Earnings Call Transcript
NORFOLK SOUTHERN CORP (NSC)
Earnings Call Transcript - NSC Q3 2022
Operator, Operator
Greetings and welcome to the Norfolk Southern Corporation Third Quarter 2022 Earnings Call. It's my pleasure to introduce Luke Nichols, Senior Director of Investor Relations. Thank you, Mr. Nichols. You may now begin.
Luke Nichols, Senior Director of Investor Relations
Thank you, and good morning, everyone. Please note that during today's call, we will make certain forward-looking statements which are subject to risks and uncertainties and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a full disclosure of those risks and uncertainties we view as most important. Our presentation slides are available at nscorp.com in the Investors section, along with our reconciliation of any non-GAAP measures used today to the comparable GAAP measures. A full transcript and download will be posted after the call. Turning to Slide 3, it's now my pleasure to introduce Norfolk Southern's President and Chief Executive Officer, Alan Shaw.
Alan Shaw, CEO
Good morning, everyone. Welcome to Norfolk Southern's Third Quarter 2022 Earnings Call. I'm joined today by Cindy Sanborn, Chief Operating Officer; Ed Elkins, Chief Marketing Officer; and Mark George, Chief Financial Officer. The Norfolk Southern team delivered strong financial results in the third quarter, achieving quarterly records for revenue, net income, and earnings per share. We also demonstrated our focus on productivity and efficiency with significant OR improvement, as Mark will describe in a moment. Thank you to all the men and women of Norfolk Southern for their remarkable work this quarter and throughout the year, proudly serving our customers and improving the quality of our product. We are qualifying conductors at a robust pace, executing and refining our TOP|SPG operating plan and further strengthening our leadership team and operations. The impact is evident across our network. We see improved operating metrics, such as higher train speeds and shorter dwells. We see improved customer-facing service metrics. We hear improved feedback from customers who are talking to us about adding business. Volume is the lagging indicator, and we are confident our broad and continuing service improvement will drive growth opportunities in the months ahead. Today, the NS team is providing better service, creating network capacity for growth and demonstrating the customer-centric operations-driven approach. That is the foundation of our success. During the quarter, we reached tentative agreements with the unions that represent our craft colleagues. This was a critical first step. The tentative agreements recognize the significant contributions of our people and keep them among the highest paid craft workers in any industry. In my continuing field visits with frontline railroaders and local supervisors, I've been able to express my appreciation for the vital work they do for Norfolk Southern, our customers, and the U.S. economy. Working on the railroad has always been a great opportunity to build a fulfilling career, and we want to keep it that way. In the final days of the cooling off period is the possibility of service disruption. We took a transparent no-surprises approach to communicating with our customers, which helped them make informed decisions about how to keep their goods and materials moving. This is an excellent illustration of what it means to be customer-centric. Even though it created a modest headwind on volume, as Ed will describe, we received positive feedback from many of our customers. We'll take that same no surprises approach every time because it's how we will deepen customer trust and enhance long-term value creation and growth. Now, I'll turn the discussion to Cindy for additional detail on our strong operating progress during the quarter.
Cynthia Sanborn, COO
Good morning. Turning to Slide 5, our resolve to improve service levels is paying off. During the quarter, we executed a smooth rollout of the latest evolution of our PSR-based operating plan, TOP|SPG, and ended the quarter with network velocity more than 20% improved from where it was entering the quarter. As a result, the service recovery glide path we charted earlier this year for the STB is trending well ahead of schedule. We have more improvements to make with progress being fueled by staffing initiatives, TOP|SPG and disciplined field execution. We are gaining momentum and will continue to drive to enhance our customer service and create capacity. Slide 6 highlights where we are with staffing levels of our transportation workforce. Our pipeline of trainees remains robust, and we have reached the waypoint target of approximately 7,300 qualified T&E staff a month ahead of schedule. This was accomplished through our innovative approach to recruiting and reinforces the advantage we have to recruit a high-quality craft workforce that takes pride in moving the economy forward. As you heard from Alan, we are pleased to have reached tentative agreements in the quarter to keep that workforce among the highest paid in the nation. Slide 7 continues the discussion on service improvements we are making. Last quarter, we shared with you the decision to adjust a couple of our existing major terminals from flat switching to humping. Those shifts went smoothly and are paying dividends today. We are leveraging a similar number of crew starts as we had entering this year inside our yards and terminals and are now moving cars more fluidly through those facilities. As a result, the railcar fleet is moving faster through our terminals. We're operating at high levels of productivity and creating capacity within our switching resources to drive further growth and productivity. As I said last quarter, we will remain flexible to most optimally manage assets, control costs, serve our customers and do so safely. Moving to Slide 8. GTMs were flat year-over-year, coupled with crew starts that were up 1%, produced flat train length and weight. We are very focused on the implementation of TOP|SPG in the quarter and are now poised for growth on our train network. Active Locomotives were up for the fourth consecutive quarter in support of service recovery. And I am pleased to say that as we regain fluidity over the last couple of months, Active Locomotives are trending down on both a sequential and year-over-year basis. The skill of our mechanical workforce, coupled with our DC to AC modernization strategy, allowed us to deploy search fleet capacities to support service recovery at historic levels of reliability. As I've discussed, we're continuing the modernization program in support of reliability and capacity in the future. Lastly, this marked our fourth consecutive quarter of fuel efficiency gains, again, due in part to our fleet investments along with shutdown compliance initiatives, augmented with enhanced communications technology and many more efforts. Slide 9 hits on a pillar of our digital strategy, Empower the Workforce, which crosses our entire operations group. Through Empower the Workforce, we provide mobile, self-service capabilities to our field forces and enable them to better manage their work with modern mobile applications. They are no longer tied to fixed base reporting and can input and retrieve information when they need it in modern, user-friendly mobile applications. We have a mobility group of technology specialists that are responsible for providing consistent, consumer-grade mobile applications to our transportation, engineering and mechanical forces. Whether it's an application for reporting railcar pickups and set-offs, obtaining track authority or recording bridge inspections, we are providing information where and when our employees need it in order to better manage their workday. To wrap up, Slide 10 is a snapshot of our progress on operating safely. We've been aggressively hiring and have a strong focus on equipping our workforce with the training and tools to perform safely and efficiently. I want to thank our entire workforce for their focus on the job at hand throughout the very dynamic third quarter. I am pleased with our progress, but we'll never be satisfied until we reach zero accidents and injuries. Thank you, and I will now turn the call over to Ed.
Ed Elkins, CFO
Thank you, Cindy, and good morning, everyone. All right. Turning to Slide 12, let's review our results for the third quarter where we achieved record quarterly results in several categories. Total revenue improved 17% year-over-year to $3.3 billion as fuel surcharge and favorable price conditions more than offset a 2% decline in volume. Most notably, revenue per unit, excluding fuel, increased significantly and established a new record in both our merchandise sector and for Norfolk Southern overall. These results reflect a strong price environment and the deliberate efforts of our commercial teams to pursue these opportunities. Before I comment on our individual business groups, I would like to address the impact of our collaborative mitigation efforts in response to a potential labor disruption this quarter. Coming out of August, we were encouraged by the upward trajectory of our volumes. As we move through September and concerns of a labor disruption grew stronger, we acted to guard against the potentially negative impacts on our customers and the communities that we serve in keeping with our no-surprises approach to customer engagement. We spoke with our customers early on about our plans to limit the risk of stranded, hazardous materials and security-sensitive freight like Intermodal by restricting service for these products. We estimate that this approach accounted for roughly 40% to 50% of the volume decline in the quarter or $20 million to $25 million in lost revenue, mostly in our Intermodal markets. Our goal as a customer-centric organization is to gain credibility as a transparent and trusted service provider so that our customers integrate NS further into their supply chain needs. We can only achieve that goal with proactive communication and planning that minimizes disruption. Our customers told us that they appreciated our industry-leading communication, and we're confident that our approach will deliver long-term value for Norfolk Southern, for our shareholders and for our customers. We are pleased that a labor disruption was avoided, and we remain committed to providing quality service that our customers can rely on for their supply chain needs. Now continuing to our business group's performance in the third quarter. Merchandise volume was down 2% year-over-year, driven by declines in our steel and ethanol markets that were partially offset by higher demand for sand and aggregates. With respect to steel, service challenges related to equipment availability negatively impacted our ability to meet demand. Ethanol shipments were also down as consumption of gasoline declined in the third quarter on a year-over-year basis. On the positive side, shipments of sand increased more than 43% year-over-year on higher demand related to the strong market for natural gas production. Aggregates were also up due to higher levels of construction activity. Merchandise revenue improved 13% year-over-year to a quarterly record of $1.9 billion on higher revenue from fuel surcharges and from price gains. Moving on to Intermodal, revenue improved 16% for the quarter despite a 5% decline in volume. Revenue per unit reached a record level this quarter, driven by higher revenue from fuel surcharge and price. Intermodal shipments continue to be pressured by supply chain congestion and equipment shortages. This temporary shift was felt most strongly in our domestic business, where volume was down 4% year-over-year. International Intermodal volume declines were driven primarily by car supply and private chassis shortages, both reducing customer demand for inland point Intermodal and limiting our ability to satisfy that demand. Lastly, coal market conditions were again favorable for us this quarter, enabling us to deliver 43% growth in revenue for the franchise from volume growth, price improvement and fuel surcharge revenue. Volume growth was led by shipments of utility coal that were up on higher demand spurred by high natural gas prices. Export coal volume was also up due to some carryover from the second quarter and generally improved coal supply. Coal volume growth was partially offset by year-over-year declines in coke shipments due to facility closures. Overall, our performance for the quarter reflects continued progress on our strategic plan to drive value for our customers and shareholders while simultaneously working to address pressures related to volume. Moving to our outlook for the remainder of the year on Slide 13. Our service is trending in the right direction, and we expect that to be a tailwind to volumes in the fourth quarter. Additionally, we're optimistic that consumer spending and manufacturing activity will support volumes for the remainder of the year. Those expectations are somewhat muted in light of looming recession risks and tightening financial conditions that are pressuring economic activity, especially in interest rate-sensitive markets like housing. Volume in our merchandise segment will benefit from growing activity in automotive markets, with U.S. light vehicle production currently expected to increase in the fourth quarter of '22 compared to 2021. Also contributing to growth will be new opportunities to move corn and other grains. Much of the Southeast corn crop is down significantly versus last year. This is likely to increase demand for Midwest-originated corn by rail. Since emerging from the pandemic low, manufacturing activity has been increasing at a steady rate. But we're beginning to see that growth level off, with forecasts calling for growth to moderate to 3% year-over-year in the fourth quarter. As the Fed tightens interest rates, mortgage rates have increased to levels that are cooling the housing market. This reduced demand affects several of our merchandise as well as Intermodal markets. Overall, we expect merchandise volumes to be relatively flat in the fourth quarter, with some upside potential as service continues to recover. Within Intermodal, our expectation is for volume to be down slightly year-over-year, with opportunities from easing terminal congestion and equipment supply being offset by expectations for weaker demand and a softening truck market. On the domestic side, national Intermodal volume trends are showing signs of slowing, suggesting weaker peak season demand. However, consumer spending, which has historically been a big driver of this market, is currently forecasted to hold steady through the end of the year, providing underlying support for our domestic Intermodal volumes. We continue to see volume opportunity for domestic Intermodal as our service recovers, and we expect customers to shift loads from the highway to rail as we intently focus on improving domestic Intermodal service. International Intermodal will continue to struggle with congestion and equipment supply, and we expect Intermodal storage charges to remain elevated as long as those issues continue. When supply chain congestion does ease, we expect to deliver additional international volume for customers as Inland Point Intermodal becomes more attractive. And finally, our expectations for coal are that volumes will continue to improve year-over-year in the fourth quarter, driven by strength in the markets for both utility and export coal. EIA's latest forecast is for natural gas prices to remain elevated through the end of the year. This will increase demand for coal as a competitive alternative. Seaborne coal prices are expected to remain at relatively high levels through the end of the year, indicating continued demand for U.S. coal abroad. We also anticipate increased coal supply in the fourth quarter, primarily for export, which will create opportunities for coal volume growth. To summarize, we have a number of uncertain market signals in front of us right now, but our focus remains on impacting the things that we can control to deliver quality service to our customers and increase value for our shareholders. Overall, we have a fantastic portfolio of customers. And as always, I want to take this opportunity to thank them for their business and for their ongoing partnership. I will now turn it over to Mark for an update on our financial results.
Mark George, CFO
Thank you, and good morning. Starting on Slide 15, Ed walked you through the drivers of our 17% growth in revenues. You'll see operating expense of $355 million or 21%, and that includes a $117 million true-up to our compensation accruals based on the terms of the tentative labor agreements. This resulted in the operating ratio increasing year-over-year to 62% for the quarter. Operating income grew $136 million or 12% despite that headwind. EPS was up 34% or $1.04, thanks to strong earnings growth coupled with share shrink, but also from an adjustment to income tax expense related to Pennsylvania's rate reduction that was enacted in the quarter. You will recall we did signal this in our second quarter earnings release. Let's take a moment on Slide 16 to drill specifically into the labor cost adjustments that we reported. As I mentioned, we increased our wage accruals by $117 million in Q3, with $88 million of that amount related to past periods and $29 million related specifically to Q3 2022. The columns represent the period in which the adjustments relate. These amounts, including the impact of the bonus payments, represent more than 2x what we had been assuming. We anticipate another $23 million of incremental expense in Q4, bringing the total amount for the year to $140 million, which represents as much as 110 basis points of headwind to the full year OR from what we had been expecting. It is also worth noting that there is an additional $50 million of incremental labor cost that will be capitalized into property additions this year. Now let's take a moment on Slide 17 to reconcile the drivers of OR and EPS since there are some movers in the quarter. The impact of the $88 million out-of-period wage accruals in Q3 was meaningful, representing a 270 basis point headwind to the OR and $0.28 on EPS. We did have a favorable legal settlement in the quarter that provided a $0.05 of help to EPS and 40 basis points of help on the OR. The favorable state tax rate change caused a $136 million reduction to our deferred tax liability, which equates to $0.58 of EPS lift. That leaves a core improvement in EPS of $0.69 and improvement in the operating ratio of 50 basis points, which, I'll point out, includes the absorption of 90 basis points of headwind from the $29 million in-period incremental labor cost adjustments that I spoke to on the prior slide. Moving now to Slide 18 and the changes in operating expenses of $355 million, which represents a 21% increase year-over-year. Fuel was the primary driver, up $175 million or 84% due almost entirely to price. But as Cindy noted, we did enjoy benefits associated with a 3% fuel efficiency improvement. Compensation and benefits are up 21% due to the elevated labor costs associated with the tentative agreements. Moving on, you'll see purchase services and rents collectively up $52 million. Inflation and slower network speed continue to drive up these two cost categories. Materials, claims, and other expenses were down 4% or $7 million year-over-year, helped in part from the $15 million favorable legal settlement in the other category. Turning now to Slide 19 for the P&L below operating income. Other income was an expense of $2 million in the quarter, $16 million unfavorable compared to last year, driven by losses on the company-owned life insurance investments due to negative equity and fixed income market returns in the quarter. While pretax income was up 11% in the quarter, net income was up 27% due to the 12.4% effective tax rate in the quarter, thanks to the benefit recorded from the state tax rate change. EPS was up 34%, greater than net income growth supported by our capital allocation strategy that includes share repurchases. Shifting to Slide 20. Cash from operations through nine months is up $111 million while property additions were higher by $257 million. As we discussed last quarter, I expect capital expenditures to be at the high end of the $1.8 billion to $1.9 billion guidance range, with materials inflation and now incremental wage inflation creating meaningful headwinds. Free cash flow conversion stands at 86%. Shareholder distributions have been strong this year with a 15% increase to our dividends plus continuing solid share repurchase activity. And with that, I'll hand back over to Alan.
Alan Shaw, CEO
Thank you, Mark. Noting the considerable changes that occurred in the third quarter, I'd like to update you on our outlook for the balance of 2022. As you'll see on Slide 21, based on the strong Q3 revenue performance, we now see full year revenue growth of 13% plus year-over-year. Ongoing strength in RPU driven by fuel surcharges and strong price gains are helping us overcome lagging volumes which, as Ed laid out, we expect to be flattish overall in Q4. Turning to the operating ratio, we are tracking to our previous guidance, excluding the impact from the tentative labor agreements. Mark laid out $140 million of incremental impact for the year, which is roughly 110 basis points of OR headwind. As such, we now expect the all-in OR for the full year to be roughly 62% based on our current assessment of the market. Since I became CEO in May, you have heard me speak to the strengths of our team and culture, our powerful network and the macroeconomic trends supporting highway-to-rail conversion. I have shared some thoughts on our customer-centric operations-driven approach and spoken to the bright future ahead for Norfolk Southern. I continue to be encouraged by my engagements with all of our team members and their commitment to serving our customers. As we approach our December 6 Investor Day, we are eager to share a more detailed view of our long-term strategy for value creation. We will now open the call to questions.
Operator, Operator
Our first question today will be from Justin Long with Stephens.
Justin Long, Analyst
Just to start on the 2022 guidance. If I look at what you're guiding for revenue and your commentary on volumes, it implies that yields will be down at a decent amount sequentially in the fourth quarter. So I was wondering if you could provide more color on that, specifically around coal RPU. And then maybe secondly, there have been a lot of inefficiencies in the network this year. Is there a way you can put a number on what that cost has been in 2022 as we think about service recovering and that potential future tailwind?
Alan Shaw, CEO
Yes, certainly. We see some potential headwinds in some of our markets moving into the fourth quarter, specifically energy, as you called out. And I'll let Ed talk about the projected impact on the top line.
Ed Elkins, CFO
Sure. We've seen how seaborne coal prices have fallen, but they have done a new floor and they remain at relatively high levels. On the utility side, we expect there's still a lot of demand out there for that. You factor in what's going on in Europe, and we feel pretty good on the utility side on the steam coal side. The met coal side is a different story. There's a lot of cross currents and headwinds, particularly from China that we see. Steel production in China remains muted, and the housing situation there, which consumes a tremendous amount of steel in that market, remains off kilter, so to speak. So we are more guarded about the met coal side of the business. Does that answer your question?
Alan Shaw, CEO
Well, and also, Ed, talk about your outlook for fuel surcharge revenue.
Ed Elkins, CFO
Yes. Fuel surcharge, when we look at the forward curves and we know we have a 2-month lag, we are expecting that there is a headwind. That's when we come into play in the fourth quarter.
Justin Long, Analyst
Okay. So it sounds like it's more a function of fuel and coal RPU versus any slowdown in core price.
Alan Shaw, CEO
That's right.
Ed Elkins, CFO
Yes, you've heard us talk about this before. We price to the value of our service in the market, and we're very diligent about that. We are confident with our commercial teams that we're identifying places where we're adding value. We had... we'll see RPU less fuel records in merchandise and overall this quarter, and we've had almost 6 years of revenue improvement or RPU improvement in Intermodal and almost 7 years on our merchandise side. That's through a lot of up and down cycles, freight recessions and freight boom times, and we've consistently been able to deliver. So we're very focused on that side of the business.
Alan Shaw, CEO
And as we price to the value of our product, the value of our product is improving.
Justin Long, Analyst
Got it. And maybe, Mark, on the network inefficiency cost question?
Mark George, CFO
Yes. Clearly, we're suffering incremental service costs related to where we are in our service product today. Honestly, it's at least $40 million a quarter, and those things are... they show up in comp and ben, it shows up in purchase services. And as things improve going into 2023, we'll start to see relief in the P&L there.
Operator, Operator
Our next question is from the line of Jordan Alliger with Goldman Sachs.
Jordan Alliger, Analyst
So you've talked about volumes and hopefully seeing some improvement there, but I'm just sort of curious when do we see these service metrics more fully translate to volume capability based on demand? And why has there been such a lag?
Alan Shaw, CEO
Jordan, as we noted, volume is a lag to service. We had seen a lot of improvement in our volume sequentially heading up to the potential work stoppage in mid-September. We're starting to see some improvements now.
Ed Elkins, CFO
Yes, I'll reiterate what I mentioned earlier; we felt we had significant momentum leading up to the strike potential. We have previously discussed the IPI issue impacting our railroad, which continues to affect volumes in the third quarter as our international customers opted for more port-to-port services, particularly on short-haul routes sensitive to spot truck rates. Our revenue per tonne in Intermodal dropped by 1% alongside a 5% decrease in volume, reinforcing that the challenges are most prominent in these short-haul routes. Some factors influencing these IPI decisions include ocean freight rates, which are returning to more normal levels. We serve a diverse range of international customers, and when we look back to pre-pandemic times, the IPI business played a key role in our customers' supply chains. As inland congestion alleviates, those supply chains are expected to normalize, and our customers have indicated they plan to increase their usage of IPI as this unfolds. We engage with our customers daily and are encouraged by the positive feedback we’re receiving. Customers are approaching us, recognizing improvements in our service and seeking to increase their volume on the railroad. For instance, in the agricultural markets, we've been able to engage in spot markets that were previously unavailable to us, thanks to new capacity and enhancements in our service. That serves as a clear example.
Operator, Operator
Our next question comes from the line of Chris Wetherbee with Citi.
Chris Wetherbee, Analyst
I guess we are seeing some warning signals in terms of economic factors, and I guess I just wanted to make sure I understood sort of how you guys are going to manage the network as you sort of potentially deal with those maybe in the first half of next year, maybe over the course of next year. You've got the service improvement underway. It looks like hiring is kind of where you need it to be. I guess how flexible can the network be through potential volume volatility as we kind of progress over the course of the next several quarters?
Alan Shaw, CEO
Chris, we are intently focused on continuing our service recovery. It is the value of our product. And as Ed noted, we price to the value of the product. And as our product value improves, we continue to see more volume and revenue opportunities for us. We're encouraged by the number of conductor trainees in our pipeline. Right now, it's about 950, which is, I think, pretty close to our high in 2022. And we are continuing to hire for some specific locations. As we've talked about, we have about 95 different true hiring locations. We're going to reassess our legacy assumptions on staffing, and we're not going to make any unilateral commitments on what we're going to do going forward. I will commit that we will be data-driven in our approach, and we're going to make decisions based on the long-term value creation, balancing service, cost control, and growth. Cindy, you're thinking about some specific opportunities to add more flexibility.
Cynthia Sanborn, COO
Yes. In the short term, we have training opportunities to replenish our locomotive engineer ranks, which were reduced to conductors. This will allow us to elevate them when necessary, as training an engineer takes longer than training a conductor. We will also enhance our Go Team membership, adding a few more people as part of our resiliency strategy. To improve conductor availability during the recent challenges, we've qualified them in a single segment where they will be working. Now, we need to qualify them in other segments from the same supply point. We have several actions planned to ensure we are prepared for any upturn. During this downturn, we will manage these opportunities, and as we enter an upturn, these resources will be available to us.
Christian Wetherbee, Analyst
Okay. That's helpful. And I guess, I think there's been some concern for the industry broadly that if we were to see maybe a more sudden drop-off in volume that the industry would be less sort of able to react as quickly as possible, sort of resulting potentially in worse decremental margins than we've seen in previous downturns. I think that sort of has something to do with furloughing employees, maybe a bit more aggressively in previous times. Any thoughts on whether you think that is a valid concern as we go into next year? Or are there enough levers that you have to pull to be able to offset that?
Cynthia Sanborn, COO
I believe the labor market has changed compared to the past, and our approach to recruiting is also different now. We understand the time it takes to train and hire new employees, and we are managing through 95 distinct hiring groups. It is crucial for us to navigate downturns effectively so that we are well-positioned for the eventual upturns, which is essential for our long-term growth. We have tools like managing attrition that can assist us if necessary, but it is also important that we maintain a strong hiring pipeline to manage any potential upturns. We aim to handle both sides effectively.
Operator, Operator
Our next question is from the line of Scott Group with Wolfe Research.
Scott Group, Analyst
Mark, you talked about at least $40 million a quarter of sort of network inefficiencies. I'm wondering how much of storage revenue, though, are we seeing per quarter? And what's a more normal number? So as service gets better, that $40 million of cost goes away, but maybe how much of this storage revenue goes? I'm just trying to understand the puts and takes.
Mark George, CFO
Yes. Scott, clearly, there is some storage revenue that helps mitigate that, the accessorial revenues that we talked to. And certainly, as service recovers, we'll start to see those accessorial revenues come down. Ed, I don't know if you want to talk about the pacing in which you see that...
Ed Elkins, CFO
Yes. No, earlier this year, we thought that the supply chains would unlock faster, and we would start to see that storage number come off as customers got more fluid into warehousing on the street. Frankly, that hadn't happened. If you look at many of our hinterland markets, particularly deeper into the Midwest, we continue to see the same issues that we saw earlier. So the storage number continues to remain elevated, and we expect right now that it's going to continue to be elevated in the fourth quarter. I think next year, we're hopeful that supply chains will unlock, and there'll be more opportunities move volume instead of storage.
Alan Shaw, CEO
And it's also true that while storage revenue is elevated, the year-over-year comps are slowing down.
Scott Group, Analyst
When considering the factors for next year, I believe it will likely be another good year for pricing and service improvements, although there is some uncertainty regarding volume and wage inflation. Do you think we have what it takes to start increasing margins again next year?
Mark George, CFO
Well, we're actually putting together the budget for '23 now, and there's a lot of big assumptions that have to be made. So we'll be back to you with '23 guidance. Certainly, that's our goal at this point in time. We've got to get inflation under control. We've got to try to get some offsets on the top line from that. How much volume we can get is going to be a big lever as well. So we'll come back to you with the '23 numbers.
Operator, Operator
Our next question comes from the line of Jason Seidl with Cowen.
Jason Seidl, Analyst
I wanted to look a little bit about Intermodal's growth rate and sort of how much do you think it's been impacted by, A, your service levels and, B, some of the labor issues that we saw last quarter. So in other words, what's a good economic base to look at '23 off of '22?
Alan Shaw, CEO
Intermodal is clearly a growth driver for us going forward. Ed, why don't you talk about how we're going to continue to leverage that unique franchise strength?
Ed Elkins, CFO
We believe that we have the strongest Intermodal franchise in North America. Our location is central to U.S. consumer markets and manufacturing, with excellent access to all East Coast ports and Western railroads. We engage with our customers daily, and they are investing in growth. Our channel partners are preparing to expand alongside Norfolk Southern as our service improves. As our service enhances, we create more opportunities for them to address ongoing supply chain challenges. We recognize the mixed signals present in the macroeconomic landscape. However, we are optimistic about the manufacturing sector, which showed promising results in September. While future orders seem to be a bit of a slowdown, we acknowledge the impact of rising interest rates and persistent inflation leading to some demand reduction. Nevertheless, we are confident that Intermodal remains a valuable option for our customers and channel partners to save on costs in a challenging inflationary environment by shifting freight from highways to railroads.
Alan Shaw, CEO
Jason, we're looking forward to sharing more of our long-term vision for value creation at our Investor Day in six weeks. And clearly, Intermodal is a key component of that.
Jason Seidl, Analyst
I am eager to hear your insights. I was just trying to estimate how much the growth points, service, labor issues, and equipment shortages may have cost you this year on a three-quarter basis so far.
Alan Shaw, CEO
Well, I think you nailed them all. And then I think you should also add in this IPI issue where the short-haul business from the ports is being trucked. Despite that and despite the fact that our Intermodal volumes were down by 1% in the quarter, as Ed noted, our revenue ton miles in Intermodal were up 5%.
Jason Seidl, Analyst
Got you. So you think that if we didn't have all these issues, you guys have positive volumes at least this year.
Alan Shaw, CEO
There's absolutely no doubt.
Jason Seidl, Analyst
Okay. Really quick, if I can get one more in. The tax benefit in the quarter, is there going to be an ongoing benefit that will impact your future tax rate?
Mark George, CFO
Pretty modest at the total level in any given quarter. It's kind of within that range that we guide. I don't think it's going to adjust the range, the effective tax rate that we guide.
Operator, Operator
Our next question is from the line of Tom Wadewitz with UBS.
Tom Wadewitz, Analyst
Yes. So I'll give you the two questions upfront. So the first one would just be on pricing. Mark, you talked about the big assumptions in the budget for 2023 that you need top line to offset some of the inflation. I wonder maybe for Ed, if you can just give some commentary on how sensitive you think prices in your book to a weaker truckload market and falling truckload contract rates. Can you accelerate pricing against that backdrop? Or is weaker truck something we should really be mindful of? And then the second one is just on volume. I think we've had this assessment that improving service that you're delivering more capacity would translate to stronger volume. It sounds like that's maybe not the case just because the markets are getting a bit weaker. So I don't know if that's right or if you still think there are segments that are going to see stronger volumes as you continue to improve the service.
Ed Elkins, CFO
Sure. Regarding revenue and pricing, we've been in daily discussions with our customers about pricing trends. We've consistently been successful in implementing price increases as we enhance the value offered to our customers, who are able to pass that on. Our service quality is improving, and our customers are confident that as we enhance our service, they can increase their volume on the railroad. This ultimately helps them save money over the long term. We set our prices based on market value. While there is a lot of fluctuation in the spot market, we remain focused on the long-term trends in contract rates, which our customers recognize. Could you please repeat your volume question?
Tom Wadewitz, Analyst
What are your thoughts on the potential weakness in the truck market? Should we be cautious about its impact on our pricing in 2023?
Alan Shaw, CEO
Our RTMs went up 5%.
Ed Elkins, CFO
Yes. I believe the macro economy will guide our economic trajectory. Our ability to maintain our pricing success stems from the value we provide to customers. A potential recession or downturn will influence the volume we can allocate to the railroad and the amount available. However, we are confident in our capabilities. On the volume front, I can assure you that we have a robust portfolio of customers who are committed to growth. We see this taking shape, and as the IPI situation normalizes, our customers will also find value in that market.
Operator, Operator
The next question will be coming from the line of Amit Mehrotra with Deutsche Bank.
Amit Mehrotra, Analyst
Mark, I wanted to clarify the guidance of 62% operating ratio, which I believe factors in the $88 million from prior period labor adjustments and $15 million in legal settlements. It seems like it would actually be around 61.5% if we consider those extraordinary items. Could you elaborate on that? The implied fourth quarter looks to be around 63% operating ratio to achieve that 61.5%. We haven't seen numbers this low or high since the fourth quarter of '19, and since then, yield has increased over 20% and revenue has risen over 10%. I'm trying to understand if my figures are accurate and why there would be such a decline despite the improvements we've observed in the business related to yield and service.
Mark George, CFO
Thanks, Amit. The guidance we provided of 62% for the full year includes both the retroactive wage adjustment and the ongoing wage adjustments. Essentially, the $140 million encompasses all the items we mentioned this quarter. I'm not aligning with your implied 63% for Q4. If you consider everything together, I think it should be in line with the full year number for Q4.
Amit Mehrotra, Analyst
Okay. Maybe I'll discuss that later. But I'm just considering that if you exclude the $88 million, you're really looking at something that isn't ongoing since that's from a prior period. So perhaps...
Mark George, CFO
Correct. Correct.
Operator, Operator
The next question comes from the line of Bascome Majors with Susquehanna.
Bascome Majors, Analyst
As we look ahead to next year and consider the visibility regarding union labor wage increases, could you discuss the potential for broader rail inflation or any context related to cost per employee that we should consider for modeling? Specifically, what type of labor cost inflation or overall costs do you anticipate in comparison to historical trends?
Mark George, CFO
So, if you look at our compensation per employee in the third quarter, excluding the retro wage adjustments, it averages about $34,250 for the quarter. I would suggest that you use the same figure for Q4, as that reflects the new rate considering the 7% wage increase that started in July. For 2023, we usually see a reset of payroll taxes in the first quarter, which will likely increase that figure by a couple of points, along with expectations for a higher bonus payout. Therefore, you can anticipate a one or two point increase moving into the first half of next year. In the second half, you'll see another wage increase due to our contractual agreements, which may add a few more points. Overall, I expect it to rise more than a few points, but we should see some cost relief as service improves and expenses related to overtime and training begin to decrease. My outlook would reflect a one or two point increase from the current level in the first half, followed by a few additional points in the second half.
Operator, Operator
The next question is from the line of Ben Nolan with Stifel.
Ben Nolan, Analyst
As I examine the service improvements in the fourth quarter, particularly regarding train speed and dwell times, I am interested in understanding how much of these enhancements can be attributed to being fully or appropriately staffed compared to other contributing factors.
Cynthia Sanborn, COO
Thanks for the question, Ben. I think hiring is a critical part of our service improvement efforts. We established a target of about 7,550 qualified T&Es by mid-2023, and we are ahead of that target as we approach November. It's important to note that this number is supported by 95 hiring locations, so while the total is significant, we also need to ensure we have staff in the right key locations. Additionally, the TOP|SPG operating plan initiative we've implemented has helped us create a more executable plan. This initiative has led to a thorough review of connection standards and our distributed power playbook, which has allowed us to recalibrate train meet. Consequently, as we progress, our operations are becoming increasingly fluid. Overall, I would say these two factors are the most significant contributors to our improvements.
Alan Shaw, CEO
Then recall that we implemented the first phase of TOP|SPG at the very end of the second quarter. And then in the third quarter, our train speeds increased by 20%. And as Cindy noted, it applies the principles of PSR, and it's really focused on balance, simplicity, and executability.
Operator, Operator
Our next question comes from the line of Jon Chappell with Evercore ISI.
Jon Chappell, Analyst
Cindy, sticking with some of the service questions and updates to issues from the recent past hasn't been much talk about chassis recently. Is that because the availability there has cleared up meaningfully? And how does that impact as you think about the excess equipment or the spare capacity on the network once you are appropriately resourced and the economic backdrop you're looking at for next year?
Alan Shaw, CEO
Ed, some of the chassis issues in the past have been our own. Some have been our customers. Could you cover that, please?
Ed Elkins, CFO
Sure. And we've been successful in getting a portion of our order online of our chassis, and we're seeing that help in terms of fluidity. I will tell you on the international side, there still remains a lot of shortages out there mostly because I believe those units are deployed on the street or at a warehouse. And it continues to be an issue on the international side of the business, particularly in these hinterland markets, as we talked about earlier. We deployed a number of countermeasures which includes some temporary storage facilities that we've been able to open to help accommodate our customers. But we will continue to look for additional fluidity going forward, particularly on the private chassis side.
Operator, Operator
Our next question comes from the line of Brandon Oglenski with Barclays.
Brandon Oglenski, Analyst
Look, I don't mean to be near term or quarterly focused here, but can we come back to the implied 4Q sequential on the operating ratio? Because, Mark, if I back out the $88 million of prior year accruals and maybe even the legal settlement, it still looks like you're guiding OR up maybe 400 to 500 basis points sequentially, which I think would be one of the worst outcomes if we go back in time for your company. So what are we missing on the cost side? Or is this really a deceleration on the revenue front that we should be thinking?
Mark George, CFO
Yes. I think the key point here is that it primarily revolves around top line performance. The expenses are mostly in alignment with the third quarter when you disregard the historical labor adjustments and the favorable legal item we mentioned. So, ultimately, this is more about the top line. Ed addressed the RPU forecasts we used for energy pricing, and we hope those are conservative and improve. However, it's less about costs and more about a slight slowdown.
Alan Shaw, CEO
Well, I want to clear up a point. There's nothing that we're looking at that suggests a 400 to 500 basis point decline or worsening of our OR in the fourth quarter. We don't see that math.
Ed Elkins, CFO
And our core pricing story remains absolutely intact.
Operator, Operator
Our next question is from the line of Walter Spracklin with RBC Capital Markets.
Walter Spracklin, Analyst
Just a quick housekeeping question on the tax rate. You mentioned that it's not changed. Are we in the 23.5%, 24% range. Is that right?
Mark George, CFO
Yes, for now, that reflects the implied guidance on the overall tax rate. This accounts for the federal rate of 21%, along with various state rates beyond just Pennsylvania where we operate. This raises the overall rate slightly. While Pennsylvania's rate decreases a bit, we still have to consider the tax obligations in other states we pay.
Walter Spracklin, Analyst
Got it. Perfect. Okay. And then my second question is about the carryover impacts, whether they are headwinds or tailwinds that could affect operating results going into 2023. One of your peers mentioned they initially set a target for the start of the year, but they could not meet it due to headwinds and indicated that this target is off the table for next year because of some of the carryovers. I’m not sure if Cindy is the best one to address this, but are there headwinds that could affect what you expected your operating results to be at the start of the year, which might prevent you from achieving the benefits that other industry peers are experiencing? Or is that situation unique to them? Do you believe there could be a significant improvement in your operating results since those headwinds won't be present going into 2023?
Alan Shaw, CEO
As I noted before, we're going to be more than happy to share our vision for long-term value creation at our Investor Day in about 6 weeks.
Operator, Operator
Our next question is coming from the line of Ken Hoexter with Bank of America.
Ken Hoexter, Analyst
So Alan, as you highlighted earlier, I thought that was an important point regarding furloughing and decrementals. This is probably one of the most discussed topics about the future of railroads: what will happen and whether the rails can be as variable as they have been. But I want to clarify—did I hear you correctly? Did you say that labor costs were double your target? That seems like a significant increase compared to the other rail gaps. Is there a specific reason for that? Additionally, regarding the TOP|SPG, what is the current issue? As you increase the number of employees, is it a matter of equipment chassis? Are you getting the humps back up to speed? What else needs to be addressed going forward to continue improving the service?
Mark George, CFO
Yes, Ken, I'll start on the labor costs. The PEB recommendations were higher than we expected. We provided clear details on how those increases were allocated, including the retro adjustments, and we indicated that we were accruing in line with historical increases, which is what we based our labor figures on before the PEB. So the adjustment is simply a matter of calculations. Please continue.
Alan Shaw, CEO
Let me talk about the service. We improved our train speed by 20% in the third quarter, and our service metrics are better than what we had projected to the Service Transportation Board earlier this year. Our service metrics and our service product are at a level, as Ed described, that's allowing us to participate in some lucrative spot opportunities that we didn't anticipate. We could participate in a couple of months ago. We made a lot of improvement. What we're allowed to do now because of the health of our network is narrow our focus a little bit more on some specific areas in which we need to continue to improve our service price. That's our focus. It's job priority #1 on Norfolk Southern.
Cynthia Sanborn, COO
And I would add on the SPG piece, Ken, that it's a consideration, refinement, simplification, all of those types of things. Again, it's a very PSR-oriented to making sure we get asset turns as we need to and be able to create fluidity that not only helps us from a cost perspective, but it's exactly what our customers need. So there's continuing work going on there as well.
Ken Hoexter, Analyst
Can I just ask a clarification? Mark, did you mention the headwind on the lost fuel surcharge for the fourth quarter was there? Or was it just we're going to have a headwind? I don't know if you'd put in on that.
Mark George, CFO
Actually, Ken, thanks for the opportunity to clear that up a little bit. That was another thing that's driving the fourth quarter operating ratio in the implied math, too, is fuel surcharge. The net fuel surcharge was actually a benefit here in the third quarter. And based on where fuel prices are going, it spins to become a headwind again just like it was in the first half.
Operator, Operator
Our next question is from the line of Ari Rosa with Credit Suisse.
Ari Rosa, Analyst
I wanted to begin with a philosophical question. Could you address how you are balancing the desire for volume growth against operating ratio improvement? For a long time, it seems the argument for NS has been that if we grow, we will outpace the industry, which might cause our operating ratios to lag behind our peers. Could you provide an update on how you are managing this tension? Additionally, we see that you are increasing headcount and resources, but you anticipate volume growth to be flat in the fourth quarter. Can you discuss this and the opportunity to align volume with these higher resource levels over time?
Alan Shaw, CEO
Yes. Ari, we firmly believe that service and margin improvement support each other. And frankly, you saw that in the third quarter. The service improved. Our margin improved versus the second quarter. With respect to fourth quarter volumes, just note that normal seasonality would suggest generally about a 5% decline in volume in the fourth quarter relative to the third. So as our service continues to improve, we believe we're going to outperform normal seasonality on our volumes. And longer term, our commitment is to industry competitive margins with above-market growth.
Ari Rosa, Analyst
Okay. That's helpful. And then just really quickly, Alan, you mentioned that you're getting increased inquiries from customers based on kind of some of these service improvements. I was hoping you could just add some color around where those inquiries are coming in, what's the nature of those inquiries. Again, it's a little difficult to reconcile with the notion of volume growth maybe being a little bit flat or at least as implied by the guide. Just maybe give us some color around the nature of those conversations with customers.
Alan Shaw, CEO
Ed, you're talking to our customers every day, as am I, but you're certainly much closer to this.
Ed Elkins, CFO
Yes. Overall sentiment from our customers is that things have improved, and we're continuing to move in the right direction. We're hearing that every day from a range with customers. One thing that we're certain about is as we increase train speed and reduce the amount of dwell, we're going to have more capacity to deliver value to our customers, and we're hearing that from them. I'll use the ag markets as an example on the bulk side where we are seeing customers come to us and come to us with spot opportunities that we probably wouldn't have been able to execute on in prior periods, but we're able to now. And so we're diligently looking at these opportunities, and it really means looking at opportunities where we can be successful and add value. There are several of those on the bulk side, and we'll continue to look for them.
Operator, Operator
This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.