Q3 2019 Earnings Call
Greetings and welcome to the Norfolk Southern Corporation third quarter 2019 earnings Conference call. At this time all participants are in listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
A reminder, this conference is being recorded it is now my pleasure to introduce your host.
Pete Sharable director of Investor Relations. Thank you Mr. Sharable you may begin.
Thank you Melissa and good morning.
Yeah.
Please note that during today's call may make certain forward looking statements, which are subject to risks and uncertainties.
Well, if you're really from actual results.
Please refer to our quarterly reports filed with the you see for a full discussion those risks and uncertainties new deals most important.
This was a bit presenters are available on our website, Norfolk, southern Dot com and Investor section.
Our non-GAAP reconciliation.
Additionally, the transcripts and downloads will be posted up pretty cool.
My pleasure introduced Norfolk, Southern's Chairman club.
He jumped worse.
Good morning, everyone and welcome to Norfolk, Southern's third quarter 29, Ci earnings call.
Joining me today, our Allen Shah Chief Marketing Officer, Mike Miller, Chief Operating Officer, and City Airport Chief Financial Officer.
Turning to our financial results for the fourth quarter income from operations was approximately 1 billion net income was 657 million.
Yes was to 49 at the operating ratio improved to 64.9%.
These results include the unfavorable impact, although $32 million right off the receivable, resulting from a legal dispute which affected the youre buying 110 basis points and B T. S. One nonsense.
As highlighted on slide four these were record results, including a record fourth quarter and year to date.
Earlier this year, we outlined a dynamic watching you operating plan top 21 capable of creating value in all market conditions.
In the month since particularly in the second half of this year volumes across the transportation sector, including our volumes termed sharply lower.
In response, leveraging top 21, arching doubling down on productivity and achieved major resource reductions for example in the third quarter, you reduced crude starch and we crude supply 11% year over year.
That was nearly double the rate volume decline driving a 9% decrease in employment levels.
Following the first phase of top 21 swiftly moved to phase two which includes we funded the yard and intense deployment of additional distributed power on low trains and blending intermodal and unit trains between existing frames wearables useful.
These efforts are producing further reductions in crew starts searching the and were pretty Myles.
[laughter] become clean shooting our intermodal terminals.
For the third phase of top 21, using the Formula we used to successfully overhauled carload network, while sustaining a high level of network performance service.
Earlier in the or I spoke about the momentum building across our organization and our commitment to enhancing operational and financial ouch.
This commitment is evidenced by significant expense reduction so far this year, which Cindy will describe in more detail later in the call.
Was wondering trending below our expectations in the second half and some unusual costs expected in the fourth quarter.
We continue to expect operating ratio improvement for the figure.
Having proven now seems likely to be less than our on your forecast of at least 100 basis points.
Nevertheless, we remain confident we can achieve our goal of 60 or like 2021.
Additional cost structural changes and future revenue growth.
For example, we're pursuing savings opportunities that fuel mechanical and other aspects of operations.
Michael speech.
And we continue to drive bottom line improvement with pricing increases commensurate with the value of our service. If there was also evident in the third quarter and your today, you know revenue per unit and revenue per revenue Tomorrow trench.
How long will speak further about those president of it.
All of us at Norfolk, Southern are committed to transforming our company to drive shareholder value creation.
As I've said before we are embracing new ideas and positioning leaders throughout the organization or champions for change.
We're all working hard operated safely and efficiently as possible and deliver what we promised to our customers and shareholders.
Results so far this year.
Food service levels for our customers, a lower operating ratio and bottom line growth.
The return of nearly $2.3 billion to shareholders with that I'll now turn the call over Jew Allen.
Thank you, Jeff Hi, good morning, everyone.
Third quarter, we continued our focus on pricing to the value of our service product and the library productivity gains.
Generating a record third quarter operating ratio despite difficult economic conditions.
[noise] trade uncertainty continues to influence the economic environment, which coupled with lower spot truck and commodity pricing negatively impacted volume during the quarter.
As we cycle through the headwinds associated with the market, we have and will maintain our focus on margin improvement.
Driven by price service and productivity.
Collaborating with our customers.
Body platform for growth.
[noise] as shown on slide six.
6% decline at volume led to a 4% revenue declined in the quarter.
Increased router forget it.
Which has improved year over year for 11 consecutive course, partially offset the volume decrease.
The consistent delivery of ARPU growth.
Highlights the effectiveness of our pricing strategy.
Third quarter revenue in our merchandise segment was flat year over year, it's continuing stryker pricing offset volume declines.
Volume declined 4%, resulting from reduced steel and natural gas yes.
Favorable fuel price differentials drug gains in crude oil the east coast refiners.
During the quarter, we experienced growth in automotive and aggregates as a result increased production. It is not served out of clients and improved service respectively.
[noise] intermodal revenue declined 5% due to reduced volume in our domestic franchise.
Strong relationships with steamship lines and share shift the east Coast Sports Authority's international volume growth year over year.
Domestic intermodal decline due to lower spot truck pricing and a weekend manufacturing environment.
Intermodal ARPU was flat quarter as pricing increases were offset by the negative mix impact of increase international volume and lower fuel surcharge revenue.
[noise] turning to Colin.
Revenue was down 13% in the third quarter.
Our utility portfolio was impacted by additional natural gas capacity and prices, that's perhaps called work.
Export thermal and metallurgical prices remain at low levels, making it difficult for U.S. calls they compete globally.
Improved pricing drove a revenue per unit increase of 2%.
Good thing that's why.
We expect the same factors affecting third quarter volumes to persist in the fourth quarter.
Macroeconomic conditions tariff uncertainty and global weakness continues to negatively influenced business investment manufacturing and exports.
Lower commodity pricing will in fact, many of our markets According coal and steel.
Truck loadings are expected to be flat for the rest of 29 thing with excess capacity keeping spot truck rates low.
While we expect a challenging economic environment for the remainder of the year, we remain focused on our strategic plan to drive market I've heard about.
We're collaborating with our customers daily to fine tune, our service product and identify long term growth opportunities.
Our strategic plan is producing pricing and efficiency gains.
Well, we committed to the execution of the plan.
While meeting our customers' expectations and establishing a platform for future profitable growth.
I'll now turn it over to Mike for an update on operations.
Thank you Alan today.
David you want to stayed up our operations and the efficiencies we are creating with our top 21 place.
In the third quarter, we delivered strong service for customers.
Further progress over the next iteration of top 21 and began implementing initiatives in top 21 base to our rolling basis.
Our operational momentum is driving significant cost savings and where flux you know dynamic playing in accordance with market conditions.
We continue realizing efficiencies, while providing a superior service product work customers.
Moving to slide nine we have continued are laser focused on execution overplaying principles precision schedule forever.
We substantially improved train speed and troubled well compared to last year and delivered record quarterly performance.
We've achieved that support our strategy to meet our customers' expectations, while eliminating costs and prudently managing our assets.
The operation continues to be resilient.
Evidenced by our ability to work through two recent major incidents in the fourth quarter a bridge outage at large derailment.
Minimal disruption to our customer supply chains.
This shows the strong resiliency of our operating Bob.
These overall results are due to relentless execution by our operations team and other employee supporting it.
We want to thank our field employees for their unwavering focus on safety service and efficiency.
Turning to our service and productivity metrics on slides here.
These metrics aligned with our strategic plan as they measure keep productivity and customer service levels.
We have been aggressively reducing our resources to meet our productivity goals. They count GTM is dropping by 9% in the core.
Consistent with prior quarters, the blue bars represent our goals for 2019.
Starting with the service delivery index, which is the on time delivery performance of our scheduled shipments indexed to 2018.
This is a customer facing metric that combines intermodal availability and shipment consistency, which measures tripped playing it appeared adherents for general merchandise as well as automotive traffic.
Strong service performance continues in the third quarter, and we expect to drive further improvement.
We are trending ahead, where we thought we would be with 30 any productivity go over 2019, and we anticipate this trend will continue for the remainder at the year.
We are at our lowest t. any headcount on record ever reduced by 13% versus third quarter 2018.
While still providing exceptional service.
We are already realizing the benefits of our top 21 plant.
The results are driving the comp and benefit improvements to which Cindy will speak.
As mentioned during the last call, we're continuing to work on improving our try anyways.
Majority of our goal was backend loaded as the first phase or the top 21 operating plan was successfully implemented on July 1st.
We are receiving improvements in our general merchandise to train ways, which were offset by headwinds associated with intermodal and co waters.
Locomotive productivity continues to be an important metric for Ns, we're tracking to meet our goal well this year.
We're going to rationalizing our locomotives.
Which is 22% lower than the same period last year.
We are also have an aggressive initiative to rationalize resources associated with the maintenance of these locomotives, including a reduction of 525 positions already this year.
We will continue to focus on the remaining resources required to maintain this lower fleet size.
And the cars online, which is down 20% versus our 2018 baseline continues to trend very positively thanks to our best think consistent service product.
This includes cards and storage, which can be deployed as market conditions for.
Turning to our progress our top 21 operating plan on slide 11.
As you may recall or operating plan has four major objectives.
Operator is one that work.
Execute a balanced training plane between terminals.
Serve our customers frequently and reduce dependence on major Charles.
The first phase a top 21, primarily focused on our general merchandise bulk and automotive business and will successfully implemented our July 1st.
We have been aggressively implementing the next phase, which has an added emphasis on distributive power to drive further trade consolidations.
We have increased the number of de trades per day by more than two and a half times with the expansion of this initiative since our top 21 rollout.
We will continue to SVP trade across the network, which will have the benefit of improving train weight and fuel efficiency.
Regarding deal efficiency, we have several other initiatives for improvement.
Specifically, one sharing that healthy energy management lead locomotives.
Compliance with horsepower per ton procedures, and three compliance with usage of energy management technology.
We are also sinking up our local schedule and the new train plant.
We are implementing these changes on a rolling basis and driving significant structural improvements.
Specifically total security for general merchandise and although traffic is down 27% versus pre top 21, and real train miles were down 13%.
Additionally, we had been working to calibrate our local plan to maximize efficiency, while continuing to provide good service to our customers.
Together. These changes have helped to continue drive down crew starts waukegan velocity and customer service.
We have also the governor process and clean cheating on intermodal terminals and preparing for the third phase top 21, which remodels all traffic for additional opportunities.
This will drive further cost and resource reductions and improve our fuel efficiency.
I will now turn it over to Sandy who will cover our financials.
Thank you Mike Good morning, everyone [noise].
I'll begin with or operating results on slide 13.
The continued execution of our strategic plan delivering tangible results that are flowing through to the bottom line.
The structural changes, we're making including the implementation of our PSR based operating plan generated expense saving and compensation and benefits.
And equipment right.
These savings as well as lower fuel prices more than offset the decline in revenue.
However, in the third quarter, we wrote off a $32 million receivable as result of illegal to speed, which added 110 basis points to the operating ratio and lower earnings per share by nine cents.
Income from really operations for the quarter was nearly $1 billion.
And we reduced our third quarter operating ratio by 50 basis point.
She being a third quarter record 64.9%.
Moving to slide 14.
We are delivering cost savings as evident in the $82 million decline and operating expenses.
Our new operating plans have resulted in fewer trains on the network and reduce Chris.
Compensation and benefit [laughter] decline as a result, a $47 million and saving due to lower employee level.
And reduced overtime and recruit.
We drove average headcount down by approximately 1000 employees from last quarter and have reduced headcount by 2400 compared to last year.
We also remain intensely focused on improving asset utilization.
By increasing the velocity of our network and improving fluidity, we have significantly reduce the need for locomotives and freight cars.
I'll be in equipment rental savings of $35 million.
We also achieved savings of $10 million immaterial expense.
Due to fewer locomotives in service and freight cars online.
Partially offsetting the efficiency gain that we delivered in the quarter was $13 million write off that I previously mentioned.
We also experienced $17 million of additional than you do increase pay rate.
Finally, lower fuel price and a decrease in consumption dropped to $48 million decline.
[noise] fuel efficiency continues to be an area of focus and we know there are opportunities to generate savings during previous efficiency.
Oh.
Slide 15 summarizes our third quarter results.
Income from railway operations was slightly under last year's record non operating items added an additional $60 million expense.
Third quarter net income was $657 million and diluted earnings per share was $2.49.
Recapping our user they cash flows on slide 16.
Cash from operating activities was $3 billion and free cash flow for the first nine month was $1.5 billion.
We continue to return capital to shareholders.
Vince by the 9% increase in the quarterly dividend, we announced in July .
Dividends and share repurchases totaled almost $2.3 billion.
First nine months.
As we head towards the conclusion of the here.
Want to highlight a few specific item that will impact the fourth quarter.
First starting with headcount.
We expect a continuation of position reduction in the fourth quarter.
By year end, we expect headcount to approximate 23300, which is the reduction of over 3200 physicians compared to the same time last year.
Also we except incentive compensation to be favorable prior year.
The magnitude will depend upon our full year results.
However, as Mike mentioned earlier, there's been some specific incidents in the fourth quarter that will result in increments.
We expect additional costs associated with featuring train you don't break outage and lighting damage, resulting from a large derailment will approximate 20.
$25 million an additional expenses.
Additionally, we expect the gains associated with the sales operating property will be lower than last year.
Yeah, we called that fourth quarter of 2018 included $145 million and gains on sale operating property.
Whereas we expect the current quarter too about the about one third of that [noise].
[noise] the execution of our strategic plan is delivering results and even in the face of obstacle unforeseen at the outset up this year. We're confident we will improve our full year operating ratio in 2019 and achieve our goal of 65 2021.
We are seeing the benefits associated with our operating plan.
Absolutely identifying and implementing further measures that will produce [laughter] financial result.
And drive shareholder value.
Thank you for attention and I'll turn the call back over to Jeff.
Thank you study.
As we've outlined and does our third quarter results demonstrate we continue to build momentum by executing planned initiatives and pushing well beyond many of the goals we set out earlier this year.
You are hard at work preparing for the third phase of top 21, right sizing, our local and guard operations further consolidating road friends and going after cost savings in fuel and mechanical operations.
While pursuing all of these efforts the Norfolk Southern team continues to provide superior service to our customers, enabling us to price do our value in the marketplace, while ensuring we are positioned at the leading edge of right when it returns.
These actions give us confidence will reach a 60 operating ratio by 2021.
Before we open the call for Q1 day I do want to recognize Cindy for her 34 years service to more southern and her support to her final day here at the company on November 1st.
I have valued the role she has played in pioneering new technologies, our company developing our strategic plan and delivering shareholder returns.
On behalf of the entire board and management team my Thanks, Cindy for her many contributions and wish her well in retirement.
Well now open the line for QNX operator.
Thank you we will now they're kind of question and answer session. If you'd like to ask a question. Please press star one I know telephone keypad, a confirmation code will indicate your line is into question Q.
The press Star, Tim if he'd like to remove your question from the Q [noise].
Participants usually speaker.
To be necessary to pick up or has that before pressing the star.
The number of analysts joining us on today's call [noise].
We will be limiting everyone to one primary question and my follow up questions to accommodate if many participants as possible.
Our first question comes on line of just along with Stephens. Please proceed with your question.
Thanks, Good morning, and congrats Andy on the retirement.
Maybe to start with the O. our guidance for 2019 I just wanted to clarify something are you excluding the impact of the 32 million dollar write off and Threeq you in that guidance and then you know Cindy you mention the $25 million have unusual costs.
It's in the fourth quarters I'm, just curious if you exclude that 32 million dollar write off and the 25 million dollar dollars of unusual items in the fourth quarter, if that Oh, our guidance of at least 100 basis points that you previously put out there what had been achievable.
Just Justin it's Jim Let me, let me see if I can clarify for you what we have said this morning.
Our guidance is that we expect to achieve.
A full year operating ratio improvement year over year.
Even with the additional expenses.
And the trend in revenue and even with the.
Receivables write off that we discussed earlier.
So but also in key launch those things, we do not expect to be able to hit our goal of at least a 100 basis points improvement in the operating ratio.
Now with that said.
That does not diminish our confidence in any way that we can get to 60 operating ratio by 2021.
And to back that up I, just want to take a minute to reach out what we have achieved to date because those achievements are the foundation of further improvements that we make to get to the 60 operating ratio.
And I'll just touch again on our operating plan because that in many ways is the bedrock of of the improvements we have made and we'll continue to make.
Current phase one as of July one we cut over it seamless we see an immediate reduction in train starts in active trends on the network as we have shown previously we see a sharp decline in crucial says we showed you today.
There was no disruption services results in a couple over.
In phase two.
We pursue additional freight consolidations.
We blend more intermodal bulk and carload traffic, we accelerate distributed power by now we have more than double the number of GP trades per day or operating on the network.
We pursue further rationalization of equipment.
We work to sync up the local operating plan would be network plan and.
That results in additional crude start reductions as you can see on monks line 11, who start reductions actually accelerate coming out of the initial cutover as we move through first.
And then we pursue intermodal clean sheet into the analog if you will to the clean she did in merchandise that work and we're hard at work on fuel efficiency initiatives, where we know we had some ground to make up.
So these are the things that are operated today in phase three.
The top 21, we will we model all traffic to unlock additional efficiencies.
Now what have been the results in terms of resources of these various phases of top 21, so let's start with T. productivity as Mike mentioned, a t. any down 13% versus third quarter 2018, giving us the lowest feeney head count on record where our company.
Oh in terms of locomotive productivity.
We have reduced the number of locomotives out there by 22% versus last year.
And that reduction in locomotives operating on the network along with the reduction in cars online yielded an additional reduction of 525.
Mechanical positions, Oregon, the ship, which together with the T. any reductions, which together with other employment. We reductions we have made gave us 9% <unk> lower overall headcount with more to come before.
Cars online down 20% versus the 2018.
Benchmark, yielding significant equipment rent savings along with the locomotive reductions Cindy went through the different expense categories, the compensation benefits savings or the material savings the equipment rent savings that that would result of these resource reductions in top top and one phase three there will be works that we will.
See through additional train consolidations additional reductions in crew starts and we would expect to see TV redemptions follow.
With continued rationalization of work, mostly you will see a lower maintenance spending.
Oh, and and so on and so forth and lastly, we will stay very focused on our pricing plan, our yield up strategy, which showed.
Excellent results in third world and for the full year to date, we're determined to price to the value of our servicing them on to close.
Thanks, Dan that's a great and comprehensive answer I think secondly, I just wanted to ask a a bigger picture question obviously.
Were dealing with a more challenging demand backdrop right now as we think about that guidance to get to 60, L.R. and 2021 do you think that's still achievable if the demand environment stays around current levels on the call environment stays around current levels or do we need to see.
Positive inflection in demand in order to hit that 60 O R.
We are determined to achieve the 60 or goal by 2021 in any foreseeable revenue environment, including the one we are in now but yeah ours is a balanced plan and we've said that along we are pursuing growth. We believe we Ah we will see the fruits of our efforts in the form of a resumption of growth.
During the remaining years of our current strategic but if we don't.
We will push even harder on efficiency measures on productivity measures to get them safety or.
Thank you. Our next question comes in line of Allison Landry with Credit Suisse. Please proceed with your question.
Thanks, Good morning.
Now that you're up here in phase two of I've top 21, and as you move into phase three should we start to expect you know a meaningful acceleration in that year over year. Our improvement I guess, you know just as you're talking about all the trains you're eliminating and the increasing train weights and adding that to deep you. Yeah, why why wouldn't you be able to.
To move below 60, L.R. more quickly you know as as we've seen west with many of your peers.
If we can get to 60 or sooner or else. We will continue to push we are we're determined to do all we can to generate shareholder value through growth in through.
Lower operating ratio.
Sixtys our goal by 2021, if we can do better than that we certainly well.
Okay.
And then I was hoping maybe you could offer some thoughts on the recent addition to to the board by caught my show a what role would you expect him to to play in and out and you know how is that.
Materializing self our thank you.
Well it as as you know brings a great deal of experience in our industry, having served as CEO of Canadian National He brings a indepth knowledge of a reward operations of refinances. He served as CEO and CFO for a number of years and so he is a most welcome addition to our board were.
Looking forward to.
Having him advice and counsel us as we pursue all of the initiatives.
That we intend to pursue.
The next few years and beyond.
Thank you. Our next question comes from the line of Brian Ossenbeck with JP Morgan. Please proceed with your question.
Hi, Thanks, Good morning, I appreciate taking the question so Alan maybe on for you on Uncalled was little surprise, you that ARPU was up sequentially ex fuel, perhaps maybe you can give some color behind that and where do you think this goes in fourq year, 19, and 2020, yeah, obviously the.
Export markets are telling us.
Things are going to get worse before they get better again, so just wanted to see if there's any other offsets that you might have.
From a pricing are you a perspective, considering it was a bit stronger this quarter I haven't than we expected.
Yeah, absolutely Brian as.
As I've noted in my prepared remarks, we continue to deliver strong pricing across all of our business units coal is no exception coal will be pressured and the fourth quarter with the reduction and the seaborne coking coal price.
So you should see a sequential decline and export coal pricing as we move into the fourth quarter and that's gonna be running up against some difficult comps because at the same this time last year, where we were seeing a sequential improvement and export.
Coal pricing, so that won't be a headwind for us throughout all of this we are continuing to focus on pricing to the value of our product and we're delivering a very good product or customers.
Okay, and then one on on fueling train weights for you Mike Yeah, we've seen some pretty good progress on fuel in particular from for the rest of the class ones, but looking at Norfolk, It looks like fuel efficiency gallons per passenger teams actually getting a bit worse sequentially and year over year. So.
They were seeing train rates aren't moving up as fast.
As you think throughout the course of the plan, but what can you offer on onshore and they've got some initiatives there, but it seems to be a pretty big factor.
For efficiency gains that others have realized but you haven't been able to hit that sort of stride.
Yes, so on the fuel efficiency side, we are seeing an increase in a general merchandise train weight. So that was part of the top 21 plan, we're getting those benefits, but there are offset by the headwinds of the of the lower train weight. So the intermodal and full trains and we're making a were taken actions to to address.
That you'll see more of that in in phase two as we go forward and then some of that on page three as well.
But we also have a very aggressive initiative on utilizing the energy management technology that we've been rolling out and so this is an all hands on Dec thing and and we've got a folks down in our new consolidated network operations Center, a really staying on top of this so making sure.
We got the right locomotive on the head end, that's got to working energy management.
And then making sure that we're using the right horsepower per tonnage for our trains being very aggressive with that and then making sure that that were complying with the energy management technology, So big initiative.
We expect that to be a paying off as we go forward, Brian I'd like to weigh in on this as well.
We benchmark our peers performance overtime and do so extensively and we are aware of the ground could we have to pick up.
We have met because we have not made progress despite a best efforts in the last couple of quarters.
That's going to change we are focused on all the things that Mike as outlined.
Running water have your friends is certainly part of it.
Oh onboard energy management real time fuel monitoring.
Oh horsepower friendly Tom.
Appliance and so forth hosted initiatives in place, which we believe will bear fruit, which we believe will bear fruit as I'm holding our operations team AAA accountable to battle.
Thank you. Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, Thanks morning, guys. So I want to go back to suggestions first question because I'm not sure if I understood. The answer. So you guys said, there's 32 million to legal costs in the third and you talked about 25 million a bridge costs in the fourth.
So that's 50 basis points to award.
If we were to exclude those but would you have been hitting the award targets or not I get world try to understand is this a small margin miss that arguably understandable or is this a bigger margin mix.
Cindy why don't you give the trial.
Okay. So Scott as Jim said previously the 32 million and a additional cost the 25 million, which we're not only French costs, but also leading costs associated with realm. It.
Our guidance to I Miss on the 100 basis points are improving that we don't exclude either one of them.
You know, we're going to continue to push as hard as they can to ER to improve the L.R., but those have not been excluded in that in that guidance today.
No I understood.
I understand there not exclude I'm, just saying as we do them as we play with our models. If we were to exclude them would you be hitting that award target or not I think that's what we're all trying to understand.
[noise] I think that I would say that we will well we will miss our target.
The extent of it is probably not material it it's not a big mess, but ah, but it will be enough.
Again, though that does not diminish our confidence in any way to we'll get to 60 operating ratio by 2021.
Okay, and then Jim So I.
I mean, all the rails, you're dealing with the same volume issues no I look so far I think every rail has had better margin improvement then you so far in the third quarter, even though you're at Oh, a lower starting point. So do you feel like you're going so fast enough do you feel like you've got the right.
People to to get US here, so and then.
Another difference is sort of on the capital front is there with volumes week or are there opportunities to sort of change that there are capital spent.
We are.
Controlling the things that we can control and doing so aggressively so we've been through all of the expense savings initiatives, which for fruit in the in the third quarter him for the year to date.
And we will continue to push on all those things as hard as we must to get to that 60 operating ratio by 2021.
We've got a great team in place and everybody is aligned around our bottom line a shovel ready goals.
Oh.
Let's see the second part of your question Scott answer was yeah. Yeah. So we have previously talked about a range of 16% to 18% of revenue for capital spending what really matters. Here, obviously is a shareholder returns and return on capital. That's what we're managing to that's that's why we are targeting that level of capital spend.
Because we believe it is is the optimal range with capital spend relative to revenue.
To generate the return on capital in the shareholder returns were seeking to generate.
Oh, it's it's a range and in lead times, we may take it down somewhat within within that range.
But again, it really gets back to return on capital and our our goal of generating superior shareholder value.
Thank you. Our next question comes online Jordan Alger with Goldman Sachs. Please proceed with your question.
Yeah, Hi morning.
A question. So I know you've reiterated the 60 operating ratio on 2021, I'm just sort of curious if volumes stay kind of soft for at least the first part of.
Our next year I mean can you give some sort of sense for.
Yeah, how much you think oh, our and PSR benefits, Ken can push things in 2020, you know even with a.
Let's say first half continuing softness environment. Thanks.
We've spent a good deal of time already this morning talking about be efficiency initiatives.
Those that are well underway in phase two of soft 21.
Those will come to fruition 2020, so we will see the the full year benefit other expense savings from all of those initiatives, which we're we're pushing so hard on in 2019.
Then we get into phase three approximately one which will result in additional cost structural savings in 2021, and those will be again the drivers of further expense savings on roads 60 operating ratio.
Okay, and then just a quick follow up on intermodal.
Comps, obviously get pretty easy by middle of next year.
You know, if we get some truck capacity tightening and maybe spot pricing.
Turning to the other way a little bit.
Would you expect or can you potentially anticipate some sort of inflection, especially given where your network is on on rail intermodal volumes. I mean is that something that's conceivable as we move through next year again, assuming the economy is reasonably okay.
Well certainly.
Jordan, we are aligned with the best channel partners in the business and we're aligned with the steamship lines that are adding capacity to the east coast as you see a shift from the west coast of these guys. So.
We've got some strategic advantages to our intermodal franchise, which make it the best in the east and so absolutely as as the economy turns and we deliver a very strong service product to our customers. We anticipate that intermodal is going to remain a growth engine for Norfolk Southern intermodal revenues as you know.
Grew by 11% in 2017, and then followed that with an 18% growth last year, we've got a great franchise, great customers, it's going to continue to pay dividends for Fourq our shareholders.
Thank you. Our next question comes from the line of Ravi Shanker with Morgan Stanley . Please proceed with your question.
Hi, Thanks, Wendy I mean, one gates clarify your your current go to market strategy on price are you at a point, where you guys can come on the price you need to make the yield up targets without losing volume or do you think that's more of a 2020 or 2021 thing when there are more changes made to the network.
No.
Ravi we are very confident and our ability to price to a.
They vastly improved service product and we're providing our customers with a platform for growth you know take a look at our and our merchandise and that work in which the year over year rate of increase in price has improved for nine consecutive quarters and you also see it reflected in ARPU trends and revenue per ton.
I will trend. So we're intently focused on price even in this weak economic backdrop, because we've got a great franchise and they a great service product.
Got it none of the follow up you guys recently appointed.
Claude Mongeau do your board and disappointing your P.S., our strategy kind of where do you looking for from him.
No what role is he likes to play.
As I as I mentioned earlier quotas and Outstanding addition to our board with his extensive experience in the industry.
Yes operations knowledge and experience the same on finance side. So he will be a welcome addition, he is a welcome addition to our board and we'll bring all of that and more as we proceed through Rps her journey.
For the next couple of years and beyond.
Thank you. Our next question comes from the line a funny someone with BMO capital markets. Please proceed with your question.
Good morning.
Maybe Alan.
If it pricing in the intermodal business doesn't really improve lift truck pricing competition remains intense.
Getting intermodal margin improved to the level needed to achieve a 60% of car over the next couple of years and and and Ah If you're if your.
If you're a.
Looking on the operating side are there that's meaningful step that can be taken in the intermodal network.
Improve the or if you can maybe outline those.
No.
You know you take a look at the cyclical nature of that they trucking industry. We saw weakness in this and the spot truck market in 2011 in 2015, and 2019 and through all of that we continued to deliver year over year rate increases in intermodal every single quarter.
So we're very confident and the strength the unique strength of our intermodal franchise, our alignment with the best Channel partners in the business and we're going to cycle through this as I as we noted before our we grow revenue by 11% in 2017, and 18% and 28 and we've got a very strong franchise.
The spot market will will recover and we're going to be positioned for for growth because of the very strong service product that we're delivering.
Okay, and maybe just follow up on the operational side, you mentioned clean cheating and intermodal what does that exactly and pay Alvin.
And if it can describe to us what what is going on on the on the operating five that would give a gun to improve the the margin performance of that business.
Mike wants to come so on the intermodal terminals just like we did the clean sheeting of our merchandise terminals were looking at each terminal and making sure that we have the best practices across all the terminals in our intermodal network.
We we've got Oh, all the right processes and procedures and then once we do that will sink that up with the a train planned for more efficiencies going forward and and ER and the continued to deliver good service product same type. So it's kinda that deep dive into each one of the each one of the intermodal Charles using.
Good industrial engineering practices to make them as efficient as possible and more importantly, consistent best practices across all the intermodal terminals, Mike I'm very encouraged by this process, because we and our customers saw the benefits and the merchandise network as we claims she did the merchandising that where you saw reflected in a reader.
Suction and well you thought you saw reflected an increase in train speed and you saw it reflected in an improvement and our sci or customer facing service metrics and so I'm confident that we're going to continue to deliver the same as we apply the same principle story and metal franchise great point.
Thank you. Our next question comes from the line of Jason Seidl with Cowen and company. Please proceed with your question.
Oh, Thanks, operator, but hey, guys. Good morning, I wanted to talk a little bit about your teeny productivity you showed a slight improvement in 2019, you put a check that are saying you're sort of on track, but if we look out to your 2021 goal. That's a much larger step up could you walk us through how you guys playing on getting there.
Mike.
Yes, it's it's going to be the continuation of the things that we've done where we continue to look at increasing increasing the size of the trains and that drives a crew starts Dale.
Continuing the distributed power strategy, we're going to do more and more of that and that will drive train consolidations and then continue to look at our local and yard that work and making sure we're as efficient as possible. There. So and you know as we as we go through all this we uncover more on.
Opportunities and when we uncover those more opportunities.
We get into that we take the benefits of it and then we go the next step. So this has been a very good process for us to continue down that path and we will continue to do that we've got we've got more in the gas tank with all these.
Phases that we're talking about so yeah, we're going to get there.
Okay, and one of the jump a little bit tack on to Scotts Capex question going forward, Jim I think you mentioned.
A range of 16, 18% you know given what we've seen.
In the overall demand environment and the competitive truck market should we look at 2020 is probably be towards the lower end of that range.
Jason will will give you some weren't guidance on Capex expected capex when we meet again in January .
But let me say this is the majority of our of our capital budget as you well the great majority is replenishment capital spending including.
Our DC to AC conversion program.
Which is meant to will juvenate, our locomotive fleet. So for us that's it that's a pretty significant a line item in of itself in the capital budget or under the category sustaining capital spending.
And then of course, there's everything else that goes into a sustained franchise rail cost valves personal loans over the.
The growth piece of it or we will protect project, it's relatively small compared to the the sustaining capex.
But it needs to be part of the plan because we do aspire to grow and we believe we have growth prospects that will generate excellent shareholder returns downward.
[noise] maintain our next question comes on line of Chris Wetherbee with Citi. Please proceed with your question.
Hey, Thanks, Good morning, one to asking about head count obviously, you made some progress here and target further progress in the fourth quarter. When do you get a central maybe how you feel like the workforce is calibrated to the volume environment you assuming some degree of stabilization how much more is there to go as you kind of run through phase two in phase three of top 21 should we be thinking about her.
Thinking about sort of headcount through the beginning.
2020 [noise].
[noise] City one she once you go back over 100 or expecting or in the fourth quarter, reflecting a end of year versus your average added headcount in the fourth quarter versus last year.
And then talk a little bit about where the government yep well, Chris as I said, we expect the you're in headcount to be at 20 around 23300, which is 3200 less than the end of last year of 2018. So we've made you know obviously significant progress I mean, our original estimates for head count reduction.
This year were 500, so that has really been accelerating and obviously a big part of that structural there's been a there's been deductions associated with by him and you could moderate that is volume goes up.
Her down, but we certainly expect going into next year. So you've heard all the initiatives that Mike has talked about both in terms of T. Any as well as mechanical that we expect head count to continue to come down.
Yeah, we also want to be sure error.
Or when will grow freak.
So.
That's a balancing act and we want to be shouldn't we.
Population as as optimal yes, you can in a declining volume environment like we're in now what we also want to be confident that we can handle the business. When it comes back we believed that we have to reform for that for just that and that's it no responding appropriately in the current volume environment.
But we are also protecting our ability to handle the business when it returns down the road.
Okay. Okay. That's helpful. I appreciate it and then if I could turn to purchase services you know.
Up sequentially, although volumes were down one to get a sense the big.
On the cost side, you guys when you're thinking about sort of the plan. If it continues to roll out over the next few phases, how big an opportunity is that whether anything specific there or just kind of how can you go from here.
Cindy.
Well, Chris as we've talked before about purchase services like you'll say if you look at purchased services and rents we have seen big improvements as I mentioned before on equipment rents side, a 35 million dollar improvement a year over year and that's really been associated with just the improved velocity of of the network as well as.
Yeah, I'm getting a lot of these cars offline. So that has been favorable or we expect that to continue to be favorable going forward I'm parts and services in rats. There's this a lot of different things that are in that category.
From this volume dependent although not as much as you would think we if we have pointed out in the prior quarters that we've had additional.
Spending on the I.T. side, we're going to continue to develop invested I change and we've seen that on capital spending as well as in this particular item.
We think that that's really prudent investment to be making because it's supposed to some things that are going to improve the productivity of the workforce the reliability of our equipment and so forth. We didnt have you know we've had a little bit additional expenditure in purchasers and rent.
He shared it with freight cars, that's as we've taken freight cars offline and we had to trend then back at least since we've had some additional repair costs associated with that so.
Yeah, there's some puts and takes there, but you know overall I think you'll see purchased services.
We continue a similarly as we move forward sequentially.
Thank you our next question comes online.
<unk> with Deutsche Bank. Please proceed with your question.
Thanks, Thanks for squeezing me and I appreciate it I'm just a quick one the first one at least will be quick was there any impact in the quarter from the strike at General Motors I know auto volumes were actually up in the quarter and yield was kind of flat I didn't know if there was any anything to call out there with respect to stranded or unabsorbed costs related to that or even in the fourth quarter.
Yes.
Alamosa, yeah, the timing of that work stoppage will more.
More impact our volumes in the fourth quarter.
Any stranded costs associated with that that we should think about fourth quarter or not not not enough to call out.
No.
Okay, and then Jim.
I wanted to just if I could just follow up I think on the one of the very first questions and I think it's really the most important one with respect to your or targets for 2021 at least and has obviously in the context of you guys walking back. This year is our improvement so when we when we look back in February or February 11th when you did that the investor day in it.
Plan a you know you guys were very explicit about your revenue targets, 5% compounded annual growth rate for the entire business, 10% revenue growth in intermodal I was hoping that you could be I specific now.
10 months later, so or little bit less than that given what's happened in the revenue framework. How you know how the revenue side of the of the business rolls up to our target and I understand you know you're not going to use revenues excuse and there's a lot of productivity, but given how specific you were in February we'd appreciate it I think if you can give us.
Some sense of what that revenue roll up looks like now relative to the five and 10% growth you did in February that to get to that 60 target 60 by 2021 target South Florida, Florida.
I would say this first of all about the strategic land as with any such plan you assumptions. There are in our good for about as long as it takes the engine dry on the on the strategic plan. So you know conditions change business conditions change the revenue picture. The volume Fisher has trend change rather dramatically since we issued the the three year plan.
In February you, Josh you know, we've always said one of our hallmarks is flexibility and adjustability.
That's what we did in 2016, when we saw significant.
Volume decline and we responded with additional productivity initiatives in order to hit our goals. That's what we will do again.
At this time around.
Now we will review with you our revised macro assumptions in January .
Port on the fourth quarter results and we will give you our productivity goals our tier one metrics going forward for the next couple of years, we'll give you some high level assumptions with regard to revenue as part of the Atlanta as well.
Thank you. Our next question comes from the line of Tom Wadewitz with GBM. Please proceed with your question.
Hi, good morning, So Alan I wanted to get your thoughts on the export coal framework for 2020.
Just maybe if you could give us a sense about you know at current prices back tonnage.
[noise] down pretty meaningfully or you know if you look at seaborne prices do you think it's more of a hit two year Oh, yeah. The the revenue per per ton that you're achieving just maybe some broader thoughts about that and I don't know if you want to tied to you know I've met coal levels, and where you really have the sensitivity to a tonnage decline.
Fine.
[noise] comments that as I've talked about right at current prices. It makes it really difficult for U.S. coals to compete in the market folks on the with respect to thermal and metallurgical now we've talked before about some of the thermal contracts are effectively hedged, but not the contracts between the producers in the.
Receivers are effectively hedged through 2019, and so you will see pressure and the thermal market as we roll into 2020 and the the met market is going to follow demand overseas and the global economy, and as seaborne coking coal pricing and I'll provide a lot more color on that.
That on our fourth quarter earnings calls, we start talking about 2020.
Yes, I guess, if you look back you know just to kind of [noise].
Look at levels of export coal on nor folk and the 2015 16 area. You were kind of 15 16 million tons. You know I think 2019, you're running at a rate of like something like 24 million tons. So do you think this feels.
Like 15, 16 or would you say, hey, we haven't fallen to that level of feels better than that so you know just trying to get offensive.
You know the.
Right framework to consider given that there's obviously pressure on the export market.
Yes, there is pressure and.
We've been pretty clear about that let's let's just talk about coal broadly right now calls about 12% of our volume.
And export coal is about 25% of our coal volume so.
So there you are talking about a little bit less than 3% of our overall volume. It's important to us is important or franchise over we've got a very diverse franchise as we built out our intermodal network. So it's yeah I'll provide more color and more historical context on the outlook for export coal in the fourth quarter call yeah. They import.
Thing to consider is that we've got a great merchandise network, a great intermodal franchise, and we are securing price, reflecting the value of our product.
Thank you. Our next question comes from the line of Bascome majors with Susquehanna Financial Group. Please proceed with your question.
Yeah. Thank you on the receivables write off you took for the September jury ruling on the German coal trigger brace contract or is there any accruing revenue for liquidated damages in that this year and is there any go forward impact associated with that ruling.
Study.
Yeah, that's him a weve recognized that we think is the probable financial impact of that legal dispute.
Yeah.
<unk> was that all backward looking or is there some ongoing impact included in that charge.
That's a backward.
Thank you.
Thank you. Our next question comes from line of Ken Hoexter with Bank of America Merrill Lynch. Please proceed with your question.
Hi, good good morning, and I know all our has been hit a lot, but in an environment, where you're supposed to be significantly cutting costs and walking away from the 100 basis point improvement and your peer is doing 400 better basis points better excluding the real estate sales and you've got employees down 9% cars and trains are down.
And maybe talk about why is this not getting better or or Mike, but why are we not seeing a stair step improvement at this point given the changes you've made is it just that the coal margins are are impacting so much overwhelmingly gains or was there something else that constraining the ability to get that stair step improvement.
Well, what Ken certainly, we're dealing with a different sort of revenue and volume context and we're in the first so that's that's been a major major change we have responded aggressively to that change with the with the resource reductions we've been through this morning.
Positions locomotives freight cars materials, all favorable inexpensive so you're seeing you're seeing the momentum.
In expense reductions from our acceleration of various initiatives with more to come.
We still do you expect to see operating ratio for the full year, but because of the additional expenses that we've been through this one in the fourth quarter.
We don't expect to meet the a at least 100 basis points goal, but you don't that does not diminish our confidence we can get to 60 operating ratio by 2021.
And then I guess, maybe Alan.
Given that volumes have gotten worse now here sequentially at and seemingly at an accelerating pace I don't know if there was this is related to the derailments any talked about but you're now down 8% quarter to date I know, it's only a couple of weeks in the fourth quarter, but down from 5% to 6%.
Call, Steve seems to be staying down mid teens, but Alan you mentioned things are still ugly, but are things getting.
Worse at an accelerating pace, just looking at intermodal and and AG and some of the other commodities outside of kinda autos from the strike. It just seems like where we're accelerating on the downside maybe your view on the on on economic side.
It can what we're not really saying it is much of a peak within the intermodal franchise and so so that is certainly have any impact on volumes and year over year comps.
Thank you ladies and gentlemen, this does conclude our question and answer session on I'll turn the floor back to Mr. Squires for any closing comments.
I want to thank you all from your questions and for participating in today's call them. We look forward to speaking with you again in January thank you.
Thank you. This [laughter] today's teleconference. You may disconnect your lines at this time. Thank you for your participation.