Q1 2020 Earnings Call
Greetings and welcome to Norfolk, Southern corporations first quarter Twentytwenty earnings Conference call.
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A brief question answer session will follow the formal presentation.
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It's now my pleasure to introduce Pete Sharable director of Investor Relations. Thank you Mr. trouble you may begin.
Thank you and good morning, everyone.
Please note the during today's call we may make certain forward looking statements, which are subject to risks and uncertainties and may differ materially from actual results.
Please refer to our annual and quarterly reports filed with the FCC for a full discussion of those risks and uncertainties, we view as most important.
Our presentation slides are available Norfolk, Southern Dot com any investor section along with our non-GAAP reconciliation.
Additionally, a transcript and downloads will be posted after the call.
It is now my pleasure to introduce Norfolk, Southern's, Chairman, President and CEO, Jim Squires.
Good morning, everyone and welcome to Norfolk, Southern's first quarter 2020 earnings call.
Joining me today, our Allen Shah Chief Marketing Officer, Mike Wheeler, Chief operating Officer, and Mark, Georgia, Chief Financial Officer.
Before we discuss our financial results I'd first like to thank our employees for their dedication during these unprecedented times.
Norfolk Southern employees are proud to be delivering and a central service.
In a video message to employees dispatch or Misty Braden expressed the sentiment well when she said we supply America with the goods that they are shored up right now and I hope everybody that works for Norfolk, Southern feels a central after this.
It is truly inspirational to watch our employees rise to the challenge.
In response to the Cobot 19 pandemic, we established three simple goals early on protect our employees.
Serve our customers and exercise strong financial discipline.
I'll talk briefly about the steps, we're taking in each area.
Our first responsibility is to protect our people. We acted quickly based on CDC guidelines and took extensive measures to keep employees safe.
We transitioned to most of our office employees to remote work in a matter of days.
For employees, whose jobs require them to work on site, we implemented social distancing and established rigorous cleaning protocols for their work environments.
Our preventive measures combined with the diligence of our employees have kept the number of confirmed cobot 19 cases at Norfolk Southern low.
I'm also pleased to report that our employees are working safely through the many potential distractions.
Our thoughts are with all those whose lives have been impacted by the virus.
Our second goal is to continue providing an excellent service product for our customers and that's exactly what we're doing.
Our customers are making rapid adjustments to their operations due to the impacts of the <unk> virus and we're right there with them every day as a valued partner.
They count on us for reliable service close collaboration and nimble operational adjustments and we're delivering.
We'll address our third goal, which is to exercise strong financial discipline throughout the balance of this call.
The work we've done to implement our strategic plan has made us and even more resilient business, putting us in a good position to navigate the current market disruptions.
I'll now turn to our financial results for the quarter.
Allow me to first remind everyone of our announcement on April 16th, but noncash charge of $385 million related to the ongoing disposition of 703 locomotives.
Thanks to the excellent execution of our strategic plan our fleet today, it's more efficient and were able to operate with significantly fewer locomotives.
Mark will provide additional color, but as you can see on slide five we've provided an adjusted view of our financials to exclude this charge. This is what I will reference in the rest of my comments this morning.
Adjusted EPS for the quarter was $2.58 and the adjusted operating ratio was 63.7%.
These numbers improved upon last year's record results by 3% and 230 basis points respectively.
Within the context of an 11% volume decline they are remarkable achievements that demonstrate this team's urgency to transform our company.
We also set records and metrics such as screen performance terminal dwell and shipment consistency among others and accelerated crews start reductions in excess of declining volumes for a third straight quarter.
When coupled with the ongoing realignment of resources around our new operating model, we reduced operating expenses by $202 million in the first quarter when excluding the noncash locomotive charge.
Our team is committed to driving improvements across the network and significantly and consistently lowering our operating ratio.
We're focused on the factors within our control and confident that by continuing to adjust and successfully execute our strategic plan. We're building a stronger more resilient and a more profitable Norfolk southern.
I'll now turn the call over to Alan and the team to begin detailing our first quarter results and our progress executing the strategic plan.
Hi.
Thank you Jim good morning, everyone.
First quarter started what the impact of low natural gas prices and mild weather on our coal franchise in February we saw the initial impacts of the covert 19 crisis impacting international intermodal volume.
It's cobot 19 evolve into a global pandemic majority of our markets experienced volume declines with business levels further impacted by plummeting energy prices.
In the face of this challenging environment, we're flexible and responsive to market changes and customer needs adjusting our operating plan of resources where necessary.
We remain focused on our long term strategy with an emphasis on superior service to our customers and margin improvement demonstrated by consistent growth in revenue per unit and revenue per revenue ton mile over the last three years.
Our services the best in Norfolk Southern history.
<unk> to the commitment of our employees to respond to rapidly evolving customer requirements and deliver an exceptional service product.
Well, producing structural and volume metric improvements to our costs.
Moving to slide seven the impacts of Cobot, 19, energy and excess truck capacity lowered our revenue by 8%.
With the volume decline, partially offset by our P less fuel gross and all three business groups.
Marking our 13th consecutive quarter of delivering year over year ARPU growth.
Merchandise revenue was down 1%.
Its record RP, you, partially offset a 5% volume decrease.
Automotive Carlos declined due to plant shutdowns late in the quarter in response to covert 19.
Steel volumes continued to be impacted by weak demand in frac sand faced pressure from low energy prices, while favorable spreads allow to increases in crude oil volumes.
Intermodal revenue declined 9% driven by a loose truck market lower demand and the early negative impacts of covert 19 in our international group.
ARPU gains propelled by our strong service product.
Offset some of the impacts of the volume decline.
Coal volumes and revenue were both down 31% year over year.
Driven by extremely low natural gas prices throughout the mild winter.
Our export franchise also experienced slight volume losses due to low seaborne prices.
Moving to our outlook on slide eight we continue to monitor monitor the combination of cobot, 19, pandemic and energy decline and the unprecedented impact on our markets.
We projected year over year volume declines across all business groups with large impacts in the second quarter and future volumes dependent upon the depth of the downturn and the timing of the reopening of the economy.
As well as energy prices.
We are partnering with our customers to affect necessary short term adjustments that allow for quick and decisive reactions to market changes.
Remaining in close collaboration with our customers and economic allies that place their confidence in Norfolk seller.
The chart on slide eight classifies our markets by revenue and the sensitivity to both cobot 19 and energy.
The agriculture forced and consumer group includes among other markets food products.
Which remained in high demand and ethanol, which will decline due to demand and energy prices.
Lower consumer spending and disruptions in the supply chain will likely continue to impact automotive intermodal and other consumer driven products.
Intermodal will be further influenced by low oil prices and the associated competitive dynamics with truck.
Shutdowns in automotive another other manufacturing will drive declines in the already saw steel market.
Our crude market will be adversely impacted by low energy prices and decreased demand from cobot 19 disruptions.
Natural gas prices, a mild weather, coupled with declining industrial and commercial load will negatively impact our utility market.
Lastly, export coal will continue to be pressured by lower seaborne coal prices and cobot 19.
We maintain strong customer relationships built collaboration and constant communication, which facilitated our flawless implementation of PSR last year.
We continue this approach as we adjust our network to conserve resources, while continuing to meet our customers' needs.
The economic headwinds will significantly impact 2020 revenue the strength of our franchise our commitment to collaboration deep customer relationships and superior service product provide the foundation for success through this downturn and as economic conditions improve.
Our portfolio ranges from the most powerful intermodal franchise in the east.
Two broad participation and over 50% of the consumer industrial and energy markets that drive the U.S. economy.
We are leveraging our deep market knowledge to partner with our customers innovate logistics solutions for evolving slide supply chain requirements, securing new opportunities in the near term and for when markets normalize.
I will now turn it over to Mike for an update on operations.
Thank you Alan.
Today I'll update you on the state of our operations.
First quarter continued our story of superior service and improved cost structure, leading to increased operational leverage even in the face of declining volumes.
We are continually improving our operating plan and using PSR principles to deliver superior execution.
Going to slide 10 continued improvements in train speed and terminal dwell despite tougher year over year comps drove record quarterly terminal dwell train performance customer service at the car load level and unprecedented executional success in this.
Service sensitive intermodal segment.
We achieved these milestones with fewer assets and lower employment levels.
Further, reducing our cost structure and driving efficiency.
These trends have continued into the second quarter.
Moving onto our service and productivity metrics on slide 11, which I have shared with you in prior calls.
These metrics measure important productivity and customer service levels and are indicators of our success meeting our productivity goals.
The service delivery index measures, our on time performance at the shipment level and as index to 2018.
Our first quarter 2020 performance is at our 2021 goal and we are confident they will maintain these service levels throughout the year.
Our lowest teeny head count on record drive substantial year over year productivity, while still providing stellar service.
As I will show you on the next slide we continue to aggressively size, our train plan to the changing business levels.
We continued our momentum of train weight improvements showing further progress in the first quarter.
Remember that we re targeted this goal to 6700 tons in light of continued changes in the coal market.
Productivity driven by our top 21 operating plan will boost us towards this goal. Despite the challenges of the current volume environment.
We made considerable progress in locomotive productivity in 2019 by rationalizing our fleet.
A trend that continued in the first quarter of 2020.
Our active locomotive fleet is almost 15% lower and Twentytwenty then in the first quarter of 2019.
And our recent locomotive disposition announcement reinforces our commitment to getting the most out of our fleet.
We also thought it will be useful to show you our year over year progress in fuel efficiency.
This is an area of focus for us and the improvements in gallons per ton mile reflect the results of efforts on many fronts, including increased train weight continued rationalization of the DC to AC upgrade of our locomotive fleet.
Increased use of energy management technology, and completion of our full PTC footprint.
Finally, even after we raised the bar on the cars online goal, we continue to beat our targets.
First quarter results were measurably better than goal and we set a new record earlier this month.
To be clear. This count includes cars in storage that can be brought out as business rebounds.
Slide 12 shows our fifth consecutive quarter of accelerated reductions in crew starts we're continuously improving our top 21 plan and are now completing phase three of the program.
This will deliver the three phases of the program in 18 months instead of the anticipated three years.
The first quarter saw 19% fewer crew starts showing increased leverage between crew starts and volume.
After we complete phase three of top 21, we will continue to optimize the operating plan in part by combining traffic of all types on single trains and reviewing our yard network for further rationalization.
Before I shifted discussing Norfolk Southern's operational response to the Cobot 19 pandemic I want to emphasize our positive operational momentum.
We're making progress through long term structural changes in our asset base service levels and productivity drivers.
We will continue to build on our progress from 2019, following PSR principles, while proactively adapting our operating plan to the economic environment.
Turning to slide 13, I'm very proud of how Norfolk Southern's Railroaders have dealt with both the threat in the business impact as a pandemic.
We took early proactive measures to protect our workforce and make sure that been at work continued to be the safest part of the Nineth employees day, because railroad was very fluid and service levels were very high we were able to quickly store surplus equipment, while also mobilized in employee.
I used to provide extra manpower in hot zones like Northern New Jersey.
We made special efforts to assist customers.
Expediting shipments of goods in short supply or that were urgently needed.
All the while we maintain service levels and the railroad has run even faster in April.
As you can see on slide 14, the pandemic also mandated a proactive response to the drop in volume tactically, we very quickly over just a few days remove the blocks and trains Caribbean auto parts in finished vehicles from our top 21 plan.
Crew starts dropped almost as quickly as volume, enabling us to preserve leverage even a shipment counts declined.
We will again redesign the operating plan is auto volume rebounds, using our operating levers to handle returning volumes in the most efficient way possible.
While we do not yet know the shape of the recovery curve. We're taking this time of lower traffic has an opportunity to challenge ourselves.
And our capabilities to improve our top 21 operating plan in the long term.
For example, we are successfully handling carload traffic on premium intermodal trains lending previously separate service networks in a way that allows us to maintain service frequency and train size, while reducing costs.
In addition, we're taking hard looks at our yard and terminal network testing, what we can live without.
I'll now turn it over to Mark who will cover the financials.
Thank you and good morning, everyone.
Before I get into the review of adjusted financials, just a moment to talk about the locomotive write down that we disclose two weeks ago.
Simply said, it's a capacity dividend of our top 21 PSR implementation.
Which has resulted in the decongestant of our yards and road network, allowing cars to turn quicker in the terminals and trains to move faster on the network.
The blending of our discrete networks resulted in fewer but longer trains fewer trains along with better balancing of our routes require fewer locomotives.
We entered 2020 with roughly 1000 locomotives on the sidelines out of the approximate fleet of 3900.
We spent time this quarter aligning on exactly how many locomotives we would need even at 2018 volume levels.
Our operations team essentially model the capacity requirements.
Post PSR world.
And determined that of our stored locomotives 703 are deemed excess and available for sale. While the balance are held for surge and in cycle for AC upgrades.
In fact 298 of the seven to three were effectively sold in Q1.
While the remaining will be marketed for sale or scrapped in the next 12 months.
The 385 million is essentially the remaining book value on those locomotives that otherwise would have been depreciated in the piano in the years to come.
In the process the team targeted removal of the oldest leased reliable at least efficient of the locomotives and eliminated entire model lines moving us to a more homogenous fleet of 10 models from 19.
With that we were able to also eliminate inventory and rationalize mechanical resources.
So moving now to slide 17.
And the remaining slides will reflect adjusted results excluding the impact from the locomotive right though.
Recall this slide format, we introduced last quarter to show large and anomalous events that impact our results.
There is just one item in the quarter worth calling out.
And that as a onetime benefit on an income tax refund related to the 2012 tax year.
That provide a nine cents a vps tailwind in the quarter and contributed to the 12.6% effective tax rate.
No other meaningful adjustments in Q1 of 2019 or 2020, so the improvement in the operating ratio of 230 basis points was core.
Now moving to the adjusted results on Slide 18, a very strong operational quarter as both Jim and Mike described earlier.
Revenue was down 8% driven by an 11% volume contraction that was partially offset by the strong ARPU improvement that Alan spoke to thanks to our effective yield up strategy enabled by our enhanced customer service delivery.
Operating expenses were 11% lower almost mitigating the revenue decline in dollar terms.
And that resulted in the strong 230 basis point or improvement.
Which follows the 240 basis point core or improvement we showed in Q4, despite a softer environment during that time.
And you see on the right very strong free cash flow performance, a record $589 million, which is 42% greater than Q1 of last year.
So now drilling into the operating expense categories on slide 19.
We drove down compensation of benefits in the quarter, 14% year over year on a 19% reduction in employees versus Q1 of 29 team.
Employee count was down 6% sequentially from Q4.
Our employment levels decline throughout the quarter and this below with lower costs associated with benefits overtime re crews and incentive compensation saved us $105 million.
Fuel was down 61 million from a combination of lower prices as well as lower consumption from both volume and.
And also efficiency gains.
Consumption declined 15% on the 10% decrease in GTM, despite significant adverse commodity mix.
Materials and other spending was down 24 million or 13%.
Led by a $15 million reduction in material spend.
Gains on operating properties amounted to $11 million, which was lower than the $17 million recorded in Q1 of 29 team.
Purchased services, and Rins was down 21 million or 5%.
With purchase services alone down 7%.
Rents were actually up 5% in the quarter due to lower equity income from the TTX joint venture that more than offset savings from lower rent spend.
So when looking at the Big picture the underlying change to our cost structure continues to shine through in the first quarter.
As we reduce and realign resources around our new operating model.
Moving to slide 20, let's take a look at our summarized first quarter financial results below the income from operations line.
Other income was down $22 million from lower investment returns on corporate owned life insurance.
And the lower effective tax rate of 12.6% was driven by the refund I discussed earlier as well as benefits from stock based compensation.
This first quarter low MTR will provide benefit to the full year effective tax rate as we expect the remaining quarters to return to the guidance range of 23% to 24%.
Moving now to slide 21 as mentioned, we generated a record Q1 free cash flow of $589 million. Thanks to expanding margins, but also from constraining, our capital spend which was $100 million less than last year.
And we returned $708 million to shareholders in the quarter with a solid dividend bolstered by our continued share repurchase activity.
Now, let's talk outlook on slide 22.
Obviously, the economic environment has progressively worse and here in Q2.
And while we can't be certain of the severity and duration of the downturn in 2020.
We do know that revenue will be much lower than we thought at the beginning of the year.
So we get pulled our guidance for flat revenue for 2020, as well as the guidance for or improvement.
We are modeling a number of revenues scenarios. So that we are positioned to respond as a scenario starts to play out.
We are focused on what we can control.
Service and costs.
We feel that with modest revenue contractions, we can manage to match it with cost takeout.
But steep revenue declines you just can't keep up with certainly not in the short term.
To help you in your modeling and for illustrative purposes you.
You see the piano cost categories that provide a general sense, how they are correlated to volume changes.
Most categories have an element of cost that is directly tied to volume.
And on a mostly immediate basis fuel being the most obvious.
But there are also structural components that take longer to move.
As well as gray areas that are also subject to volume.
But pretty dependent on management decisions that are influenced by the expected duration of the downturn in the anticipated pace of recovery.
We never want to cut in a way, where we can handle volume when a recovery occurs which would then adversely impact customer service.
And we absolutely won't compromise on network safety.
In aggregate roughly 50% to 60% of our costs could be categorized as volume variable and semi variable.
The balance a structural cost and there's a reason I refer to this category as structural instead of fixed which connotes permanent.
We have been and continue to work on structural costs trying to eliminate not just variablize, though.
And we are looking at all structural buckets, including even the biggest one depreciation.
The category that many we'll consider truly fixed.
We have to look at how we can keep this bar from getting faster.
And certainly adding fewer assets overtime helps.
But there are even unique opportunities to make it skinnier.
Our recent locomotive action for example will generate roughly $25 million of annual depreciation savings.
Going forward.
So all structural cost is under constant review by this committed leadership team that's dedicated to evaluating all opportunities.
So while a deep revenue decline may put short term pressure on the Omar I have every confidence that when we're on the other side of this market dislocation.
We will be coiled up with great operating leverage to deliver significant or improvement.
Let me wrap on slide 23.
Given the steep drop in the markets and the lack of clarity on the slope of recovery, it's important to share with you a bit about our financial standing.
On top of significant expansion of free cash flow generation. We also maintained a solid balance sheet with good debt capacity and robust access to credit markets.
We have relatively light levels of debt maturities in the next two years.
More importantly, we have already significantly dial back on our capital spend budget for 2020, recognizing the challenging environment that we are entering.
Property additions will be limited to roughly 1.5 billion. This year, regardless of revenue, which is a reduction from our 2019 spending levels by $500 million or 25%.
It's the right thing to do it would be the lowest level of spend in absolute dollars since 2010.
While not jeopardizing safety service or near term revenue opportunities.
So we feel real good about our liquidity and our ability to weather the storm.
Thank you ill turn the call back over to Jim.
Thank you Mark there's much for us to be proud of in our report today from our strong first quarter financial performance to the incredible job the men and women of Norfolk Southern are doing to keep the trains running.
Our industry faces a difficult volume environment with an uncertain trajectory.
By executing our strategic plan exercising capital discipline, and serving our customers well Norfolk southern is poised to emerge stronger and ready for growth as the economy recovers.
Thank you for your attention and we'll now open the line for Q and a operator.
Thank you we will now be conducting a question and answer session.
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Due to the number of analysts joining us on the call today, we will be limiting every one to one primary question and one follow up question to accommodate as many participants as possible.
Thank you. Our first question is from Jason Seidl of Cowen. Please go ahead.
Thank you operator, gentlemen, good morning, I hope everyone is doing well.
I wanted to.
Jump on the outlook question I think one of you mentioned.
Sort of not cutting too much.
Into the system not only for safety, but to handle.
The rebound whenever it does come.
How much in expenses do you think you're holding in anticipation of that lets see if you look at the automotive sector for example plans being shut down.
How much more expenses as Norfolk sort of maintaining right now and how do you think about.
Forecasting some of these areas for us for headcount or equipment demand.
Good morning, Jason It's Jim.
We are committed to managing our volume variable and structural cost through this downturn. So you saw evidence of that in the first quarter with adjusted expense reductions totaling 202 million. We are pulling every lever at our disposal when it comes to cost reductions in this environment and that's the right thing to do.
Given the trend in the revenue this year's Nevertheless, we do.
We believe we're capable of responding to it to the upturn, which will come as volume growth resumes, we expect to generate significant operating leverage and that will result in rapid margin improvement and bottom line growth.
And right now are you guys looking at the anticipated rebound because clearly we're going to see GQ, that's going to take a big step down right from even from.
Weakness in one Q, what does Norfolk looking forward in terms of it.
A gradual recovery and how should we think about headcount throughout the system as we move throughout the quarters.
Well growth will resume and when it does as I said, we will have the resources in place and we expect to generate significant operating leverage.
Let me, let me talk a little bit further about kind of next steps in terms of cost reductions and I'll ask Alan to comment on the topline outlook.
So we're pressing the top 21 accelerator right now and that as Mike said that means crew start reductions going forward a hard look at our yard and facilities network blending more trains the kind of step straight out of the PSR playbook to continue to drive down costs. So Alan what about the the revenue outlook and good morning, Jason We're we're still.
Very tight with our customers add modulating our expenses appropriately because we're going to make sure that were there as they start to recover the first step would be say reopening within auto manufacturing and Thats generally targeted to start slowly in the middle of may that should pull some additional raw materials or the pipeline.
As well say steel for example on some plastics and then as as I noted on slide eight you know really is about just the reopening of the economy and a improvement in energy prices resolution of that is is open ended and so it remains critical for us to state close and tight with.
Customers as as we plan going forward.
The next question is from Allison Landry of Credit Suisse. Please go ahead.
Good morning, Thank you.
Good progress on the improvement in and the first quarter.
So I know you with you that that 2020 guidance expect some near term margin pressure, but I don't think I heard you comment on that 2021, our guidance. So is this intact and do you think 60 is still achievable.
Good morning, Allison, we did not pull our guidance for 60 in 2021, and we're still focused on getting to a 60, our as fast as we can the timing and shape of the recovery, we will likely have an impact for sure, but but one things for certain as I said, we get to the other side of this and growth resumes our operating leverage will be very powerful and should drive.
Rapid or improvement and bottom line growth.
Okay.
And then just sort of in light of the collapse in volumes are you seeing any increase where there's been some customers with respect to the yield up strategy I.
I think we've heard from from a number of shippers that said there being asked our monthly volume commitment liquidated damages in exchange for one year contracts. So just hoping to get your thoughts on whether this is leading to some share losses to drop and if you're considering any changes to the pricing strategy in order to keep more volume on the network. Thank you.
Also there are lot of unknowns and the market space right now.
Our critical role in the nations economy, and our customer supply chains is clearly evident right now that is not an unknown we are pricing.
Value of our product, we're pricing to the value of our franchise and we're very confident in our understanding of the market.
We are maintaining a long term view of this and were made is maintaining that long term view of our business decisions to benefit our shareholders. We understand that eventually we're going to cycle through this market and we've got a great franchise and a great approach to support our customers growth when that occurs.
The next question is from Scott Group of Wolfe Research. Please go ahead.
Hey, Thanks morning, guys. So I want to ask a few things on on the cost side, maybe just starting with with labor.
Comp employee was up 6% sequentially.
Six restarts, our 6% year over year any thoughts on how we should be thinking about comp per employee going forward.
And then any thoughts on.
Where what you're doing with head count right now and given the volume environment.
Mark.
Yes, Scott.
Youre right the comp for employee did move 6% sequentially, but remember these are quarter to quarter. In particular is is very lumpy.
And you're always going to have some noise on the timing of when you have.
Incentive accrual top ups or write backs so.
Thank you Gotta look at it more over time when you look at it over time, you're always going to be fighting inflation.
Wage inflation, so thats certainly something that we're dealing with every year.
And but but generally we're really shifting our focus to the absolute cup event numbers, which.
As you know have gone down and continue to decline in part from the volume, but in particular from the PSR.
Actions that we've taken.
I guess im not sure I fall so like so as we think about going forward.
It was I guess was there anything unusual in this first quarter on the comp for.
Copper employee or should we assume like this level continues.
Forward.
Meaning so look I think getting into four in the first quarter, you had headcount down 6% sequentially, but I think labor costs total labor costs to your point were only down one or 2% sequentially.
You had some incentive accrual disparities between quarters. So that's one thing we're in Q4 you had.
Based on the way the year ended.
You ended up having a benefit or pick up from writing back some of the incentive accruals.
So that certainly drop the Q4 number and creates a little bit of a tougher compare sequentially.
I think from here, you'll see that it's going to be more even throughout the year.
The next question is from Brian Ossenbeck of JP Morgan. Please proceed with your question.
Yes.
Hey, good morning, Thanks for taking my question.
Mark can you go back to the locomotive side, and maybe just walk us through the potential benefits that some of the you may be recognized already are called out like the depreciation.
And then can lay out the different components on the labor side, maybe even further on the DNA side on efficiency side for fuel and just how do you think about what this has done for Norfolk, So far and what it could represent in the future caused this year next year as it rolls out completely.
Sure I mean.
We talk a little bit about the locomotives first and.
Yes, we took out 250 locomotives last year as we launched the top 21 strategic plan.
And.
Mainly those were on the sidelines, but they were with a lot of other locomotives that we had on the sidelines. We knew that every quarter throughout this year, we were probably going to see.
We're going to convince ourselves that we were going to have more and more surplus locomotives, so rather than leak it out over time.
We really held hands as an organization and said look.
We've got very good progress here.
Liberating assets in the field.
Where can we be.
In a post PSR world.
With regard to locomotive needs.
And.
There were several iterations I think the PSR experts that we have in house really push the envelope and said look we know where we can get too. So we had a thousand when we started the year on the sidelines.
The numbers initially started with 400, maybe maybe 450.
The team iterative several times and ultimately got back to a number of 703, where we said that is absolutely doable. Even if we go back to 2018 volume levels, we can still manage with the remaining fleet.
So we decided rather than just like this out over time to take a look at it was clearly a significant portion of the of that particular asset base. So we decided the right thing to do the appropriate thing to do.
It's actually pull it out of group accounting and and write it off.
The benefit of doing that.
First off as we get the organization focused on removing assets and I think thats a very important thing for for any company. When you have surplus acts assets is to eradicate because assets attract cost you guys aren't congestion in our case, you've got network congestion by parking all these excess locomotives, let's commit to get.
Rid of them quickly and then they will attract less cost less maintenance and less attention and less property tax whatever.
Whatever you can assigned to it will end up being savings so its healthier just to get.
So recognize what surplus upfront and move as quick as possible to remove.
From the from the company's properties.
And then.
By removing them from group accounting you also now have taken that 385 million dollar asset.
And you avoid depreciating it over many years and edge absorbing it into your remaining assets. It seems like it's a it's a very unusual form of counting thats relatively unique to to our industry.
There you have group accounting.
Attaching.
Excess book value from discarded assets to remaining assets and depreciating further overtime. So we avoid doing that we get rid of it we get appreciation.
If it in the future.
So that's really.
How this came about.
Okay and can you offer any any commentary on just what that means for.
Maintenance or mechanical resources fuel economy going from.
Two more homogenous fleet in any anything beyond the DNA that you're looking to.
Realize in the next couple of quarters or intent to 21.
Yes, clearly clearly they attract less maintenance and.
Part of that 385 million was a little bit of inventory that went for the for the model lines that are no longer here the seven model lines, we eliminated.
So thats another trailing benefit that we have.
And but yes, clearly we're going to have some mechanical benefit from this savings that arise from having.
Fewer locomotives and have more streamlined fleet model, what maybe Mike you want to make some comments, yes, I mean, it helps your whole material network, because you're managing less less materials with less models lot of these models were smaller smaller type models and so that helps should be efficient and it's also going to help or a shot footprint going for.
Orders, we continue to rationalize that you've heard some of things we're doing there and those are coming to fruition now and those will help that as well. So yes, there's a lot ancillary benefits to this going forward.
Remember, Brian we got rid of 300 to those already in Q1 to the physical assets have been removed.
And there's just the remaining 400 now that over the next 12 months hopefully the next nine months or so.
I will follow.
The next question is from David Ross of Stifel. Please proceed with your question.
Good morning, gentlemen.
To talk little bit about phase three of top 21, we mentioned combining.
The cars of all different types onto a single train.
Where are you in that process has that been done yet whats left and how might mix in the second quarters, you're doing this.
I would say not look normal depending on the restarted the economy in which commodity types come back online and in is that youre going to create any issues. It completing phase three.
Well, Mike went through the the steps that we've taken under top 21, and essentially we have completed all of the network redesign.
To this point that we had mapped out through 2021, so all all phases of top 21 that we had initially signal we would implement we have implemented at this point going forward. Our focus as we've said is on additional crew start reductions blending more trends.
Hard look at the facilities, we use the yards, we used to support network operations, Mike anything dead, Yes, we've been talking with you on all the quarters about our blending of our networks. You know, we first started talking about blending bulk into the general into the general merchandise and we did that and then we started blending the automotive into the.
General merchandise as well and that was a big part of of top 21 last year very successful and as we've continued on Weve blended weve blended general merchandise and bulk into the intermodal network. That's been very successful and then now we're in the process of blending.
Traffic even into our premium network. So we are really blended all the different traffic types into our network. So work to the point now where a train is a train so those are.
Our phase three implementation is really in place and the beauty of this as you go forward in traffic comes back we are blended now the train as a train in it can ride on a train the is it the right service requirement that it needs, but also as efficient as efficient as it can be so we're real.
Early in a good place with that with our network with the.
Top 21 implementation and going forward, we're just going to continue to optimize the network is traffic as traffic comes back on a David if I could add one thing. It also benefits us in our customers and that it provides us with a broader product offerings and no longer do we need to find enough density for.
Hey point to point intermodal Trey, we could find smaller blocks of intermodal and put it on a merchandise training and open up some lines, which we're doing.
That's great color. Thank you.
The next question is from Jordan earlier of Goldman Sachs. Please go ahead.
Yes, Hi, I just wanted to follow up a bit on on the price for the yield question a bit.
Obviously volumes have been impacted.
Pretty heavily hearing thus far as he said I think mentioned, Dan that 30%, which which is trailing the industry at to some degree and just curious at Santander yields are tending to be better. So I'm just curious at sending the volume discrepancy maybe related to that or how do you deal with price or yield.
In the face of means.
Steep declines going forward. Thanks.
Jordan at Norfolk, Southern we are fierce competitors and we're determined to make decisions and the long term best interest of our shareholders. We've got a deep knowledge of our markets and we're confident in.
And our ability to price to the value of our service product, which is outstanding and our franchise with a focus on margin improvement and also provide our customers with the platform for growth and you can see this in our ARPU and revenue for revenue ton mile trends over the last three years, I'd say stay consistent and a strategic approach for.
For us there are some specific market forces that are impacting our volumes last year, 60% of our call volume was and the utility coal network that volume was down 44% and the first quarter of this year.
Yeah, we participate and the energy markets, whether thats, frac sand or ethanol and those have been pressured they've been pressured for much of the year as I called out and separately. We also are highly integrated with customers who are integrated steel mills. So.
That has taken a a hit throughout the year Bob.
One thing to point out as we are running against our toughest year over year comps.
The year I believe we 20 of last year. So mid May was our highest volume week of the year. So that that's causing part of the volume decline year over year, but we also understand it is important to note that our opportunities are within that 800 billion dollar plus truck and logistics.
Market, we've got the most powerful intermodal franchise in the east and as you know we are aligned with a best channel partners in the industry. We've got a diverse merchandise network with a great service product.
Staying very close to our customers and we're collaborating with them right now a near term opportunities as they adjust the supply chain dislocations and our longer term opportunities. So we're confident about where we're headed.
Thank you.
The next question is from Brandon Oglenski of Barclays. Please proceed with your question.
Hey, good morning, and thanks for taking my question on I guess, if we could just follow up there, though I mean in an environment coming out of post coded are you talked with your customers right now about what's going to take for recovery and get them back up to prior volume levels and does that include changes in service patterns or pricing or no.
I guess, what's the path forward once we get beyond the shutdowns here.
Yes, right I think you are going to see some differences and supply chain requirements moving forward there is going to be potentially more forward position positioning there's got to be more an emphasis on reliability consistency and frankly that benefits Norfolk southern because we've got the best intermodal.
Franchise in the east.
And when the recovery happens people are going to be focused on capacity cost service and ESG and Norfolk Southern offers all of that relative to our primary form of competition, which is which is truck. So we touch over 50% of the consumption and the manufacturing and.
Economy, we're staying close to our customers even now we're we're launching innovative service products. So we're pretty confident about where things are headed once the economy reopens.
Okay I appreciate that and then maybe fault for marker. Jim you guys did say that some of your cost variability is dependent on service product that Cetaceans and Jimmy I thought was pretty bullish that.
Backing off of the 2021 of our target. So I guess are you putting a cost structure in place where you see line of sight to achieving that type of operating ratio.
Some sort of volume level in the future.
Well the the question.
It is not yet, but when we get to 60 operating ratio that remains our goal we're going to get there as quickly as we can and yes that will be through a leaner cost structure.
With the kinds of cost structural initiatives that we've been through this morning.
And so yes, that's very much part of the.
Part of the outlook and we believe we will have strong operating leverage when growth resumes, which it will.
Alright, thank you.
The next question comes from Bascome majors Susquehanna. Please proceed with your question.
Yes, thanks for taking my questions Mark most of the class ones that pulled the guidance like you did today, but several have continued to provide investors with some sort of framework to think about kind of a worst case free cash flow scenario in their own stress tests of the business. How should we think about free cash flow for Norfolk This year.
Thanks, Thats gone so.
We model to a number of different scenarios.
And we haven't picked one because we know whatever what we pick will be wrong.
But weve modeled.
High single digit declines to to mid upper teen declines on revenue and volumes to two twentys and Thirtys and in all those circumstances in cases, you're going to see that.
We've modeled freak positive cash flow contribution, we're going to grow cash flow. This year, regardless, but one thing we are doing is to preserve cash.
You would have noticed we've really taken a significant chunk out of capital expenditures this year to make sure that we maintain the proper balance and we augment our liquidity and certainly what is going to be an uncertain time, because we don't know how deep this will go and how long it will last before recovery.
Begins again, so in pretty much all those scenarios, we modeled we're still generating positive cash flow and positive free cash flow.
And we feel actually very good about our whole liquidity equation as well as you can see from the slide I shared we've got plenty of.
Plenty of.
Vehicles to go for credit if we need it.
And again the capital reduction is also very.
Very meaningful to us as well as frankly, a very strong cash balance that we're sitting.
Thank you. Thank you for walking us through that I'm sorry.
So im the January call, maybe to take that a step further to the structural discussion you said one of the biggest surprises coming into this industry from the outside with the capital intensity of the business and that was going to be a priority for year to take a hard look at that as the CFO.
As you've been going through these this process.
Broader structural cost reductions any update you could have on some opportunities you think where you could kind of change that equation longer term Ns.
Yes, I mean.
Thank you see a little bit evidenced of that here.
With the capital reduction that we've done very early in the year.
You don't cut 500 million or 25% out of your out of your annual capital spend easily. So we really got together as a team and.
Similar to the whole locomotive discussion I just went through we reiterated several times on what we could do to reduce capital spend and get to a new baseline level of for which.
To be honest.
This is a low level, we haven't been here since 2010 in absolute dollars, but we felt it was the right thing to do because we sense that there was going to be volume pressure sure enough. It's it's come.
And it's it's real in front of a so I'm glad we've gone through this exercise.
From here, though as revenue grows I would hope that we were able to contain.
Both in Capex at a more moderate pace below the pace of revenue growth in the future and maybe grow into a lower percentage of revenue.
Below the 16 to 18 it.
You know at some point. So that's one thing that I think the organization is is very keen on and then the second.
Frankly is what we talked about with regard to the locomotive rationalization itself. We took a long hard look at the assets and in that particular pool and frankly, we're going to shift over now look at other pools of assets, we have as well.
Make sure what are the perils of group depreciation.
Is that you're not necessarily motivated are incentivized to be looking at the assets once they're on the books.
This case I think we have to look at that because they do attract costs.
We have a lot of buildings out there along the network that maybe we don't need anymore structures.
That again, a to attract maintenance cost they attract electricity costs they attract property assessments.
Those are well take one area, we might look at we've seen our coal franchise shrinks considerably do we have surplus assets in coal that we need to reexamine and we look at so we're we're asking these questions as a team. The team is open minded about it and.
Thank you again, you see in first quarter some evidence of that.
The next question is from Ravi Shanker Morgan Stanley. Please proceed with your question.
Thanks, just wanted to follow up on the discussion about the incremental margins when volumes do come back.
You have a pretty lucrative cost structure slide on slide 22 of your deck. That's really helpful, which shows that you have a pretty variable our semi variable cost structure, which should help you on the way down, but I mean, how does that not become an impediment to incremental margins under way back up again.
Even that needed by the nature of its if it's more variable a lot of those cost need to come back.
Well, we do we do expect to be able to.
Hold the line on many of the costs within our cost structure as volumes return and therein lies the operating leverage in the model now certainly we will have some volumetric expense increases with volume.
On the way up as as is the case on the way down, but the but the key will be two to hold the line in terms of additions to the asset and resource base as much as we possibly can we know we can do that.
And ride that wave of volume upsurge, which should generate rapid and significant operating ratio improvement and bottom line growth.
Okay.
And as a follow up.
How would you characterize the competitive environment in the east.
Obviously, we know what's happening the truck side, but just more with your earlier.
Yes trucks are very competitive right now those are the opportunities for us that.
That is supported by our the strength of our franchise and those are the service products that were developing right now as to help our customers.
And that as they deal with changes in their supply chain and we're working on near term solutions and.
Long term solutions as I've noted, we got to make a wonderful merchandise franchise with broad exposure to the U.S. economy.
We've got a great intermodal franchise, the best in the East and we've got an outstanding service product and.
Just within their mall you can go back three years.
For years to go out five years, and you can see that Norfolk, southern and our customers have haste the growth in the entire industry during that time in go all the way back to recovery from the great recession and 2010.
So at some as I've talked about before we are making decisions in the long term best interest of our shareholders that includes our market approach and our willingness to partner with our customers to support their growth over the long term.
The next question comes from Ken Hoekstra of Bank of America. Please proceed with your question.
Hey, good morning, and great job in the on the cost side and then the locomotive move micro Jim just an interesting move in shutting the yards and some of the other steps you're taking during this this volume downturn, maybe can you talk a bit about what moves you could see becoming more permanent are there. Some examples that you you can talk to I know you talked.
Little bit about the blending of the trains, but just want to understand as the business comes back what what are these steps that you are taking you see could be a bit more permanent.
Yeah sure. Thank you as you as you've noted you know we've been looking at our at our term loan yards for long term system. So it's a great recession, we the to either idled or converted five of our hump terminals. We did two of them two of them last year and.
We're continuing to look at that and those are long term structural cost reductions and you'll you'll see more of that as we go forward I would also note that we've talked about weve.
Shut down a lot of our smaller outline yards brought that traffic in consolidated it and as Mark noted those are assets overtime that will go away and take take less costs, but we continue to look at it and find out what we can live without and we've got a lot of opportune.
Entities out there that we're looking at more to come and you'll hear more about it is as we go forward, but yes. Those up those those are things were looking at and are going to do.
Okay.
Hi, Alan maybe just I. Appreciate your we are competitive comment before when you're talking about the competitive market, but just looking at coal being down 60%. This past week and really taken a beating lately. How do you plan for this is that are you looking at the business structurally disappearing is it's something that's.
As a mild winter and you expect to come back as the export and domestic markets come back maybe just talk about your views on that that market a bit.
But can we understand that our utility coal our nation's utility coal franchise is that a secular decline. So what you see from US is a response and working with our customers on ways to promote coal dispatch relative to natural gas, but also we're adjusting our franchise as well you saw that.
And several short line activities you saw that idling of Asheville, and just this quarter you saw it and the sale of our Pocahontas Land Corporation assets.
Stockpiles and the utility coal franchise right now are incredibly either at about 125 days.
Coal burn and March was at a national National record low at 29 million tons and so I think coal is our utility coal franchise is going to be pressured for a considerable amount of time, we need to get the economy back running.
So industrial and commercial load comes back and we're also going to need to see an overall increase in energy prices prices in the PJM now are in the teams right now for.
For electricity and that's that is not going to promote.
Coal burn.
The next question is from Chris Wetherbee of Citi. Please proceed with your question.
Hey, great. Thanks, good morning.
Maybe market drilling a little bit more specific around some of the Capex comments I think when you outlined or when the company outlined the plan the PSR plan.
Locomotives were caught a decent size chunk of the 16% to 18% Capex spend over time I think it seems like some of the actions you guys have taken recently have the potential to really rationalize that even just.
This year, but potentially in 2021 in 2022.
Is that the right way to think about it or could there be other puts and takes it might drive that number back up into that sort of.
Longer term range, just want to make sure I understand it. This is sort of a spin that that likely is going to come down relative to maybe what you thought it was a year and a half ago or so.
Yes, thanks for the question Chris.
I'm going to tag team this with Mike but.
The reduction in the Capex is really little bit across the board.
Not so much on the locomotives but.
Other areas, whether its ITC, a little bit of our maintenance.
We have really taken a look at all the various categories and tried to bring it down a notch.
Even some of the terminal spends.
Especially given the volume pressures that we have so it really went across the board.
And we know, though like I mentioned earlier, we're going to have pressure to raise from here, but I want Mike maybe you can talk a little bit about locomotives at one versus non cat one on the up stuff sure yeah on the locomotive DC to AC conversions.
We're committed to that revitalization because we've got we've got some DC locomotives out there that.
That upgrading to the AC is really cost efficient from a capital standpoint, and been really pleased with the reliability from there. So so that project will continue on.
Going forward over the next couple of years, it's the gets the right thing to do what we did push out we had we had taken some opportunistic additional DC to AC conversions that we were looking at this year, we're pushing those out we're not going to do those.
Some rebuild of our yard and and local fleet. We've we've pushed out so the DC to AC conversions will continue at at the pace that we've talked about.
In the past relative to the.
To the capital expenditures you know, we we're very fortunate that we've got some great technology and.
And our company, particularly on the on the engineering side, we are making sure that we are putting our rails ties in ballast in the right locations. We've got technology. These days that are they are using machine vision to determine whether ties are good or not or even doing X rays internally. So we.
We're making sure that when we put ties in demand right place at the right time same thing with rail, where we were using predictive analytics to determine where where the rail needs to be replaced at and that's allowing us to really pinpoint our asset replacements, and we're really comfortable with the.
Fact that we're doing the right thing for maintaining this railroad and a long term both on the locomotive reliability front as well as the track infrastructure.
Got it okay. That's very helpful. I appreciate the color and then maybe a quick follow up Alan what do you think about the truckload market I think there's a building sense that coming through this downturn when volume comes back we could be coming into a somewhat tighter truckload market than than what we sort of exited so can you talk about sort of how that kind of please.
Into the strategy on the intermodal side and what the opportunities might be there for you.
Yeah, Chris It's that's very similar to what you saw and 2009 in 2010 isn't that where.
Where are you saw some pretty considerable supply reactions on the truckload side to a steep downturn and spot prices. So for us it means continuing to collaborate with our best in class supply chain partners, our and our channel partners on how we give us.
Them and exceptional service product, how we look for new opportunities new planes for them to grow into and then it's also selling the things are going to be pretty darn valuable post Cove at night team, which is capacity a lower cost structure than than truck it service and its SG.
And we've got the best intermodal franchise in the so we're in great shape there.
Got it thanks for the time appreciate it.
The next question is from Justin long of Stephens. Please proceed with your question.
Thanks, and good morning, maybe that follow up on that last question regarding domestic intermodal. Obviously, one thing that's changed it that fall off in fuel prices. So I was wondering if you could comment on that gap and pricing between contractual intermodal pricing contractual truckload pricing.
In your network today, and as you think about domestic intermodal going forward do you feel that it is still at a GDP plus growth business whenever things recover even if fuel prices hang out around current levels.
And just in the GAAP US has certainly close the real pressure as coming from that that spot truck market and.
At some point as the economy starts to improve and as there are supply.
Ramifications throughout the truckload market thats going to particularly affect the spot market. So it's important for us to maintain that vision as we're approaching the market not chase the spot truck our you've heard me talk about that before it hits.
That's not what that long term best interests of our corporation. So we are we're focused on what we can deliver and that as a great service product a great intermodal franchise that has allowed our customers to outpace the industry and growth over any number of years.
Okay, and you may be looking bigger picture at the volume performance and that the business. Obviously, it's weak across that the board right now, but theres, a pretty substantial difference and the year to date volumes that in asked versus your eastern competitor I'm curious.
You could just comment on that gap has there been any major market share losses. This year that are driving that is it's a function of.
Mix and as you look at that gap, how should we be thinking about the actions you're taking set to close that gap and the timing around that going forward. Thank you.
So adjusted as one of the things that I had talked about is the utility coal franchise, which is.
Last year was 60% of our volume utility of our coal volume in the first quarter is now 44%, so thats, having an impact on us the ethanol markets, whether that's in found feedstocks such as corn, our outbound ethanol is having an impact on us frac sand, we've talked about the energy impact.
Integrated steel mills.
As having an impact on our franchise and frankly the.
The spot trucking market is having an impact on.
On intermodal and we saw an impact on international intermodal and in Asia business in February and so all of that contributes to tougher year over year comps as I noted.
We're still writing or comparing against pretty elevated volumes of last year, we'll get through that and week 20.
In which our volumes or at the highest level of last year and just overall, we understand the markets and we're pretty confident in our knowledge of the markets and we're very confident in our ability to price to the value of our product and the value of our franchise and make the best long term decisions for our shareholders and you see that.
And ARPU and revenue for revenue revenue ton mile trends not just this quarter, but over the last three plus years.
Okay. Thanks, I appreciate the time.
The next question is from John Chappelle of Evercore ISI. Please proceed with your question.
Thank you good morning, everyone.
Mark first question for years in order to time on.
Solutions.
Any comment on copper occurred.
We then.
We're very disciplined manner and top oxy nothing the pause button on the buyback program includes little bit more clarity on coming out of us.
Yes, Thank you John.
Certainly we were we continued full steam in Q1 on the share repurchase activity.
Now obviously as we do see the markets our.
Contracting significantly we are going to take a more.
Conservative approach to looking at share repurchase while maintaining flexibility for when.
Depending on the depth of declined but also the pace of recovery. So I think we will we will certainly take a more muted approach here.
Okay. Thank you and then followed for Michael really quickly.
I've talked about the locomotive plan and a lot of the service not just 18, but when you look at the TSR implementation per se may 1st relative to where you are sitting on your first what are some of the other adaptation Nate plan for 2020, given the precipitous fall in volume.
Well I think the thing that is.
Beneficial for US is that we're able to adapt quickly right as volumes come out we've been able to take the take the tray crew starts out you saw that in my slides I'll note that in in the April so far we've pretty much matched the volume decline.
Against.
With the crew start decline is around 30%, so which matched it pretty well. So the thing that we've come out come out of this with is a really nimble organization that can adapt quickly to volume volume changes, whether that's on the downside like we've shown on the upside when it occurs.
And we're going to get a lot of leverage when that happens because of it.
Alright, Thank you Michael Thanks, Mark.
Thank you.
The last question comes from Thomas Wadewitz of Yes. Please proceed with your question.
Yes, good morning wanted to follow up little bit on.
Train starts and leverage maybe if I can refer.
Mike Your slide you think slide 11, so you are improving and all the metrics against the train weight.
Expansion are probably moving with train length has been more muted obviously a function of.
Volume backdrop.
So how do you think about coming out the other side with the ratio might be.
Or how rapidly you might need to bring back crane starts.
Or is there a period of a couple of quarters, where you just really see that metric expand a lot.
And you don't have to add train starts back for a longer trains.
You know it really will depend on where the where the traffic comes back and what type of traffic. It is obviously, if it's if its full bulk you're going to get more of an incremental train starts but if it's just across the board. We've got capacity still in our train lengths to add add train lengths.
Before we have to do a lot of train starts we've got capacity in the terminals as well with the both the road crews the local service crews in the yard crews to handle the capacity. So we've got a while before we have to to make.
Train start ruddock or increases so we're still going to continue to get the upside leverage is this thing up existing spools up its in a great place.
Do you do you think there could be.
When volumes I mean, obviously looking out to the other side, but you think you could actually run without adding tradings for a while where you see positive volumes.
Correct, yes.
And then on where the traffic comes from.
And that's our plan thats it Thats our plan Thats, our goal and Thats. The that's the ability of this organization to do that.
This concludes the question and answer session I will now I'll turn the call back over to Mr., Jim Squires for closing comments.
Thank you for your questions. This morning, we look forward to talking to you again next quarter stay safe everyone. Thank you.
Ladies and gentlemen, thank you for your participation. This does conclude todays teleconference. You may now disconnect your lines and have a wonderful day.
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Thanks.
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