Casey asked to bring that from the U.
S. Gulf Coast into Mexico. So that gives us a lot of confidence that this is So a great business for us. In fact, when you look at the share data, 3rd party's share of importation Total demand has actually increased from high teens to 25% this year. So there is more product being shipped by Companies like KCS.
And I think what's happening here, we've got kind of half of our business in unit trains, Half of it in manifest, it's the manifest side of this that the government is doing a little more sampling to make sure that products are getting labeled properly And it's created a little bit of a backlog. But just here recently, we cleared up a lot of that backlog working with the regulators down in And the demand dynamics are such that we think this is going to continue to be a really good business for us. So maybe just a short term dislocation versus any kind of permanent impact to that business for us.
Got it. Thank you, Mike. Thanks, John.
The next question comes from Amit Mehrotra from Deutsche Bank. Please go ahead.
Hey, thanks operator. Hi everybody. Pat, I just there's obviously a lot of headlines in the rail sector last couple of weeks around Regulatory and the Biden executive order, wondering what you can talk about that. I mean, they obviously mentioned consolidation, not specifically at least, But then also the idea of reciprocal switching, you've obviously had time to think about it and what the impact Your business and the industry as a whole, wondering if you can comment at all in terms of what you think the implications are, if any?
I'll do my best, but it's really sort of unclear. And if you think back last week, we had A headline based upon a rumor that came out a day before the executive order, which was pretty shocking to everyone. And then when we saw the details in the executive order, I think people calmed down quite a bit. One thing to remember, and I'm actually At the executive order here as I'm answering your question and I've highlighted a few things here. This is literally a guidance To the STB, the executive order includes language like the Chair of the Surface Transportation Board is encouraged To work with the rest of the Board to do the following, consider rulemaking on reciprocal switching, Consider rulemaking on other relevant matters of competitive access and then jumping ahead Specifically to mergers in the process of determining whether a merger acquisition or other transaction involving rail carriers is Fulfillment of other rules that are already existing.
I think if you look at the Half that has been laid out by the Canadian National using the current rules Of the STV for mergers and the languages in this executive order, one could conclude they are 1 and the same. So I don't think there's any different standard for evaluating a merger in the executive order That's inconsistent with what the current rules, the so called new rules of the FPD already involved. As it is always the case in situations like this, we really won't know Full impact on some of these things until time plays out. But we also know that the STV has a very Full backlog and docket of activities, including rules on reciprocal Switching that I think are going to be priorities of the STV in the near future In addition to the merger activity that they have on their plate, including ours.
Okay. Appreciate you answering that question. The follow-up for me, I guess, for Mike, I think you guys have done a phenomenal job over Last couple of years, I mean, you've knocked the cover off the ball operationally quarter after quarter. So I don't want to extrapolate too much from a 1 quarter blip, if you will, especially in the backdrop of the The congestion that we're in, but Mike, the incremental margin is assumed by your guidance Next year is like north of 80%, which is a huge number. I understand some of the cost items in the first half, particularly in the Q1.
But a lot of these things that you're expecting to revert is a little bit difficult to have a lot of visibility on. And so Why is 85% incrementals next year the right number given all that's going on today, especially all the resources that you're throwing at trying to Thanks a lot of the issues. If you can just help us get some comfort and confidence around how you're thinking about the framework for next year as implied by the guidance? Thank you.
Sure. Sure. I'll take a stab. And as I said in my prepared comments, we think we can get roughly half of this from the revenue Line and roughly half of it from the cost side. But if you think about just a really incredibly strong demand environment and all the Macroeconomic indicators, whether it's GDP or PMI or corporate investment, Industrial production, inventories being at all time lows give us a lot of confidence around the top line.
And At 2 thirds to 70 kind of percent incremental margins, you get a couple of 100 basis points out of that. So I think we feel pretty good about where we're at with demand and being able to deliver that. And then clearly, we need to Prove in the operating side of the house and that's costing us combined with fuel and congestion and Couple of these one time costs, couple of 100 basis points and you get rid of that and you see your way to I think Some really nice improvement in operating ratio year over year. So, yes, I realize It's a bit of a show me story. We're from Missouri, the show me state and we've got some credibility here from having delivered as you acknowledged Over the last few years and we'll get this thing back on track.
Got it. Okay, very good. Thank you very much. Have a great weekend everybody.
You too. Thank you.
The next question comes from Jason Seidl from Cowen. Please go ahead.
Thank you, operator. Pat, Mike, team, good morning, everybody. Two quick questions here. 1, in terms of pricing, it sounds like there were some clearly some pressures on the cost side that are Cause you to be more aggressive in the back half of the year. Should we expect higher contract renewals?
And how should we think about the Spread of those contract renewals in relationship to the rail cost inflation that you're going to see.
Well, I think generally, it's no surprise inflation is ticking up. And as contracts come up for renewal, we're going to have to Take that into consideration as we reprice that business. The good news is we've seen an environment where over the last few quarters, Price increases have roughly been the same. We've now got a step up in inflation, so we need to kind of deal with Going forward because our long term strategy has always been to price above the cost of inflation. But an interesting dynamic and even the Fed looking at their long term projections around inflation Would suggest inflation is going to come back down in 2022.
So there are interesting discussions with customers to have and We're going to do our best to continue to make sure we cover cost increases in our business here.
But in terms of the spread, Mike, do you think that that's going to change that much between your price increases and your costs?
Well, we're yes, yes, we've kind of moved away over the last year from giving specific numbers there. But clearly in the You would have seen a negative spread, but that doesn't mean over the course of the year as you go through Contract renewals that we can't keep that at a positive level.
Okay. Fair enough. My follow-up question is going to be looking at sort of the Margins on some of the types of business that sort of may have been deferred or may be coming online in the back half of the year because you guys are obviously looking for a strong rebound going forward.
Jason, you've been doing this for 25 years, right? We never talk about segment profitability.
I keep trying though. You can't blame a
girl. But no, I would tell you this, it probably wouldn't be surprising to see us miss our auto
Pardon me, ladies and gentlemen, we have reconnected with the speakers. Please go ahead.
All right. Jason, I think your question was around
segment
profitability. And I'm not exactly sure where we got dropped there, but I was just commenting, as we look into the back half of the year And going into 2022, segments like auto were probably going to be $50,000,000 short of our Original plans because of this chip issue, you're going to have the opportunity to make that up. And We're not going to go through segment by segment giving you the profitability there and whether that's accretive or not to our overall business. But I think you Generally, just assume continued strong demand that generates great incremental margins and that's really our focus is to continue to deliver that top line growth.
And so, Mike, that assumption is that, that $50,000,000 that was lost, that's just being pushed out that you're going to make up most of that in
Yes. Listen, I don't think anybody knows exactly when this chip shortage is going to be fully resolved. It's kind of an amazing issue. I read an article the other day that the total value of the chips for these cars are less than $1 But we can't get any, so you can't complete the production process of putting a vehicle together. You'd like to think this gets resolved fairly soon and we're being told by the OEMs despite some Incremental shutdowns here in the 3rd quarter that that issue will begin to subside in the 4th quarter And going into 2022, we're going to see really strong auto production, second, third shift.
Demand is incredibly high right now. I don't know if you've ever driven by a dealer lot lately, but you'll see more bare Asphalt than you will cars, it's pretty tough to order a car these days, long, long, weak times. And so the demand environment is pretty strong. We think this is going to begin to really deliver some outsized growth for us late in the year and into 2022.
I appreciate the updates and the knocking on wood that the supply chains get fixed there. Appreciate the time guys.
You bet.
Our next question comes from Justin Long from Stephens. Please go ahead.
Thanks and good morning. Just circling back to the service challenges that were faced in the quarter, how much of this would you say is related to issues that are Specific to your network, so refined products and some of the regulation there, the plant outages, Lazaro Versus a kind of broader rail network issue with some of your interchange traffic?
Yes, go ahead.
Yes. Well, some of the descriptions you had in your question, Justin, I think you answered that question where there are a number of issues that are on our network and particularly, But the conditions that are exist outside of that I think are more global issues where We have been very successful in, for example, finding new employees and hiring new employees. We've been very successful And recalling our furloughed employees that were furloughed in 2020 2021, where we see difficulty And some of the execution that creep into some of our performance like re crews and other things like that Are problematic across the entire employment base in the United States. Taxis and fuel trucks and other services that are happening across a lot of industries. But the performance issues that we're finding that are isolated onto our own network, we're addressing very well.
Oscar and the team, for example, on the refined fuel products, combined with Mike and the rest of the operating team, worked Tirelessly for 40 plus days to work with the officials in the United States in Mexico to resolve that. And As Mike said earlier in the call, we're breaking through that. We're doing as much as we can to support the customers in the auto business to be ready to service them as soon as those chips come or as they're moving equipment around in order to be prepared for that. So I would say there are a number of issues that are localized on our network that are a condition of the broader global issues on supply chain and for those that are really isolated to us, we're working As a team to resolve them as efficiently as possible and in fact some of our recoveries are disproportionately quicker than others. You look at even some of the improvements we're making on our intermodal velocity, intermodal supply chains in the U.
S. We're order of magnitude, some of our trip plans are in the plus 6 hours in the 95% range over the last 2 weeks, trending very well in recovery. So I think where we have network performance challenges that are isolated to our network, We're addressing them very aggressively and based on service and how this customer sees our service capacity and capability Where it's an outside influence, we're doing our best to mitigate those things. And in some cases, we as we said, we've gone a little long on our locomotives, Pre purchasing them in anticipation of problems in that supply chain Or locomotive availability as we see the growth across the whole transportation systems and Pre positioning employees in our critical areas, so that we know that the employment bases are going to be tough and going as aggressively as we can to hire a little bit long on that so that we're ready for that growth that's coming. I would say that that's my take on how we have kind of both a macro and a micro challenge And we are addressing both.
Okay. That's helpful. Thanks. And as my follow-up, I wanted to ask about the guidance. So Despite the change to the OR outlook, the EPS outlook was only tweaked this year.
The outlook for 2022 wasn't changed. So is the right read here that your revenue guidance has actually gotten a little bit better and that's offsetting a weaker margin outlook? Is there anything else, Mike, below the line that's influencing this?
You've got it exactly right. We're looking at revenues at the high end of our guide that we provided back in January. So that's certainly helping the flow through to net income and EPS. And just as a reminder for everyone, we've talked about this before. We have stopped our share repurchases, which was in our original guidance, but has kind of a limited impact on 2021.
And so as we kind of reset things at the end of the year for 2022 Going forward, that could potentially be a changing variable depending on where we're at with the merger, But you're spot on. It's better revenue.
Helpful. Thanks for the time.
You bet. The next question comes from Tom Wadewitz from UBS. Please go ahead.
Yes. Good morning. Pat, I know you gave us some kind of parameters about not asking certain things. I'm not sure if this fits into it or not, but I think it's more factual. Can you explain to us what happens if SCB says no to the voting trust And the merger deal doesn't expire until February.
So what's your obligation if they say no? And what What happens if
they
say no and your shareholders still vote in favor of the deal?
What happens if they say no and the shareholders that you're going to look at, the shareholder vote is going to whether it occurs Before or after the STB decision is going to be conditioned on a Closing into a voting trust. So the shareholder vote will assume that There will be a closing into the voting trust. And then your other question really is it's hard to answer because It will really it will be a decision on our part, our Board's part, On CN's part and including and taking into consideration all of the information that will be available at that Including any color or explanation from the STB as to what's behind their decision, including the possibility that there would be technical reasons. So remember that The CN original CN Voting Trust application was turned down or sent back on a technical matter because The fact that there wasn't a merger application associated with the voting trust application. I remind everyone of that just to make sure you remember that there are Any number of reasons and factors that we cannot begin to anticipate at this When as to what might be included in a vote in an STB decision and all of it has to be taken into consideration by our Board and certainly by
Okay. What about with respect to Break fees and other obligations, do you get out of some of the break fees if your shareholders approve The deal, I'm just trying to think about the obviously, there's a chance you can end up going down a different path and break So I just want to make sure I fully understand your obligations. If you continue to The deal doesn't expire until February, but it's possible STB could say no. So could you give a thought on that, just how break fees Would change in your obligations during that period?
Well, again, I'm not going to Speculate on the conditions and circumstances around STB decisions. I think the break fees, The mechanics of the break fees are pretty thoroughly detailed in the merger agreement, which is part of the proxy. So I will Fall back on my statement that I'll just refer to those documents.
Okay. So it sounds like it's just pretty unclear what happens and that's if the voting trust is rejected. Okay. Thanks for entertaining the questions.
Okay.
The next question comes from Chris Wetherbee from Citigroup. Please go ahead.
Yes, hey, thanks. Good morning, guys. Maybe just following along a little bit on the last line of questions. I don't know if the Board or you, Pat, have contemplated the prospects of potentially pursuing a merger without a voting trust. Is that simply just a no go as it Right now, is that something that would there could be circumstances that could lead to that being a potential option for you?
Well, Chris, I'm going to probably disappoint you with my answer, but we are totally focused on getting voting trust approval and think that we have a very strong case and application. And then beyond that, it really is It wouldn't be appropriate for me to comment on what the SPB is going to say and what our Board's response would be.
Okay. That's fair. And then when you think about the executive order, one of the things that we've been getting Customers and obviously you guys have had some struggles with some service here in the short term as you've acknowledged. How much of a remedy is service improvement you think to the potential regulatory scrutiny or maybe if there is incremental regulatory scrutiny coming from the executive order, I guess, is this something That is a little bit more controllable from your perspective in terms of improving service in the shorter term has the potential to put you on a stronger footing in terms of
I don't necessarily see them as being tied together. I know the SPB Before the executive order, has been very focused on service. They hold hearings. There's An advisory group of the SPB, it's called RSTAC. We have an employee of KCS who is on that Committee, over time, they have gone from probably monthly meetings to quarterly meetings Service levels were improved to weekly meetings and I think just recently they Scale that back a little bit, I believe, from weekly to monthly.
But that is an organization that is intended to be sort of a clearinghouse of information and feedback from shippers And Railroad and STB. So there's a very high level of interest and scrutiny from the STB On service levels, we have all received, I know you've seen this, all of the CEOs, all of the railroads have received Request from the SDB for comment, some detail about what we are doing to prepare for service recovery. Normally, these things, these letters come to us just prior to the seasonal peak, But this time they came to us a little bit early. So I see the STB's interest in service level Recovery and resource commitments as certainly predating the executive order And I know from just interactions that we've had with the STB, including comments that Chairman Overman has made publicly That will continue to be a very heightened focus. So we are taking those requests and that interest level very Seriously, as you can see from the materials that we presented, we have proactively brought back resources, we brought back We've got crews in training.
We think we are on a good path to make sure that we have adequate sources to complete our service recovery and handle our growth both in the U. S. And Mexico. So I would say We're taking those inquiries and the concern that the STB has over service very seriously and responding in ways that we think are necessary and appropriate and don't see the executive order as necessarily changing any of that.
Okay. That's helpful color. Thanks for the time. Appreciate
it. Thanks.
The next question comes from Ken Hoexter from Bank of America. Please go ahead.
Hey, great. Good morning. So Pat or maybe a question for Sami, but Union Pacific suspended international intermodal traffic for a week last night. I guess we've seen this before In El Paso, Phoenix, maybe the West Coast ports in the early to mid 2000s, after the mega mergers of the late '90s. What's your thought on the ability for Contagion on Some of the supply chain shortages, is there any impact to your network given the interaction with UP from Mexico?
And then just my follow on question, I'll throw them both at you, but maybe can you provide any details on that contract dispute?
Well, I'll take the first one. No,
the last one. And just to comment on the first part, Obviously, we can't comment on what's going on specifically at UP, but there's no doubt you used the word contagion. And there is the North American rail network is a network. And particularly given Our interdependence with other carriers and obviously elevated in cross order traffic. When other railroads have difficulty on their network, we feel it.
In a lot of cases, we help them. There are detour options and other things that we can do to serve our joint customers and That's very much the way we think of it is, particularly given the fact that we interchange so much traffic at the border with other carriers, these are joint Customers, we are not we have no nothing to gain from fully cooperating with The level of coordination and communication with the other carriers is very high. So On a very daily basis, we try to find ways to help each other to relieve congestion, to improve The utilization efficiency of assets and different gateways and different routes, but Particularly being among the smallest, it's hard for when the rest of the industry is tight and And struggling with service and capacity issues, we are definitely going to
notice it. And you know, Ken, this is Sami. A lot of the supply chain issues have been across the rail industry, the trucking industry, a lot of industries And a lot of it is bringing people back. And like we have been talking about congestion and all the rest of the year, The roller coaster of volume drops and increases, you go down about 30%, 40% This time last year, then you go up about 30%, 40% after and you have to bring people back. It's not a trivial exercise and trying to bring back also the assets like a lot of locomotives were stored.
We had to activate them. And when you look at the numbers, the GTMs as an example in Q2 compared to Q2 last year, they went up by 30%. The headcount in transportation went up by 8%. So 8% against 30% volume increase. The mechanical headcount went up by 3%.
So bringing people back is not a trivial exercise and it did for sure to some of this congestion. But at the same time, it does provide a nice productivity Because if you recall, when we said in PSR Phase 2, which was last year, we're very much oriented obviously towards making up for the lost revenue. And we said that in Phase 3, which is 2021, we don't want to lose all the gains that we made. So We did conserve a lot of the gains because the headcounts are not going up at the same level as the volume increases and the train lengths Did not go down very much. It went down by about 2%, which means that the train starts and all the rest.
We have conserved a lot of what we did last year. So The game really is how can you absorb the volumes, how can you improve the service, which was the thrust of Phase 1 of 2019 and we have done a lot of work in that area. We have each pushed the envelope on The local service and the industry jobs and the spotting and pulling percentages, which went up from like 70% to 87%. The game is how can you improve the service, absorb the volumes and still maintain some of the efficiency gains that we have done. We're talking about locomotives.
Actually, 69 locomotives are going to leave our network in the next 3 weeks. Leave the network, not go in storage. They are leaving the network Because a lot of the locomotives are actually demo locomotives that we're working on with a vendor. So the efficiency is still there, But at the same time, the service is primordial and this is really the balancing act that we are trying to do And this is a challenge to the supply chain to your question.
Sami, just to wrap up on that. Is it hard to get the employees In terms of the labor market right now for the rail network, for your network?
I would say that initially it was, A couple of months ago when we started the training classes, it was tough to get people back and actually approach even people that we had that we wanted to bring back And they said they are no longer interested. Obviously, a lot of the payments they have been receiving It became a hindrance, why come back when they were getting checks at home. So Initially, it was. Now recently, we have had much more success and we have I think we have about 140 people in classes, 40 of them now have marked up, meaning we can actually use them. So there is still 100 that are in the pipeline.
And when you talk about productivity and cost, well, you have 100 people here that have not gone into productive service yet, but they are counted in the headcount. So we say that the headcount is 8% higher, but It includes people who are still in training. One measure we use, I look at a lot is compared to pre pandemic, Not compared to Q2 last year, because Q2 last year, everything was not really where it is, where it needs to be. The crews right now are still 5% lower than pre pandemic and the volumes are 3% higher. The carloads are 3% higher.
So There is productivity happening and we are facing the challenges, but we are finding people now and We expect that in 2 to 3 months, we'll be completely back on track. And what John talked about, the velocity and the dwell, We have very, very clear plans now and we expect our velocity to go back up to 16, 17 miles per hour in the next, I would say, months or 2.
The next question comes from Allison Landry from Credit Suisse. Please go ahead.
Thanks. Good morning. Appreciate Excuse me, I'll just ask one, but I just wanted to go back to the topic of reciprocal switching, but sort of asking the question in a different way. Obviously, it's difficult to estimate the potential impact for the industry, never mind what actions the SCB might take down this path, if any. But Pat, I guess Is there an argument to be made that KCS would be less impacted on a relative basis versus some of your peers.
I'm just sort of thinking about the fact that you probably have less in the way of captive traffic, more interchanges, Etcetera. So, do you think that this is a fair way to think about it?
A fair way to think that KCS would be less Impacted? Yes. Right. It just really depends on what the rules are and Without knowing kind of specifically how because there are many different proposals, many different options for How reciprocal switching would be actually implemented? It's just impossible to know how it would impact us.
Allison, this is Mike. Obviously, half of our business is in Mexico, which wouldn't be impacted. So I think it's safe for you to conclude that, but what the impact is in the U. S. Relative to the others would be difficult to answer until we Really understood what specific proposal is.
Okay. Understood. I'll leave that one. Thank you.
Okay. Thanks, Austin.
The next question comes from Brian Ossenbeck from JPMorgan. Please go ahead.
Hey, good morning. Thanks for getting me on the call here at the end. I appreciate it. Two quick ones. One on the network performance chart.
If you could just give us an update on the 4 hour border window change going from 6 Before, how did that work? Was there any benefit improvement when you made that switch? And what's the visibility to going to maybe 2 or No more fluid border crossings. And then again back on the executive order, if you can just comment briefly on, I think Sami just mentioned it on spotting In polling, if we do get more data on 1st mile, last mile, how do you think we should interpret that? It's going to be sort of hard to put into context because every network It's different.
Are customers really asking for this level of disclosure? So maybe since I think we're going to hear more about that potentially in the future, Pat, if someone can give us some thoughts on first and final mile, that would be helpful. Thanks a lot.
As far as the 1st mile, last mile, I don't see any issue in giving numbers. Like I just gave some numbers, The numbers went from the 74% to 87%. Jean and the team have been Unbelievably focused. That exercise in Monterrey that John talked about was very intense and we have a lot of customers around the Monterrey area. And you can have the trip as fast as you can from origin to destination, but if you don't get it to the industry when they need it, then it doesn't make any difference.
So now we provide about 5.50 cars on a regular Base is reliable. Base is every single day in the Monterrey area. We spot 5.50 cars. And the other thing is supplying The empties also, which is another thing that is important. When a customer orders 50 empties that you give them 50 empties and you give them the right type of cars.
So that aspect has really, really improved and it's not mentioned in any of the slides here. So to your point, We should make that more public. As far as the windows, the 4 hour windows, that has been a great success And we worked actually hand in hand with Union Pacific on that because there are trains that go to UP from the bridge And now a train, instead of waiting 6 hours if you miss the window, you have to wait 6 hours for the next one. Now you wait only 4 hours if you miss. Now obviously, we don't want to miss at all if we can help it, but there There has been a nice improvement, but that improvement is all chained with the rest because it's a network.
Jean and the team did a lot of work in the Laredo yard, which has to receive the trains, okay, To plan ahead when the train arrives, so everything is ready. But the fact that now you send 4 hours' worth of trains to Coming from Mexico northbound is much better than sending to Laredo in one shot 6 hours' worth of trains. You don't flood the yard. So these are benefits and they are all coordinated with the rest of DRs on the other side of the border on the south side, Nuevo Laredo Sanchez and Monterrey and it all goes hand in hand and there is a white And there is a lot of good things that are going to happen. A lot of work was being done in yards That are not the best yards.
Like Nuevo Laredo is a very small yard. It was doing work for Sanchez, which is a very big yard. But Sanchez was affected by the refined products, okay, which grew by 100% from Q2 last year to Q2 this year. So All these things are connected, but to answer your main question, the bridge now the windows went from 6 And then the intention eventually is to go down to 0 hour windows and to build the second bridge, In which case, there are no windows at all and you go direction. Northbound goes and southbound goes at the same time without having any Sequencing between trains and that will do magic to the velocity of the KCS network because our cross border is what's growing the most.
Our cross border grew by 50% from Q2 last year to Q2 this year. And I think refined product across that is 100% increase, Right, Mike?
Yes. Yes, over that.
All right. Thank you, Sami.
The next question comes from Scott Group from Wolfe Research. Please go ahead.
Hey, thanks. Good morning, guys. So quickly, can I just clarify if for whatever reason the voting trust is blocked before August 19, does the shareholder vote still happen? And then The executive order focused a bunch on passenger service and Amtrak. Can you just talk about like how much Passenger service exposure you guys have and what you guys are planning there?
First answer, first question, yes. Shareholder vote will take place on August 19, if there is a decision prior to.
Yes.
We KCS Does not actually host any Amtrak. We have, I think, a couple of One location around St. Louis, technically Amtrak runs over our tracks, but we don't control it. We don't dispatch it. So we really have no relationship with Amtrak.
There has been Talk, obviously, from time to time with Amtrak and with other passenger And commuter metro type organizations to bring passenger service onto our network, But that's really the extent of our relationship with Amtrak. So we don't have a history with Amtrak. And if you are familiar with the Amtrak response, I think they talk about The Baton Rouge to New Orleans route that has been identified as a divestiture candidate, But there is no passenger service on that route today.
And by the way, Scott, there hasn't been passenger service on that in over 50 years. Okay. So Amtrak shouldn't be a big issue here. Just a real quick follow-up. If for whatever reason we don't get a Voting Trust decision by August 19, does the shareholder vote get delayed until there is a decision?
No. Again, as I mentioned earlier, the intention is that the shareholder vote would be subject to Shareholder approval would be subject to SDB approval for a voting trust. So if there is no decision, it would be our intention to proceed with the shareholder vote.
Okay. Thank you, guys. Appreciate the time.
You bet.
The next question comes from David Zaszoula from Barclays. Please go ahead.
Thanks for taking my question. I guess maybe for Mike, As you've had the opportunity to review some additional data with respect to potential additional traffic that you can convert Along CN line, KSU line, has that changed your opinion on the potential benefits of Converted traffic due to the merger?
Is that a question specific to the synergies?
I guess, I'm thinking more broadly on how much long term you think is convertible just as you
Yes. Well, I think CN has done a really good job of evaluating the various market opportunities that Present themselves to a combined company here. And we've done a terrific job growing our business over the years. I often use the cross border intermodal business at Laredo Depending on how you measure that, we think we have somewhere around 5% to 6% share, which that's interesting, but That's far short of the possibilities and the challenge that we've always had is we don't go to any interesting places in single line service. Not to say Kansas City is an interesting place, it is, but it's not a market like Cargo or Detroit or Toronto, which is the attraction of combining with CN and we think we can dramatically increase the share of that cross border business that is being moved by truck and move that business Off of the highway systems more environmentally friendly, we can establish premium intermodal service that we think will Compete very effectively with other modes of opportunities that are out there for shippers and provide a new Service at bottom line doesn't exist in the market today.
So I think that's a great example. And beyond that, we've looked at it segment by segment and There are tremendous opportunities for the 2 companies to provide new single line service that's pro competitive and offer shippers more options.
Thanks. And just noting your capital plan, At least the level has not changed. I guess, have you changed any composition of the capital plan In response to kind of preparing for the potential merger and maybe some additional growth or terminal facilities that You might want to put in place or is that kind of planning not kind of in pen yet?
Not really. I'd say we're executing against our plan. I mean, you always have some pluses and minuses and John was recently out on the railroad with his team and A few projects here and there. So you add a few, you take a few away, but generally, we're still on We don't see any reason why we would scale that back. We've got to continue to operate as an independent Company, obviously, both before voting trust closing and after voting trust closing and CN has offered us that opportunity in the merger agreement to spend more than what we've guided externally In the event that there are additional growth opportunities or projects that John's team needs to execute on.
So, yes, our plans have really not Changed and we've got lots of flexibility going forward under the merger agreement.
Thanks a lot.
You bet.
This concludes our question and answer session. I would like to turn the conference back over to Mr. Ottensmeier for any closing remarks.
Okay. Thank you all. Thank you for your questions. Obviously, a challenging environment for us as well as for Supply chains across North America and beyond, hopefully one of the things that you heard today is that We are very focused on improving our service and operational performance. We feel very confident about the growth opportunities They're in front of us and working very hard to realize those opportunities.
So thanks again for your attention and look forward
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.