Genesee & Wyoming's CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 1.14 | About: Genesee & (GWR)

Genesee & Wyoming Inc (NYSE:GWR)

Q1 2014 Earnings Conference Call

May 01, 2014 11:00 am ET

Executives

Matt Walsh - Senior Vice President-Corporate Development

Jack Hellmann - President, Chief Executive Officer, Director

T.J. Gallagher - Chief Financial Officer

Michael Miller - Chief Commercial Officer North America

David Brown - Chief Operating Officer

Analysts

Rob Salmon - Deutsche Bank

Allison Landry - Credit Suisse

Bill Greene - Morgan Stanley

Chris Wetherbee - Citi

Ivan Yi - Wolfe Research

Matt Elkott - Cowen and Company

Ken Hoexter - Bank of America Merrill Lynch

Justin Long - Stephens

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Genesee & Wyoming First Quarter 2014 Earnings Call. For the conference, all participants are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time. (Operator Instructions). As a reminder, today's call is being recorded.

With that being said, I will turn the conference now to Mr. Matt Walsh. Please go ahead, sir.

Matt Walsh

Thank you for joining us today on Genesee & Wyoming's Q1 2014 earnings call. Please note that we will be referring to a slide presentation during today's call. These slides are posted on the Investors page of our website, www.gwrr.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are likewise posted on the Investor’s page of our website.

We will start with the Safe Harbor statement and then proceed with the call. Some of the statements we will make during this call which represent our expectations or beliefs concerning future events are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which provides a Safe Harbor for such statements.

Our use of words such as estimate, anticipate, plan, believe, could, expect, targeting, budgeting or similar expressions are intended to identify these statements and are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations, including, but not limited to, factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission.

Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make will be realized. We do not undertake and expressly disclaim any duty to update any forward-looking statement whether as a result of new information, future events or otherwise, except as required by law, and you should recognize that this information is only accurate as of today’s date.

On the call today, we have two speakers: our President and CEO, Jack Hellmann and our CFO, T.J. Gallagher; as well as our Chief Operating Officer, David Brown and Chief Commercial Officer, Michael Miller.

I will now turn the call over to our President and CEO, Jack Hellmann.

Jack Hellmann

Thanks, Matt. Welcome to G&W's first quarter earnings call. As always, we will start our call this morning with safety. On Slide number 3, you will see that we completed the first quarter of 2014 with an FRA reportable index of 0.7 injuries per 200,000 man-hours.

Given the harsh winter conditions under which many of our employees were working, this was quite a good outcome. With better weather finally here, we are now focused on driving our safety results down to our 2014 target of 0.45.

Now, let's turn to Slide number 4, and the general overview of our first quarter. The main theme is that severe winter weather dominated our results. Four of our operating regions, Midwest, Ohio Valley, Northeast and Canada, which operate 45 short-line railroads, 4,800 miles of track and represents 35% of our total revenues were hit with a series of snowstorms as well as frigid temperatures.

To visualize what this meant to our operations, please turn to the photos on Slide number 5 for a moment. On the far left is our Midwest region, where the photo shows one of our railroads in Michigan. In some Michigan locations we received over 17 feet of snow this winter.

Next is our Ohio Valley region, where the photo shows one of our railroads that connects to Chicago, which had the coldest winter in 142 years and has been experiencing significant rail congestion. Next is our Northeast region, where the photo speaks for itself, extremely cold temperatures led to ice that created impassable conditions in several tunnels across one of our largest railroads.

Finally is our Canada region, where the definition of snow removal was redefined as snowfall and drifts were so significant that we had to use heavy equipment to create sufficient space to manually dig out trains. For a sense of scale, please look at the people in the photo.

Now, turning back to Slide number 4, the weather conditions affected us in two main ways. First was the immediate impact on our railroads. Transportation expense was high as our employees needed to work overtime to serve customers and many trains also had to be re-crewed as a result of delays further adding to transportation expense.

Fuel expense was also high due to heavy idling of locomotives to prevent engine damage in these temperatures that made auxiliary power units ineffective. Of course, snow removal expense for track and switches was extremely high due to consecutive snowstorms as well as blowing snow drifts, since snow never melted due to lower temperatures.

Keep in mind that keeping track clear is particularly difficult on low-density short lines and often requires a temporary shutdown of operations. After clearing our own rail lines, the second impact to us was congestion at connecting carriers who were also impacted by the severe weather. Keep in mind that 85% of our traffic in North America is interchanged with Class I railroads. For outbound cars, we had significant delays at interchange which increased our car hire as well as crewing expense. For inbound cars, we experienced delays as well as sharp reductions in car supply.

From a revenue standpoint, our best estimate is that we lost $15 million to $20 million of revenue in the first quarter. Some of the revenue loss was a result of our inability to provide local service. Some was because we didn’t receive railcars from the network, some was because customers lost confidence in the ability of the railroads to meet their inventory needs and some was because customers either shut down or scheduled planned maintenance due to the challenges of winter shipping. Some of our traffic was simply diverted to truck, so we believe this to be temporary.

Now, let's turn to Slide number 6, and quantify the revenue and expense impacts on the first quarter relative to our guidance. Overall, our revenue was $4 million lower than expected, while our adjusted operating income was $16 million lower than expected. Notably, our revenue mix was quite different than we anticipated, with some areas of strength such as overhead, Class I traffic in Missouri and export grain from Kansas, but this traffic was decisively offset by other areas of weakness caused by the weather. Keep in mind that our first quarter guidance for revenue and operating income already included the negative impact of winter weather in January and early February.

Turning to the bridge to guidance on Slide 6, North America weather resulted in approximately $12 million of lower operating income than guidance. That's the $5 million plus the $7 million on the table which reflects the fact that winter never relented throughout February and the first half of March.

Separately, we were also roughly $4 million below guidance on operating income in North America and Australia for non-weather related reasons. In North America, we had two major paper plants that took unscheduled maintenance outages in the Southeast and we had a forced majeure event affecting a take-or-pay contract in Marcellus Shale.

In Australia, intermodal was a bit weaker than we expected and our mix of grain was skewed towards lower margin short-haul traffic.

On Slide number 7, you will see the operating variances expressed in terms of earnings per share as well as the impact of a slightly higher tax rate and interest expense together creating a $0.20 shortfall from our February guidance. On one hand these results are disappointing compared to our expectations and are the largest variance that I can ever recall.

On the other hand, if you turn to Slide number 8, and focus on our adjusted diluted earnings per share of $0.70 and exclude the estimated weather impact, you would see a growth rate of around 18%, and if you exclude the weather and further adjusts for currency impact, you would see a growth rate over 24%. Having said that, weather volatility and currency fluctuations are facts of life, so their exclusion only helps you understand how we are thinking about the underlying business.

Now, I would like to turn to Slide number 9, G&W's five main priorities for 2014. First, is our safety target, where we remain focused on an index of 0.45. Second is our financial target where we previously had been targeting growth and pre-tax income of over 20%, excluding the RCP&E. However, as T.J. will review in a moment, we don't believe we will be able to recover the significant first quarter weather shortfall while we do expect to close on the RCP&E acquisition. As a result, our revised outlook for growth in pre-tax income in 2014, including the RCP&E is now approximately 15% which is underpinned by expected growth and pre-tax income of greater than 20% over the next nine months.

Our third priority is the successful integration of the RCP&E and we have a dedicated team devoted to that purpose. Forth, we are focused on obtaining an extension of the U.S. short-line tax credit which currently has strong bipartisan support with 242 co-sponsors or a majority in the house and 49 co-sponsors in the Senate. Fifth, we are actively engaged in multiple acquisitions and business development projects worldwide. In support of that effort, we are in the process of expanding and extending our senior credit facility, which should provide us with approximately $600 million of revolver capacity after closing the RCP&E.

With that I would now like to turn the call over to our Chief Financial Officer, T.J. Gallagher. T.J.?

T.J. Gallagher

Thanks, Jack. Good morning, everyone. I will start with Slide 10. Slide 10 shows a revenue bridge between the first quarter of 2013 and 2014. First quarter revenues were flat year-over-year as a $14.3 million increase in revenues or 3.8% was offset by the impact of the weaker Canadian and Australian dollars. In addition, we estimate that the winter weather in North America reduced our expected revenues in the first quarter by approximately $15 million to $20 million.

Moving to Slide 11, freight revenue. First quarter freight revenues increased to total of $6.6 million or 2.4%. Excluding FX, freight revenues were up $16.7 million or 6% on a combination of higher rate and volumes. We estimate that the winter weather reduced our expected freight revenues by between $12 and $17 million.

Let's move to a discussion of commodities on Slide 12. Our carloads were up around 4%, which was below our guidance of 5%, primarily due to the winter weather. Keep in mind also that the winter weather impacted commodities differently. As a result, mix of traffic in the first quarter was significantly affected as well.

As you may remember from our last earnings call, our original budget was a 10% increase in carloads, which we revised downwards in our Q1 guidance to 5%, due to weather and traffic in January and early February.

Now with that backdrop, here are the highlights. Agricultural products traffic was up 1,600 carloads or 3%, with traffic up both, in North America and Australia. Coal and coke traffic was up about 10,700 carloads or 14%, primarily due to higher steam coal demand in our Midwest and Ohio Valley regions. Metallic ores traffic was up 4,100 carloads or 27%, primarily due to higher volumes of iron ore in Australia.

Pulp and paper traffic was up 1,400 carloads or 4%, primarily due to stronger containerboard traffic in our Central and Ohio Valley regions. Minerals and stone traffic, down 1,200 carloads or 2%, primarily due to a shutdown of the customer in Australia, partially offset by higher salt volume in the U.S. Last, lumber and forest products traffic was down 1,100 carloads or 3%, due to a combination of extreme winter weather and lower log in lumber traffic in the Pacific Northwest.

Now, moving from freight volumes to freight pricing on Slide 13. Average revenues per carloads decreased 1.3%, excluding the impact of changes in the mix of commodities, changes in fuel surcharges as well as the depreciation of the Australian and Canadian dollars average revenue per carloads increased 2%, which was slightly higher than our expectation but on an entirely different mix due to weather.

Let's turn to Slide 14, to non-freight revenues. Non-freight revenues declined $5.3 million or 5.6%. In the quarter, there was a $2.9 million negative impact, due to FX, and a $3.9 million decrease in other non-freight revenues, which was primarily rail construction revenues from our Atlas subsidiary, partially offset by $1.5 million increase in switching revenues. The switching revenues increase was primarily due to the narrow gauge business in Australia. We estimate that the winter weather impact on non-freight revenues in the first quarter was approximately $2 million to $3 million.

Let’s move to Slide 15. Slide 15 shows the adjusted income from operations and operating ratio for the first quarter of 2013 and 2014. Jack has already provided the color on the weather impact to our expenses and we estimate that that impact on our operating ratio was up 400 to 500 basis points.

Now Slide 16, Australia results. Normalizing for FX, Australia revenue increased $10.7 million or about 16%, primarily due to expansion of our iron ore services and stronger intermodal traffic year-over-year. However, normalized operating income increased only $1.7 million, as the first quarter 2014 operating ratio increased to 74.9% compared with 71.7% last year.

To put these results into context, please note that our business in Australia is highly seasonal. The operating ratio is at its highest in Q1, during the Northern territory wet season, but improved throughout the year reaching its lowest point in the fourth quarter. We would normally expect an operating ratio of around 74% in the first quarter and an operating ratio and the high 60s in the latter part of the year. The increase in the operating ratio year-over-year reflects timing variances in both quarters.

For example, first quarter 2013 results benefited from a favorable timing variance of about $2 million for maintenance and equipment expense. In contrast, in the first quarter of 2014, we had a $1 million unfavorable timing variance for the same category of expense or a year-over-year variance of approximately $3 million. In addition, as we discussed earlier, we had an unfavorable mix of grain traffic in the first quarter of 2014, with relatively more shorter haul service.

Now moving to guidance on Slide 17, let me refer you to our earlier Safe Harbor statement that noted that these statements are subject to a variety of factors that could cause actual results to differ materially from our current expectations. These statements represent management’s expectations regarding future results as of today May 1, 2014 and we do not undertake any obligation to update this information.

Second quarter of 2014, we expect revenues in the range of $400 million to $410 million and an operating ratio of around 73%. We expect the carloads to increase between 3% and 4%. Net interest expense in the second quarter is expected to be approximately $13 million and we expect G&A of approximately $39 million. Our effective tax rate should be around 36% and diluted shares should be 57 million. The bottom line is that we are expecting second quarter diluted EPS between $1.5 and $1.15. Note that our second-quarter guidance excludes any impact from the RCP&E.

Moving to Slide 18, and our updated guidance for 2014, including and assuming six-month impact of the RCP&E, as well as the first quarter winter impact, we expect revenues in the range of $1.64 billion to $1.66 billion and operating ratio of around 74%, net interest expense of $52 million and a tax rate around 36%. Our reported diluted earnings per share are expected in a range of $4.15 to $4.35 with diluted shares outstanding of 57 million.

Let's move to Slide 19 for a list of key changes both, positive and negative that underpinned the changes in our guidance. We will start with the positives. First, the economy feels good and we had record carloads in late March and those carload levels have remained at those same levels throughout the month of April.

Second, we expect certain commodities such as coal and salt to benefit from extreme winter weather that resulted in much depleted inventory levels. Third, we expect the RCP&E acquisition to close in the second quarter and make a positive contribution. Finally, the Australian dollar has strengthened and is now around $0.93, up from $0.88 at the beginning of the year.

On the negative side, the impact of the severe winter was much worse than expected in our original guidance. Second, there remains lingering effects from Class I congestion, including shorter car supply, which we expect to impact our operations. Finally, fuel prices are a bit higher and we have some lag in fuel surcharge recovery.

Let me close with Slide 20. We continue to have a strong balance sheet. Also, in conjunction with the RCP&E transaction, we are expanding our credit facility and extending its maturity. We plan to fund the $210 million transaction with the term loan and to also increase the size of our revolver from $425 million to $625 million. Therefore in closing, we expect to have approximately $600 million of [capacity] available to fund future potential acquisitions.

With that I will open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go to the line of Rob Salmon with Deutsche Bank. Please go ahead.

Rob Salmon - Deutsche Bank

Good morning, guys.

Jack Hellmann

Good morning, Rob.

Rob Salmon - Deutsche Bank

I guess, T.J. or Jack, there was a press release out earlier in the week about the Atlas reorganization. Can you talk a little bit about how we should be thinking about this kind of aiding G&W's industrial development efforts and if we should be thinking about any sort of cost impact in the second quarter related to that re-org?

Jack Hellmann

Yes. Sure. The reorganization of Atlas is purely an expansion of our enhanced industrial development strategy and seeking to provide customers with the option of us not just building new rails first, but also operating with our Atlas subsidiary but also operating them with our Rail Link switching subsidiary and basically giving a complete turnkey service solution to them. It's similar to what we have been doing. For example, right now we are building the rail line up in Canada for Tata Steel. In that case, we are not building it ourselves. Someone else is doing it, but we are basically taking a business that was an orphan within RailAmerica and trying to put to productive commercial use, so that's what's going on there. In terms of cost, yes. When you move this, it would be de minimis. I mean, the cost of that sort of a restructuring, you are talking a $0.5 million-ish, so it won't be material.

Rob Salmon - Deutsche Bank

Okay. Then the initial kind of reception from the customers has that been pretty strong with regard to that change and trying to drum up incremental business along your…

Jack Hellmann

Yes. I mean, we're doing it because the customers are seeking it, so it is favorably received. Yes. Michael, I don't know if you have any further observations on it.

Michael Miller

Yes. Really, for us it's about speed and ease to market for our customers, so obviously we are early into this but the market has asked this help and we think we are going to be a in a good position to leverage the Atlas capabilities to bundle this up for a better offering for the customers.

T.J. Gallagher

From a G&W standpoint, it’s just another mechanism to deploy capital versus the switching contract which is a very labor-intensive, lower margin-type business, but to the extent that you can be investing in infrastructure at the same time, you are providing a good service levels, you have got a nice competitive offering.

Rob Salmon - Deutsche Bank

It sounds like it should be nice driver for incremental traffic as we look out? T.J., quick modeling question for the guidance that you provided for Q2. It didn't sound like you are incorporating any sort of revenue or EBIT from the RCP&E transaction in Q2. I am assuming we should just be modeling that beginning Q3?

T.J. Gallagher

Sure. July 1st start up, for modeling purposes.

Jack Hellmann

Yes. I mean, you can assume that we will close probably in the month of June. That’s the plan. You can never be 100% sure of the timing of these things, but I think we are all geared up, ready to go and we would expect to be starting on June 1. For modeling purposes, assume July 1 as T.J. said, but we have had a team on the ground, we have been hiring employees, we have been ordering railcars. I mean, all the steps are being taken, so that we are ready to roll.

Rob Salmon - Deutsche Bank

Great. I appreciate the color.

Operator

Our next question is from Allison Landry with Credit Suisse. Please go ahead.

Allison Landry - Credit Suisse

Hi. Good morning.

Jack Hellmann

Good morning.

Allison Landry - Credit Suisse

…almost afternoon. I wanted to ask a question, I guess, in terms of upsizing your revolver. I think, the implications are pretty clear to everybody, so I was wondering if you could maybe talk about your M&A and natural resource development pipeline and if there has been any incremental change since the last earnings call.

Jack Hellmann

I mean, I would just say that, Allison, we have always got an active pipeline. That size of revolver allows us to move quickly and in a range of projects that we see today, so that flexibility that we need and we are willing to pay the incremental spread to pay for that capacity, because we can see several scenarios in which we have the opportunity to deploy the capital and we hate to not have it when we want to move fast, so yes. T.J, would you say anything else?

T.J. Gallagher

No. That's all.

Allison Landry - Credit Suisse

Any regions where you see something moving faster than others? I mean, you know, North America versus Austria?

Jack Hellmann

You know, it's funny. My answer to that is always wrong and we are active in every geography, where we have operations right now. I guarantee. There is one which I think might be more likely than another I guarantee you if I say that out loud, I will be wrong.

Allison Landry - Credit Suisse

Okay. Got it. You guys mentioned that intermodal in Australia was weaker than expected. Was there anything unusual outside of just sort of the normal wet season there?

Jack Hellmann

Yes, I mean, there was a reason, because we were tired of talking about weather and stuff we just left it out. I mean, yes, so we had washouts north in terms of [law] and during the monsoon season that delayed some of our service, but we frankly did not have the energy to talk about the winter here as well as the monsoon season in Australia. The fact that Adelaide hit a record temperature in the history of Adelaide in the month of February, which also had impact on some service, because it can’t run trains because of the danger of some tanks when the track is too hot, but we thought we had talked enough about whether and so we just…

Allison Landry - Credit Suisse

I don't blame you at all for not wanting to talk about it, so, I guess, is it fair to assume that we will see a rebound in intermodal?

Jack Hellmann

Yeah. The answer is yes. The intermodal traffic has been a good story for us. It's growing nicely from a volume standpoint.

T.J. Gallagher

It's up year-over-year.

Jack Hellmann

Yes. It is up year-over-year. It's slightly weaker than we thought, but it's up year-over-year and it's been building nicely and the Northern territory economy of Australia is supporting that. Our trains are still short, so we are just adding cars to the back, which has got a good margin on it.

Allison Landry - Credit Suisse

Right. Fantastic. All right. Thanks guys.

Jack Hellmann

Thanks.

Operator

We will go to Bill Greene with Morgan Stanley. Please go ahead.

Bill Greene - Morgan Stanley

Yes. Hi. Good morning. Thanks for taking the question. Jack and T.J., I am curious, you mentioned you are not sure you can make this up. Most of the other rails suggested that they think they still can. Is that maybe optimism on their part or is there something specific here that is not going to let you do it? Is it maybe, because it more diverts because of your shorter haul?

Jack Hellmann

Yes. I mean, it feels to me like we might have gotten hit a little worse which would slightly impede our ability to make it up and it's also to T.J.'s earlier comments, I mean, given that there is still some congestion out there that is clearly affecting flows there are things outside of our control. Clearly, the demand is there. I mean, the economy feels pretty good and there is a lot of coal inventories at low levels, but it's hard for us to be overly optimistic when we know that those congestion issues remain and those congestion issues have been specifically affecting us in multiple geographies. We hope we will get more back, but it’s hard to be overly optimistic because of the ongoing congestion.

Michael Miller, you got any other observations there?

Michael Miller

No. I think, you are exactly right, we feel like the economy is strong enough for us to catch up a good chunk of this, but the unknown about how the network is going to flow and spring is still out here with other weather issues, so, I mean, we are optimistic. Inventories are low that may affect your purchasing at or above 50, which means are growing, so everything looks good. We just have to be in a good position to move it. Hopefully, the network will be moving fluid here sooner rather than later.

Bill Greene - Morgan Stanley

Okay. Jack, another impression that I have here is, as I look at kind of maybe the last few quarters and I recognize a lot of these things aren’t really in your control, but it feels like there is a little bit more volatility in the outcomes here and that might just be currency and weather as it just sort of affect things, but as I look over the last sort of five or six quarters, I’m sort of like, it feels like there is more volatility here. Do you feel, post RailAmerica transaction, the organization and the operations, they have reached a level of complexity where it's getting harder to sort of predict outcomes and manage and I am just kind of curious if you feel like that is something that needs to be addressed or it's just a function of one timers?

Jack Hellmann

Yes, Bill, I think that's a completely fair question. I think, what I would start with is just a few observations on general guidance and the outlook that we provide and that our philosophy is to provide the best information that we have at the time when we speak to you and we think it is important to provide the best information we have and then explain any positive or negative variances.

Our goal isn't to be conservative and our goal isn't to be aggressive. It's just to provide our best estimate, so your point is should there be a broader range to capture the fact that you are inherently more complex as a business. I think in the last few quarters, we have been on the short side. Being statistically minded, I assume that at some point it will go the other way. I know, I could be wrong, but given that our methodology hasn't changed over time I would think that would be the case, but it leads us to seek to start to widen our range of guidance which is what T.J. just provided.

I would also note that when we are talking about, we are a pretty good-sized company. We are talking about $1 million variances and that’s the level at which we manage the business, but to your point I think it is incumbent upon us to maybe provide a little bit wider range on our expectations.

Bill Greene - Morgan Stanley

All right. Fair enough.

Jack Hellmann

Your point is well taken.

Bill Greene - Morgan Stanley

Okay. The last question is, obviously crude by rail and incidents in that segment kind of keep coming up. I am curious if you found that short lines are struggling now to get insurance. Is that more common? If so, is that an issue for GWR, but if not, does that create more opportunities for acquisitions?

Jack Hellmann

Why don't I let T.J? Actually, before we talk about insurance. I mean, first of all, we are obviously grateful that no one was hurt in the latest incident in Lynchburg and the safety of crude oil transportation is a critical policy issue for the railroads, our customers, the communities in which we do business as well as our national energy policy. As a short-line, we have taken multiple operational steps to ensure the safety of our crude oil trade.

We precede every train with a high rail vehicle we restrict the speed of our trains. We have ultrasonic and geometry tests on a quarterly basis on those routes. We are intensely focused on rules, compliance with our crews and we also support more stringent tank car standards which are currently under review in Washington D.C right now, so we are essentially in support of any policy that makes our railroads safer and our goal is to ensure that these accidents simply don't happen period. Having said that, as you think about protecting yourself with insurance, I will ask T.J. who's been in the insurance market recently speak in broad terms about what exists.

T.J. Gallagher

With respect our ability to ensure ourselves from a liability standpoint we don't think any issues with respect to insurance market capacity or pricing. Rates have gone up in this area, but the cost of insurance is de minimis in the context from a broader organization. With respect to other short lines and their ability to procure insurance, we buy insurance at much lower levels than we do. We are going to buy 15 to 20 times the levels the small or short lines buy and we are viewed as a fundamentally different capital organization from the insurance market perspective.

I think, the rates are going up. I think, in some cases some may have had difficulty buying as insurance as they would like, which again is still at a pretty nominal level compared to one of the bigger railroad companies. I don't think at this point it hasn’t yet led to more acquisition opportunities, but what is on the future that's the question we may, but that depends on another.

Bill Greene - Morgan Stanley

Okay. Great. Thank you for the time. Appreciate it.

Operator

Our next question is from Chris Wetherbee with Citi. Please go ahead.

Chris Wetherbee - Citi

Thanks. Maybe, I guess, piggyback on sort of the back of the crude question. If you see a three-year phase out of the 11 cars here in the U.S. following what Canada has sort of talked about. Do you think you still have enough potential production capacity to grow that business, production capacity for the cars I am speaking about to grow that business? Going forward, I guess that's a bigger picture sort of industry question, but just curious of your thoughts.

Jack Hellmann

The honest answer is, we don't know for sure, but obviously with a quick phase out there is going to be some constraints on capacity. By definition, that would suggest that there would be constraints on the rate of growth. Mike, I don’t know if want to make any observations. The question is if the U.S. do what the Canadians do in the same timeline essentially?

Michael Miller

Yes.

Jack Hellmann

Yes. I mean, I think by definition, one would assume that it would slow things down a bit.

Michael Miller

Yes. I would agree, Jack. We are even seeing customers trying to get out ahead of that just to create some capacity before what's actually required, but I do think if it's a compressed timeline, we are going to see probably a challenge.

Chris Wetherbee - Citi

Okay. That's helpful. I appreciate that. Then just switching gears to the guidance a little bit and may be thinking about how the network is running in the second quarter. When I looked at sort of the expectations for 20%-plus pre-tax income growth over the next nine months relative to the second quarter guide, it feels like you are at a sort of slower pace in the second quarter and I am guessing a lot of that has to do with the RCP&E acquisition in the back half of the year, but how is the network kind of running in the second quarter? Do you think there is going to be any lingering cost? You have talked a little bit about the volume side, but is that part of what's sort of driving that that's skewed more towards the back half with the growth coming then on the back of the acquisition?

Jack Hellmann

Coming out of the first quarter into the second quarter, as we have said a number of times on this call, there are still lingering issues with the broader rail network with respect to congestion and people talked about Chicago enough. We talked about car supply, so our operations are up and running. Our ability to move traffic, again those are going to depend on our connecting partners, so we expect that to get better into the third quarter, but the second quarter we are still making our way.

Chris Wetherbee - Citi

Okay, and the growth is kind of the back half-weighted growth is largely predicated on the closing of acquisition?

Jack Hellmann

It's not in large part, but in thin part.

T.J. Gallagher

Yes. It's a contributor.

Jack Hellmann

Again when we recently announced the acquisition this was on an annualized basis about $65 million revenue and a $17 million EBIT business. I mean, you can just do the math and figure out the contribution in the back half?

Chris Wetherbee - Citi

Okay. That’s helpful. I appreciate the time. Thank you.

Jack Hellmann

Thank you.

Operator

We will go to Scott Group with Wolfe Research. Please go ahead.

Ivan Yi - Wolfe Research

Good morning, guys. This is Ivan Yi on for Scott.

Jack Hellmann

Good morning. How are you?

Ivan Yi - Wolfe Research

Good. Your guidance now includes the RCP&E and about $17 million of EBIT. Does this include any synergies? If so, about how much?

Jack Hellmann

It includes six months impact, all right, so the annualized number divided by two and that includes the entirety of our initial view of the impact on our business, so that’s before we go in there and our objective obviously is to increase revenues and we have got a lot of dialogue along with customers as to what we think we can do there in that regard, but that is the base case financial model of the business that we acquired divided by two.

Ivan Yi - Wolfe Research

Got it.

T.J. Gallagher

Ivan, you are thinking this is the start-up versus buying an existing company, so there not synergies in the traditional sense.

Ivan Yi - Wolfe Research

Okay.

T.J. Gallagher

This is from ground up startup.

Jack Hellmann

You've built something.

T.J. Gallagher

You are not taking something.

Ivan Yi - Wolfe Research

Yes. Got you. Secondly, in your slide you discussed, you noted stronger U.S. petroleum product volumes offset by a weaker crude by rail in Canada. Do you expect this trend to continue, meaning, I have heard from some other rails that expect stronger Canadian crude volumes, the reverse meaning you don't have to dilute it like you would in a pipeline. Just want to hear your thoughts about future expectations there?

Jack Hellmann

Well, look, there is a lot of moving parts. The crude-by-rail market involves spreads, it involves incremental pipeline capacity that’s opening up in various geographies. In our case, we simply had lower volumes in the first quarter and I think that could have been as much due to winter whether and as it did the industry flows, if you will.

Look, we expect continued volatility. I think we have said this before. There is a lot of growth in petroleum products led by crude-by-rail or natural gas liquids, but these are commodities that have more volatility given that the movements will depend on spreads and price in different markets and new infrastructure that's being built.

Ivan Yi - Wolfe Research

…you want to comment on propane? I mean, we saw patterns in propane shipments.

T.J. Gallagher

Sure. Our petroleum products, if you go back to the commodities slide, commodity slide we are basically flat, up 2%, we would've expected them to be up a little bit more than that, in addition to the crude-by-rail in Canada, we also had an different propane flows. Typically we sent propane to California. That propane that we otherwise would've sent got re-diverted on other railroads up to the Midwest, so there is a lot of moving parts. The traffic that was moving four months ago by rail to distant markets are now in the Midwest and is now moving locally by truck again give an extreme to weather, so there is a lot of moving parts in those traffic patterns, Ivan.

Ivan Yi - Wolfe Research

Great. Thank you so much.

Operator

The next question is from Jason Seidl with Cowen and Company. Please go ahead.

Matt Elkott - Cowen and Company

Good morning. This is Matt Elkott for Jason. Thank you for taking our question. If I may take it back to the acquisition topic, just wondering if the record winter in the first quarter may have caused enough disruptions for some of the smaller carriers' maybe to make them more likely to consider an offer. Are you seeing any of that at all?

Jack Hellmann

I don't think so. No. well, they were certainly affected by it. There were a lot of railroads in a lot of pain depending on what geography you are in, but that wouldn't be sufficient to trigger a sale decision.

Matt Elkott - Cowen and Company

Okay. Then on the safety front, you guys still posted impressive safety results despite the weather. I was just wondering if achieving this had to at least in part come at the expense of some revenue or profitability.

Jack Hellmann

I don't think of it in those terms. I mean, safety is simply how we conduct ourselves at work and it's a culture that is deeply ingrained in the organization and we only do things one way. There is only one right way to do it and that is the safe way, so I wouldn't draw any conclusions about anything beyond that.

Matt Elkott - Cowen and Company

Okay. Then finally, can you guys tell us if the service challenges experienced by the BNSF affected your switching operations in the PRB region?

Jack Hellmann

Michael, do you have any observations on the PRB?

Michael Miller

Well, you can't put it just on one particular class when all the unit trains flow back into there, so obviously as flows are disrupted, the ability to load trains efficiently would certainly be disrupted a bit, so anytime the network is impacted it's going to impact our ability to load, so again it's all intertwined.

Matt Elkott - Cowen and Company

Got you. All right. Well, thank you very much gentlemen.

Operator

We go to Ken Hoexter with Bank of America Merrill Lynch. Please go ahead.

Ken Hoexter - Bank of America Merrill Lynch

Great. Good afternoon, T.J., Jack.

T.J. Gallagher

How are you?

Jack Hellmann

Hi, Ken.

Ken Hoexter - Bank of America Merrill Lynch

Good. When you think about your outlook, T.J. you mentioned 3% to 4% carload growth for the second quarter, can you maybe give your outlook for the rest of the year as well. Then at least what you built into those targets and then same thing on your pure rates just trying to understand what was built into those targets that you set?

T.J. Gallagher

Sure. The 3% to 4% carload growth for the second quarter. For the full year, we are still at 5%, and the way to simply think about is that the addition of the RCP&E offset –our Q1 winter impact, so it sort of nets out . With respect to rates, no change. We said before that we expected rates in North America up 2% to 3%, excluding fuel mix and currency on a consolidated basis 1%, so including Australia. We don't view the rate environment as having changed since our further guidance.

Ken Hoexter - Bank of America Merrill Lynch

Wonderful. Well, go ahead, Jack.

Jack Hellmann

Yes. I was just going to say what you saw. You might have led you to a different conclusion looking at the rate slide from the quarter, but just remember that mix of business was so different than what we had expected that it's virtually irrelevant.

Ken Hoexter - Bank of America Merrill Lynch

Then you mentioned congestion a bunch of times, and I guess, are you seeing that start to clear up? Is there anything you can see from your perspective or just trying to understand what kind of overhang this might be into 2Q and/or maybe into the third quarter?

Jack Hellmann

Dave, you want to take that one?

David Brown

Certainly, as we move forward, we are going to see normalization across all of rail network.

Jack Hellmann

We have had some improvements across the board, including Chicago, but there is still a way to go.

David Brown

It's just not back where it needs to be, to be fully normalized in terms of velocity, I think, you can watch the metrics, the Class I metrics that are public metrics and you see velocity in real time in those geographies and see how it’s progressing from those public measures.

Ken Hoexter - Bank of America Merrill Lynch

Right. As a user of that service, do you anticipate that getting cleaned up by second quarter or are you expecting it just because you have to talk to your customers, will that last until the third quarter?

Jack Hellmann

I think, we'll see it improved through the second quarter, and as we go into the third quarter, we will see it normalize.

Ken Hoexter - Bank of America Merrill Lynch

All right. Great. Just two real quick ones, Tata - Jack, can you just give an update, when that gets ramped up. Then T.J., any update on Europe, thoughts on investing or divesting?

T.J. Gallagher

Why don't we have Matt Walsh, the voice of the Safe Harbor statement, also is our Head of M&A, so I'll let him talk about Tata.

Matt Walsh

Sure. Construction proceeds up there. The winter is sort of, I would never say ended up there, but construction can start and our expectation is start up sometime at the end of Q2, beginning of Q3.

T.J. Gallagher

Ken, with respect to your question about Europe, I think Jack alluded to that earlier when we talked about the M&A pipeline. We are active in all the markets in which we operate.

Ken Hoexter - Bank of America Merrill Lynch

Europe was in that statement? It wasn't just, because I thought the person has just asked on U.S. and Australia?

T.J. Gallagher

No. There are things worth looking at in every geography in which we do business right now.

Ken Hoexter - Bank of America Merrill Lynch

Okay. Appreciate the time and insight. Thank you.

Operator

Next, we'll go to Justin Long with Stephens. Please go ahead.

Justin Long - Stephens

Thanks. Good morning guys.

Jack Hellmann

Good morning.

Justin Long - Stephens

Looking at your full year guidance and the expectations for an OR at 74%, it implies some pretty significant margin improvement even below the 73% you guided in the second quarter. Could you just give some more color on how you see this margin improvement progressing in the back half of the year? Also, roughly where you expect to be from a margin standpoint at the end of the year?

Jack Hellmann

Actually I think it kind of gets us back like in the back half of the year, kind of what we thought we would have been in February, so there's no material changes in our expectations for Q3 and Q4 margins. It is just that we dug ourselves a big hole with the weather in the first quarter and that has got to play out.

T.J. Gallagher

Yes. That’s how I think about it too.

Justin Long - Stephens

Okay. Fair enough. Secondly, I was wondering if you could give an update on the short-line tax credit and potential extension there. It seems like you picked up some co-sponsors in the Senate recently and you are getting close to a majority and I know it was potentially part of tax extenders bill. Could you just give us an update on where that stands and any more clarity you have on the timing?

Jack Hellmann

Yes. You can see that the numbers have continued to grow in terms of support, so I can’t remember precisely, but among the pieces of legislation out there right now, it’s like the third most popular in terms of broad bipartisan support, so that in turn suggests that it needs to find the right home and the right piece of legislation.

I believe the conventional wisdom is that it may be more likely to find a home in a lame-duck session post-November, but you have seen other - it’s possible it could come in some other place at some other time. It's very difficult to predict how legislative activity is going to unfold, but it’s got the support it needs . It just needs to find the right home.

Justin Long - Stephens

Fair enough. Last one from me, I was wondering if you could give an update on the industrial development pipeline. I know it has been pretty active recently, but you just mentioned Tata, but any other major projects or wins that are on the horizon in the next couple of quarters?

Jack Hellmann

Michael, do you want to just talk broadly about industrial development?

Michael Miller

Sure. I mean, clearly, the pipeline we have is very robust. One of the things we try to do is, keep it as full as possible, but batting average on these projects are depending upon where you are in the geography, it’s tough to predict. We have many active projects really across all the commodity sectors. Obviously, energy has been a key driver for us, but we’re also looking at particularly, now that we have gotten a bigger geography in the agriculture side of the business. There is a lot of opportunity for projects there.

We feel pretty good about the pipeline, but it's just really hard to comment as to when we will close some of these. There's actually projects now that have come up. The transload business for us has actually been growing relatively strong and we see that as another opportunity to extend our reach beyond just our rail-served customers. So, we feel pretty good about where we are and we feel like the pipeline will continue to grow over the next couple of months.

Justin Long - Stephens

Okay. Great. Good to hear that. That’s all from me. I appreciate the time.

Operator

Our next question is from Cleo Zagrean with Macquarie Capital. Please go ahead.

He did take himself out of queue and we have no additional questions in queue. Please go ahead.

Jack Hellmann

Thank you. Thank you for your time today and we will look forward to speaking to you on our second quarter call. Have a good day.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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Genesee & Wyoming, Inc. (GWR): Q1 EPS of $0.70 misses by $0.14. Revenue of $376.3M (+0.3% Y/Y) misses by $5.07M.