Gentlemen, welcome to the CSX Corporation third quarter 2018 earnings call. As a reminder, today's call is being recorded. During this call, all participants will be in a listen-only mode. Following the presentation, we will be conducting a question and answer session. To ask a question, press *1. For opening remarks and introductions, I would now like to turn the call to Mr. Kevin Boone, Chief Investor Relations Officer for CSX Corporation.
Thank you, Shirley, good afternoon, everyone. Joining me today on today's call is Jim Foote, President and Chief Executive Officer, Frank Lonegro, Chief Financial Officer, and Mark Wallace, Executive Vice President of Sales and Marketing. On slide two is our forward-looking disclosure, followed by non-GAAP disclosure on slide three. With that, it is my pleasure to introduce our President and Chief Executive Officer, Jim Foote.
Great. Thank you so much, Kevin, thank you to everyone who's joined the call. We are very excited about the strong performance of the railroad. Incredible things can be done by incredible people. The CSX workforce is proving every day that they are not going to take a back seat to anyone when it comes to running a safe, customer-focused, and efficient railroad. I want to give a special shout-out to the operating team that positioned our assets out of harm's way in advance of the recent hurricanes, and to Ricky Johnson and all the engineering folks that did an amazing job in getting us back up and running with minimal delay in the aftermath of both storms. Before moving to third quarter results, I'd like to comment on a few initiatives we worked on in the third quarter.
First, we made changes to the organizational structure in our operating department, which pushed more real-time decision-making to the field. Our management team has embraced the change, and I am encouraged by the early positive results and momentum it has delivered. Second, we announced new major initiatives at our Northwest Ohio Intermodal Terminal. This facility functioned as a sorting facility under the previous hub and spoke strategy. We will now leverage this asset and its important strategic location as a traditional intermodal terminal to drive new revenue opportunities. As part of our plan, we are working with NorthPoint Development to establish a logistics park adjacent to the terminal. This logistics center will require no capital from CSX. We also announced a new haulage agreement with BNSF that enhances western access to the facility, and we are working on expanding access from East Coast ports.
I believe these initiatives will drive long-term growth opportunities to CSX. Let's get to the results. I said it last quarter. I'll say it again today, two words sum up everything, great performance. Nothing unusual. These numbers are straightforward. EPS increased 106% to $1.05 versus $0.51 last year. Operating income growth of nearly 50%, combined with a lower tax rate and 6% fewer outstanding shares contributed to the significant year-over-year increase. Our operating ratio improved 970 basis points to 58.7, a substantial improvement and a record third quarter for CSX. The operating results are highlighted by 14% top-line growth, including 4% volume growth, combined with lower expenses despite much higher fuel costs. Let's turn to slide six. Revenue increased 14% as volume, price, fuel surcharge, and supplemental revenues all contributed to positive growth this quarter.
Looking at the business segments, each was impacted by positive price and fuel recovery. Merchandise revenues grew 12% this quarter, helped somewhat by lapping some of the service issues last year. Nearly every end market saw a double-digit increase, with the exception of fertilizers, which was impacted by a previously disclosed customer shutdown. I am encouraged by the broad-based growth across this portfolio. Coal revenues increased 14%, with strength in our export business offsetting domestic utility weakness. We also saw good growth in our steel and industrial businesses. In intermodal, we saw growth from both price and volume. In other revenues similar to previous quarters, we saw an increase in supplemental fees, including demurrage. On the next slide seven, let's take a look at our safety performance. The safety of our employees is my number one priority.
As you can see in these charts, we made some good progress this quarter and we need to sustain this momentum. The personal injury rate this quarter is encouraging, but we must improve our train accident rate. As I have mentioned, we have an initiative underway to drive further improvement. We had a strong turnout by employees in our recent safety survey, which is a good sign of employee involvement. I will continue to prioritize safety above everything else and expect us to make further progress. On the next slide eight, on the efficiency and service slide Train velocity and dwell both saw significant improvement over last year, and they are also much better than last quarter. Velocity improved 28% and dwell improved 26%, both on a year-over-year basis. Cars online continued to trend lower, down almost 14% year-over-year, despite volume increasing 4%.
This really shows the improved asset utilization we are achieving. You can see our trip plan compliance. This is a very important measure as it reflects not only the railroad's operating performance, but most importantly, how we are performing from a reliability standpoint for our customers. We have seen an improvement of 26% from the first quarter to the third quarter of this year, and we just started measuring this in 2018. While we have made good progress, there is plenty of room to improve. Let me hand it off to Frank, who will take you through the financials and operating improvements in greater detail.
Thank you, Jim, and good afternoon, everyone. Before walking through the financials, we've got a number of questions on hurricane impacts. Let me give you a quick summary. The most significant impact from Hurricane Florence was the loss of over five miles of track due to numerous washouts from flooding. As a result, the majority of the financial impact was capital in nature, which I'll discuss in a few moments. In terms of the P&L, we estimate the EPS impact to be about $0.02 in the quarter, similar to Hurricane Irma in last year's third quarter, with most of the impact attributed to lost or deferred revenue. With respect to last week's Hurricane Michael, given the location of the landfall and the speed of the storm, we do not expect the impact to be significant in the fourth quarter.
Turning to slide 10, I'll walk you through the summary income statement. Reported revenue was up 14% in the third quarter, driven by 4% more volume and revenue per unit gains of 9% from higher fuel recoveries, favorable mix, and core pricing gains, as well as higher other revenue. The overall pricing environment remained strong in the quarter with healthy demand levels, tight trucking capacity, higher fuel prices, and supportive export coal benchmarks, combined with an improved CSX service product. As in the first and second quarters, pricing for merchandise and intermodal contracts that renewed in the third quarter was particularly strong. Other revenue increased year-over-year, reflecting the benefit of higher demurrage and storage charges. We still expect other revenue to be in the $130 million-$140 million range for the fourth quarter, though likely toward the higher end of that range.
Moving to expenses, total operating expenses were 2% lower in the third quarter, reflecting the benefits of Scheduled Railroading as expenses were favorable year-over-year, even with higher volumes, higher fuel prices, and the impacts of inflation. Labor and fringe expense decreased to $30 million, or 4% year-over-year, as average headcount was down 8% despite 4% more volume. The smaller labor footprint spans both operating and G&A departments. On the operating side, significant year-over-year improvements in velocity, on-time originations and arrivals, and Trip Plan Compliance led to significantly fewer active trains and crew starts, yielding a 20% improvement in train crew efficiency as measured by GTMs per active train and engine employee. Non-productive recrews, an indicator of network fluidity, also improved by 58%. Shifting to mechanical support labor, the active locomotive count was down 12% year-over-year, including an active fleet reduction of over 300 engines since the end of Q2.
We now have over 800 locomotives in storage, in addition to the hundreds of engines we've sold, scrapped, or returned since the beginning of last year. The smaller fleet, along with freight car repair efficiencies, helped drive an 11% year-over-year decrease in our mechanical craft workforce. Our G&A headcount also continues to decline as we look for every opportunity to absorb attrition. With these operational and G&A labor efficiencies, plus the contractor workforce reductions I'll discuss in a moment, we have nearly achieved the full year 2,000 total resource reduction goal we set out on our January call. MS&O expense was lower by 9% versus the prior year. From an operational perspective, improved service levels combined with resource and asset efficiencies also yielded MS&O savings. Material savings attributed to the smaller locomotive fleet are complemented by our decision to store units that are less reliable.
The decisions we've made around storage, combined with additional fleet reliability efforts, drove a 34% year-over-year improvement in our locomotive out of service measure and further reduced costs related to materials and contracted locomotive maintenance services. Looking at non-labor costs associated with our train crews, the reduction in both road crew starts and recrews yielded lower hotel and taxi costs. Additionally, MS&O continues to benefit from our efforts to streamline contractors and consultants, particularly in our technology department. Similar to recent quarters, results benefited from line sale and real estate gains that were $52 million higher than the prior year. We are continuing to monetize our surplus assets and are making good progress toward our $300 million target for cumulative real estate sales through 2020, along with the potential for upside from line sale proceeds.
We continue to have a strong pipeline of real estate and line sale opportunities, though the impact of these transactions will continue to be uneven from quarter to quarter and year to year. Looking at the other expense items, depreciation increased slightly due to the impact of larger net asset base. Fuel expense was up 31%, primarily due to a 27% increase in the per gallon price and increased volumes, though we were pleased to achieve record fuel efficiency in the quarter. We will drive further fuel savings through continued improvement in network fluidity and the increased utilization of fuel optimization processes and technologies. Equipment rents expense declined 18%, driven by significantly improved car cycle times as we continue to see strong year-over-year and sequential service improvements. Equity earnings were favorable, primarily due to the impact of the lower tax rate at our affiliates.
We still expect equity earnings of affiliates of $20 million-$25 million in Q4. Looking below the line, interest expense increased, primarily due to the additional debt we issued earlier this year, partially offset by a lower weighted average coupon rate. Tax expense was lower in the quarter, even with significantly better pre-tax earnings, reflecting the continued benefit of tax reform. Our effective tax rate was 22.3% in the quarter, slightly lower than prior guidance, mainly due to the settling of state tax matters. Absent unique items, we expect our effective rate to be in line with prior guidance of around 24.5% for the fourth quarter. Closing out the P&L, as Jim mentioned in his opening remarks, CSX delivered operating income of nearly $1.3 billion, third quarter record operating ratio of 58.7%, and earnings per share of $1.05.
Turning to the cash side of the equation on Slide 11, year-to-date capital investments are lower by 15%. While we remain on track for the three-year $4.8 billion capital target, we now expect 2018 capital investments of about $1.7 billion, up from the prior target of $1.6 billion. The incremental capital spending is being used to accelerate Positive Train Control, fund additional investments in positive return projects, and pay for repairs related to Hurricane Florence. The reduced capital intensity of the scheduled railroading model, the substantial core earnings progress detailed on the prior slide, and the benefits of tax reform helped drive a 55% increase in year-to-date adjusted free cash flow, resulting in nearly 100% free cash flow conversion of net income. This significant improvement in free cash flow generation helped drive a nearly 50% increase in shareholder returns.
We executed $1 billion of share repurchases in the third quarter and have now completed over $3 billion of the current $5 billion buyback authority and remain on pace to complete the program by the end of Q1 2019. As we have stated throughout the year, the CSX board will continue to evaluate cash deployment and shareholder returns on an annual basis. With that, let me turn it back to Jim for his closing remarks.
Great. Thanks, Frank. Turning to Slide 13 and wrapping it up on a forward-looking basis. On last quarter's call, I said we were expecting revenue growth for this year to be in the mid-single digit range. We are now looking for full year growth to be 6%-8%. Clearly, we are doing better than we expected coming into the year. A lot of this is due to the continued strength of export coal, but all of our business groups are doing well. On the intermodal side, we have made significant strides in re-engineering our franchise to get where I believe we need to be to drive sustainable, profitable growth. Our customers understand what we are trying to accomplish and are engaged with us to make our intermodal product better.
As I sit here today, only eight months since our investor conference, by almost any measure, we are ahead of where I thought we would be. This team has delivered significant value to our customers and our shareholders by running the railroad better and better every day. I am proud of what has been accomplished and encouraged about all the opportunity in front of us. Our goal of making CSX the best-run railroad in North America is clearly attainable. Turn it back to Kevin.
All right. Thank you, Jim. In the interest of trying to get to everyone, I will ask that the analysts limit themselves to one question and one follow-up if needed. Shirley, we'll now take questions. Thank you.
Thank you. Thank you. We will now begin conducting a question-and-answer session. If you would like to ask a question, please press star one. To withdraw your question, you may press star two. Again, press star one to ask a question. One moment please for our first question. Our first question comes from Allison Landry with Credit Suisse. You may ask your question.
Hi. Good afternoon. Thanks for taking my question. I wanted to ask about the revenue per RTM trends this quarter. It looks like it was up a little more than 3%, and for the first time you've seen since 2Q17. Just wanted to understand what's driving that, if it's mix, price, a combination thereof, and if there's an impact that we should be thinking about or if this helps us to understand the success of PSR so far.
I missed the last one, but the RTM growth that we saw in Q3 is a combination of everything. Strong pricing environment, mix, and volume. Yeah. I missed the last part of your question.
I was asking about if this tells us something about where you are with the success or progress of Precision Railroading so far.
I would say yes. Clearly, we are doing very well and service is excellent. The pricing environment is very good. Customers are moving more freight back to the railroad, and that is a trend that will continue.
Okay. Thank you for the time.
Yeah, Allison, it's Jim. Clearly, part of our strategy here is to price appropriately for the service that we're providing, and to the extent that PSR gives you a better product to sell, you're going to recognize higher prices as we go forward
Okay, perfect. That's really helpful. Thank you.
Thank you. Our next question comes from Christian Wetherbee with Citi. You may ask your question.
Hey, thanks, guys. Thanks for taking the question. Wanted to talk a little bit about OR expectations as we move forward. Obviously, the operating ratio has performed extremely well over the course of the last couple of quarters. I guess, Jim, as you're sitting here thinking about sort of what you're doing on the intermodal side, can you put that into context with sort of your 60 OR target that is out there? Maybe how you think about the sort of timing of getting towards that and maybe the sustainability of these very good margins that we're seeing. I guess I'm just trying to get a sense of sort of how far along in that progress you are. You mentioned you're ahead of what you expected to be several months ago. I don't know if there's sort of a new way to think about the opportunity set going forward.
Well, I guess as I said, as I was trying to get to without being too specific, because we're not going to be too specific today anyway. Eight months ago, we put out a target to hit a 60 operating ratio in three years, I think at that point in time, everybody thought we were crazy, that couldn't be done. Now we've come in with two consecutive quarters in a row of, it's not industry-leading, right there with anybody else in the industry. As I have said on the last few quarters, I have a little more confidence that we can hit a 60 operating ratio in three years when we're kind of there today. In no way, shape, or form is that indicative of the fact that we've run out of opportunities.
We're just, as I said, I'm comfortable with the re-engineering steps that we've taken to date on our intermodal business. We're holding back because we made a commitment to our customers we wouldn't make any kind of dramatic changes until after peak season. We're holding back, we're going to be doing some more work that we've already discussed with our customers in terms of some line rationalizations, some terminal consolidations. What we're talking about with Northwest Ohio, we're committed to growing that business, but we're going to grow that business in a logical process that is sustainable and profitable for us, all of which gives us opportunities to further reduce our operating ratio as we go forward. A ton of opportunity ahead of us. Hang in there and see what we can do for you next quarter.
Okay, I appreciate it. Thanks for the color. Just a quick follow-up on the pricing side. I know you don't give a core pricing metric anymore, Jim, you've been helpful in terms of characterizing the price environment over the last couple of quarters. Just wanted to get your thoughts on 3Q maybe as it stands relative to the last couple of quarters.
What we said, Chris, in our prepared remarks was that the renewals continued to be strong and certainly in comparison to a same-store sales type of a measure, they continue to be elevated against that benchmark. We restructure contracts from time to time. We did have one that was a little less than we would like. Other than that one, you would have seen a continued sequential increase in same-store sales. Yeah, the environment's really good. The backdrop macro is really good. The service product is really good. As Jim mentioned, Mark's got his team fully engaged and driving forward and really thinking about what we're going to do in the next couple of quarters getting into 2019. The normal escalators like AII-LF and RCAF and things of that nature all look pretty strong quarter-over-quarter.
Those are also helpful as we think about contracts that are longer term in nature. Nothing's really changed from what we told you last quarter.
Okay, perfect. Thanks for the time. I appreciate it.
Thank you. Our next question comes from Brian Ossenbeck with J.P. Morgan. You may ask your question.
Hey, good afternoon. Thanks for taking my question. Jim, can you give us a little bit more context about just in general, you're not going to give too many details today, you said, on the intermodal side, but just what are some of the challenges and the opportunities of making these adjustments, given that CSX had a standalone entity in intermodal, and maybe compare it to when you were at CN, and where do you think the margin profile can actually go over time? Can it get to the corporate average at CSX?
Well, I'll take that second part of your question first. I think so. My history at CN was that that's what we did. We took it from the slowest dog to the middle of the pack. I firmly believe that if you believe in your franchise and you believe in the quality of your product, that you can sell that as a value-added service to your customers, and not just as a commodity that's going to trade in the marketplace based on price. I think based upon capacity and everything else that's an issue with our channel partners, we bring to the trucking industry and those people that use intermodal, a tremendous product with a tremendous value. We still have a long way to go to get that franchise right.
Part of the process is disassembling the old independent structure of the company, because it's not an independent company. It's part and parcel of the railroad. Those trains run on the railroad. They don't run on an intermodal railroad. They run on the railroad. All of that goes towards us building a much more efficient, highly effective, and better quality product for the customers. That's what's going to drive the growth, and that's what's going to improve the profitability of the business segment.
Okay, great. Thanks. Frank, can you just give us an update on export coal for 4Q? It seems like it's running at the run rate you had mentioned last time. If you can give us the mix of thermal and met, or at least some characteristics of that would be helpful.
Yeah. Mark speaking. Export coal, we believe heading into the back half of the year or the back Q4 of the year, is going to remain very strong. Demand is still very strong. The benchmarks are still very strong. We think we are going to see continued strength in our export coal business here heading into the end of the year.
Okay, thanks Mark.
Thank you. Next question comes from Amit Mehrotra with Deutsche Bank. You may ask your question.
Thanks, operator. Congrats on the very strong results. I feel like I've been saying that a lot to you guys this year. Jim, export coal has obviously, just following up on the last question, obviously been highly accommodative, which has helped this year's performance as well. As we think about walking the operating ratio from 2018 to 2019, how much of the improvement we could see will be predicated on what export coal volumes do next year, just given how much growth we've seen this year in the business? I'm just trying to calibrate our expectations, my expectations for what the improvement could be in 2019, given maybe some of the idiosyncratic events for this year related to export coal. Thanks.
Well, I would say it's more of the what if something happens to coal, and what would the impact be on our performance going forward as opposed to. It's not like we're going to add another 40% more export coal tonnage to the railroad, and voila, we're going to have a mid 50 operating ratio. We're assuming and have assumed during the planning process, and based upon where we stand right now, things on a forward-looking basis for export coal into 2019 look pretty good. That will be what we'll base our plan on, and we'll continue to look for ways to become more efficient. As I said, it's much more of an issue of how fit and how effectively can we pivot and react, in the event something happened to the coal business. That's something that as of right now, that would just be speculating.
We need to maintain a healthy coal business going forward, because it has a meaningful impact on it. If something happens to the export coal markets where they soften up a little bit, we'll pivot and we'll adjust just like all good railroads, all good precision schedule railroads do.
Yeah, I guess you're just going to be at 60 OR this year. I wonder if you're looking at the business, I'm sure you're looking at business many ways, but one way you're looking at is what the underlying margins of the business are doing, x the growth we see in export coal volumes, and maybe that's the reason the 2020 target should actually be 60%, given the fluid nature of those cargoes or of that freight.
Without commenting on your 60 number there, either this year or in 2020, when we look at the underlying business, the margins on the business segments are all improving independently, not just because export coal is having a good run.
Okay. If I could just ask one quick follow-up. One of the big pieces of the cost structure that you guys have been able to leverage is obviously the number of employees, and employee headcount was down another almost 8% in the quarter. As your volume guidance is going up, or sorry, your revenue guidance is going up, will you still be able to leverage that and see higher revenue and lower number of employees?
Well, we will continue to become more and more efficient, however you want to measure it, on a GTM basis, on an RPM basis, on a cargo basis. Our plan will be to continue to see a reduction in the headcount. Like I said, we're not in a position right now. Again, in January, I said we're going to take 2,000 employees out of the company this year. We already got 2,000 employees out of the company this year. Will we have a target for employee reductions, employee efficiency next year? Yes. What that number is, at the right time, we'll articulate it to you, and we will continue to become, on a per unit basis, more and more efficient all the time.
However, when we get to the point, and again, a lot of that has to do with the attrition rate and how we manage the expectations of our employees through this process. When we get to the point where we need to handle the volume, we're not going to run ourselves out of a couple brakemen here and there to screw up the railroad. We'll pivot. We'll adjust. There are certain points on the railroad today where you need employees in one location and you have excess in another. You're always managing your workforce appropriately, and we'll do that on a go-forward basis.
Okay.
You should expect, obviously, when the business comes in merchandise and intermodal, we've got ample capacity on those trains to be able to add it with very high incremental margins. If it comes in unit train commodities, certainly the margins there are good and you would want us to add any additional resources we needed to be able to handle that. I think to Jim's point, you should expect us to continue to leverage resource efficiencies over time, and our business is going to continue to grow. That was part and parcel of the framework that we laid out for you at the investor conference in March.
Right. Thanks for taking my question, guys. Congrats. Have a good one.
Thank you. Our next question comes from Ken Hoexter with Bank of America Merrill Lynch. Please ask your question.
Hey, good afternoon. I'm going to guess that's me. It's Ken Hoexter. Hey, great job. If we can just touch on the efficiency there, Frank or Jim, you talked about more room. Is there more room on the equipment reductions as well? Or now that you've put all the locomotives aside and the cars, is that the end of the equipment side of your efficiency gain?
No. Again, we took out 300 this time, this quarter. Again, we're at, in the quarter, I don't know what the velocity, 17.8, 17.9, something like that. That's way behind the industry leader. Since then, now we're up around 19, still way behind the industry leader. As we improve velocity, as we improve throughput, as we improve all aspects of the railroad, what does it do? Creates capacity, i.e., takes out locomotives. We'll continue to take out locomotives. We'll continue to take out rail cars. We'll continue to free up capacity across the road and in the terminals, because we will drive more and more efficiency and fluidity in the network. Therefore, again, that's why the employee count goes down. Employee count goes down because we need fewer, as an example, we need 30 fewer locomotives for every mile an hour we can improve our velocity.
Every 30 locomotives means you need fewer people to maintain the locomotives, which means you need fewer facilities to maintain the locomotives, and on and on and on and on and on. Fewer cars online, get them offline, get them moving. Fewer people to maintain the cars, fewer pieces, fewer inventory. That's the nature of the game here, is continuing to drive throughput. As I said, in terms of dwell, we're not the leader in dwell. We're not the leader in terms of velocity, but we will be. As we do that, we'll free up and shed more and more assets.
That's really great detail and insight. I truly appreciate that. Frank, maybe another one. I just want to clarify something you said earlier. You said there was a contract that you didn't get what you wanted. Excluding that, I think you said rates would have been up sequentially. Maybe if you can just clarify or detail what you were saying there in terms of what was going on with rates. I don't know if that was including a bad contract or something.
No, Ken, you summarized it perfectly. Absent that one restructuring deal that we did last year, same-store sales would have been up sequentially Q2 to Q3.
That was last year. That wasn't one that just happened, that is, you're seeing rates deteriorate or anything.
That's correct. That's before Foote and before Wallace.
Very important clarification. Thank you.
We're talking merchant intermodal, right?
Intermodal.
We just have to live with it. We don't have to be happy about it.
Okay. Then just a follow-up on, maybe Jim, if you can detail what you're doing on intermodal. You talked about holding off until after peak, but can you walk through changes? I know you mentioned you're reopening or accelerating some stuff in Northwest Ohio, working on the tunnel in Virginia. What is the goal on intermodal? I don't know if there's a simple way to highlight what you're doing there.
I guess the goal is, I think we were pretty clear about last year unwinding the hub and spoke system in Northwest Ohio, where you had multiple handlings of the same container on the network, which is a very expensive way to do that. A very expensive way to operate, especially when you have very short length of hauls associated with that. Last year, we unwound that to a large degree, and we talked about the fact that we took 7% of the intermodal volumes off the company in the third quarter of last year. To be honest with you, at that point in time, we thought we had fixed the intermodal network to a large degree.
What we uncovered as we went through 2018 then and began to try and build and make our terminals more effective and our trains more efficient, that we were doing similar things to the hub and spoke in Northwest Ohio. We were doing that same kind of double and triple handling of containers in many other locations on the railroad. We are unwinding those. We got rid of, I would say, about a third of that earlier this year before the peak. We have another piece of business that we will unwind, rationalize the lanes, get out of doing some of this.
A double and triple handling of containers. That'll happen at the beginning of the year, after peak season. We'll clearly assess before we start doing that kind of stuff, what the weather situation looks like and everything like that. Our goal here is to work with our customers. Our customers clearly understand what we're doing, and in a lot of cases, have been published, not only in the media but in various analyst reports, saying that what they're doing makes total sense. You can't be everything to everyone, and we're not here to win a blue ribbon for volume. We're here to win an award for being safe, customer-focused, and efficient, and making money.
Appreciate the time, Jim. Great answers. Great insight.
Thank you. Our next question comes from Thomas Wadewitz with UBS. You may ask your question.
Yeah. Good evening, congratulations on the strong results. Wanted to ask a question about, you've talked about this intermodal changes in service. You've previously, or just now, you said, kind of seven-point impact to volume with what you did last year. Can you give a framework of the changes you made in August this year, which you might do in first quarter next year? Is that a bigger impact, or what might be the total volume impact from those changes?
Tom, the two announcements that we made, one, late August that went into effect in mid-September, had about a 2% impact on our volumes. The one that we announced early October that won't take effect until early January is about 5%. Combined, it would be about the same volume impact that we announced, I guess, this time last year.
Okay. Great. Wanted to see if you could offer some thoughts on where you're at with the sales force and getting them, I guess the sales force energized and the right people in place, and engagement with the customers in terms of selling for the carload customers to leverage the service and maybe convert some truck freight. Also, if you had a little more color on the BNSF agreement, what the nature is of what you're doing with BNSF to Northwest Ohio. Thank you.
That's a crafty way of asking a follow-up.
Yeah, I know. Sorry about that.
It's okay. Clearly, what I've been focused on here the last two and a half months, has been putting together an organization that I believe that will be required, going forward, to sell, what we believe is a truly exceptional service product. We at CSX have a lot of people in sales and marketing. Over the last year and a half, some of those people have left the organization. Some people are wearing dual hats, some people are doing some other things. One of my first priorities was to truly understand what I had.
We just completed, a couple of weeks ago, a sales meeting for every sales and marketing person in the organization, where we invited the entire senior management team with a lot of the senior operating folks to come together and explain to them what we're trying to achieve and what we're trying to do, and sell service, not price. Explain to them our service product, that we actually have a product now to go in and sell to the customer, and we don't just throw in a price in the hat and hope we have the lowest price. We're doing a lot, and we're focusing on creating a winning culture in our sales department. They are incentivized, as we've just started a sales incentive program to incent them on doing what they're supposed to do and get out and sell. The last question?
BNSF.
BNSF. That haulage agreement begins here at the end of the month. We're excited for that. We're going to grow into this agreement with BNSF. We'll, I think, clearly, the volumes that we will see through the end of the year will offset some of the lane rationalizations this year that I talked about. We should see some growth in our intermodal business in Q4.
Why would you do haulage instead of some other way of getting the traffic there?
Let's say, go ahead. We took 7% off. We're up 3%. We're going to take off some of this business, and we're going to grow the business. Haulage is an effective way for us to work together into this Northwest Ohio market. We have a longstanding relationship with the BNSF, because this is exactly what we do today into the Atlanta market, the Fairburn terminal there. They have haulage from the West Coast all the way into Atlanta. It's consistent with the way we've done business with them for years.
Right. Okay. Thank you.
Thank you. Our next question comes from David Vernon with Bernstein. You may ask your question.
Hey, good afternoon, guys. Frank, I'm trying to reconcile the acceleration in some of the demurrage fees and the incidentals with what sounds like a railroad that's running a lot faster. How should we be thinking about the point in time when those incidental fees may start to come down as customers begin to comply? What's really sort of driving the above trend kind of result here in the third quarter on that fee line?
Specifically to the quarter, it had more to do with the change in the in-transit reserve. If you think about the year-over-year change, the transit times were much better this quarter than we were a year ago. The beat against the guidance that we gave you was the revenue reserve adjustment. In terms of your broader comment, I think we're a little surprised that behaviors haven't changed as much as we had expected them to earlier in the year. I think it has less to do with our service product and more to do with the fact that the trucking capacity remains tight and we've done some changes in the policies and the rates and things that we thought would incent the customers to spend the assets a little bit more quickly.
I think, if trucking capacity loosens up at some point in time in the future, you could probably see that come down a little bit. For the next quarter, we've guided you to that 130-140 range.
All right. Maybe just kind of on a related note, the $20 million step-down, is this a new normal on the equipment and other rents line, or is there something also associated with the way you're setting up that haulage agreement or the in-transit reserves that would affect that number as well? Should we just be thinking about this as the right run rate on equipment and other rents?
Got you. Neither the haulage deal nor the revenue reserve adjustments have anything to do with rents. What is helping us on the rents is that the days per load for both merchandise and automotive, and a little bit even on the intermodal side, have gotten so much better that we're having to pay less car hire, is really how it translates. We're not going to give run rates in terms of any of the various expense line items, as our velocity continues to improve, as our dwell continues to improve, as the customers do their part of the bargain in loading and unloading, you'll continue to see days per load improve, and you'll continue to see us provide efficiencies on car hire.
All right. Thanks for the clarification, guys.
Thank you. Our next question comes from Brandon Oglenski with Barclays. You may ask your question.
Hey, thanks everyone. Mark, I just want to get your perspective, now heading the marketing organization sales efforts. We talked a lot last summer about CSX service, I guess, "failing," or at least that's what a lot of the industry pundits wanted to say. How are customers engaging you today, and what's the competitive outlook looking like on some of the multi-year contracts in the 2019 into 2020? You guys clearly have taken some costs out of the equation. From our perspective, velocity is up, but how do we really measure that from a customer service perspective?
Well, listen, I've been spending a lot of time recently with customers. As Jim talked about, I think, last quarter, my number 1 priority was to get out there and sort of reestablish some relationships with some of these customers, and I've been doing that. I don't think I've been home very much. Clearly, they are witnessing the service product that we told them that was coming. They were not too happy with us last fall, but we told them we were going to improve, and we have improved, and they are witnessing that every day. Clearly, they want to keep doing business with CSX. They want to move more freight to rail and to CSX rather than truck, and they're doing that. We see evidence of that, especially in our forest products business and our metals business. You'll see those double-digit growth in volumes in Q3.
That is us winning back share that those customers had to move to truck last year or earlier in the year because our service levels weren't where they should have been. I've been visiting a lot of those customers, they want to use us. As we continue to get better and continue to improve, more and more of that freight is coming back to CSX. You'll continue to see that more in spades in Q4 and going forward.
I guess in that context, can you just remind us the long-term volume outlook you guys provided back in February? I think it was across merchandise and intermodal, whether maybe that could prove ultimately conservative.
Yeah, we did not give you volume guidance. We gave you revenue guidance.
Yeah, sorry, revenue.
Yeah, we're putting together our plans for 2019. As Jim mentioned, we'll provide some more color on that when we get on the January call.
All right. Thank you.
Thank you. Our next question comes from Scott Group with Wolfe Research. You may ask your question.
Hey, thanks. Afternoon, guys. Frank, can you give us maybe a little bit of guidance on real estate gains and headcount for the fourth quarter? Then big picture, I think at the Analyst Day over the three-year plan, you talked about a 6,000 reduction in headcount. Is that still the right long-term number to use?
In terms of the year, what Jim talked about in terms of guidance is we put out the 2,000 total workforce number, and we're essentially there. I think we'll continue to look for opportunities in Q4 to reduce that further. We'll certainly have a number internally for 2019 and beyond. Whether or not we share that, we'll talk about that as we prepare for the January call. We're going to continue, even with the volume increases that we believe will come on, we're going to continue to look for labor efficiencies. You should expect that to be part of how we continue to drive operating leverage going forward. In terms of your real estate and line sale questions, we gave the $300 million three-year sales proceeds for real estate with upside in line sales.
In the quarter, when you think about the split there, the gains were $43 million on line sales and $10 million on real estate. The line sales there are probably a little bit heavier on the gain side than they will be in the future. Part of the reason for that is one of the things that we characterize as a line sale was a lease conversion. You see more gain on that one than you would in a normal line sale. We're off to a strong start. We got a big pipeline. Q4 will depend on whether or not we see the things closing at the end of the year. There's always nuances around whether something closes in December or in January. If it closes in December, we'll have a good fourth quarter.
Okay. I guess that's helpful. Then, Mark, for you, as truckload spot pricing has softened a little bit, is that having any impact in terms of your pricing discussions as you look out to 2019 pricing?
I'm not going to get into 2019 pricing, but it's having zero impact on where we are today.
Okay. All right. Thank you, guys.
Thanks, Scott.
Thank you. Our next question comes from Justin Long with Stephens. You may ask your question.
Thanks, and congrats on the quarter. Jim, maybe to start with one for you. I know you've made some changes in your coal team. I believe you've said that you're thinking big as it relates to changes that you're contemplating for that business. Could you expand on where you stand as it relates to any structural changes you're assessing for the coal franchise and what some of those options could look like?
I guess the correct answer is we are always looking at what's the best way for us to be structured and are there more efficient arrangements, enterprise structures, or whatever it is in order to maximize the value. We certainly don't have anything like that on the horizon or near term. I'll let Mark follow up on your other parts of your question.
As I think about, you may have seen recently we just hired a new Vice President of Coal, Shon Yates. Shon was a former energy trader, former coal customer, brilliant guy. He's coming into this role, he's been here about 30 days, and he's got lots of ideas. As we think about our domestic coal business and the future of export, Shon's bringing a lot of innovative ways and look forward to him helping us go forward with our coal business.
Okay, great. Secondly, this one's probably for Frank. On CapEx, you mentioned that you pulled forward some of your spending on PTC. I just wanted to ask what drove that decision? Going forward, any change to your expectation on total CapEx for PTC or operating expense for PTC in the future?
Got you. Good question. No change in the overall guidance for the full PTC project. We've been saying $2.4 billion completed project for a number of years now. We're still on that trajectory. We're at about $2.2 billion now. The decision that Jim made was, if it's going to be a safer railroad, let's go ahead and do everything we can to get it done more quickly. The team is fully engaged in doing that. We'll still need the extension and plan to submit our request for the extension in the next couple of months, but we're making great progress there. No change in the PTC OpEx outlook. It's very consistent with what we've told you in prior quarters. Yes, the overall $4.8 billion CapEx over three years is still fully intact.
Okay, great. I appreciate the time.
Thank you.
Thank you. Our next question comes from Matt Reustle with Goldman Sachs. You may ask your question.
Yeah, just following up on CapEx. You also referenced there was a piece of the increase this year associated with hurricane relief. Should we just assume that's a very small piece of it if the overall budget of $4.8 billion is still intact for the next three years?
Yeah, it's going to be somewhere for Hurricane Florence in the $20-ish million range. PTC, obviously, we're pulling some of that forward, and then we've got some other high return projects that we have approved in the last couple of months. Obviously with Ed, Mark, and Jim, they've got some ideas of things that can help us be more effective and more efficient, and we're implementing those with some additional capital.
Understood. Okay. Then back to the other revenue line. Is there a normalized run rate that you think about whether we get there in 2019 or not? When you eventually do start to see those demurrage fees and customer behavior change? What is that, and do you think that you can offset a big portion of that with improved efficiency on the network?
Yeah, we really haven't gotten to the point where we're willing to give a long-term guide on that particular line. Just to give you some color, if you looked at it on a year-over-year basis, about three-quarters of the year-over-year increase is demurrage, incidentals, storage fees, et cetera, on both the carload and the intermodal lines, and about a quarter of it is that in-transit reserve that I mentioned earlier. Certainly, if we are spinning the railroad faster and faster, you're going to see an offsetting decrease in your rents line because car hire is going to be low.
Understood. Very helpful. Thank you.
Thank you. The next question comes from Walter Spracklin with RBC. You may ask your question.
Yeah. Thanks very much. Good afternoon, everyone. Just starting on the volume or the revenue guidance. When we were asking you last quarter about the kind of trend there, you were a little reluctant to give any change to your formal guidance based on some of the uncertainty in coal. Now, just wondering if with this change, is it that you've gotten some more visibility on coal, or is it that the rest of the non-coal business is just ramping up that even with your current outlook on coal, you felt in a position to be able to increase your guidance?
Walter, great to talk to you. I think from the very beginning, each quarter, I've said we were going to be, I think in January, we're going to be a titch better than slightly up. Then in the next quarter, I said we're going to be a titch better than slightly up, which kind of got us to, like I said, the 5% range. We've said many times, now we're going up, hey, 6%-8%. Let's say, let's call it seven. Sort of off from 5%-7% or whatever, five and a half to 7%. Clearly, at the beginning of the year, I think everybody expected that export coal was going to tail off at the midpoint of the year, it has stayed strong, and it continues to stay strong.
Yes, when we have that big of a piece of our business that has not declined, but has steadily growing, not necessarily growing more than we expected. It's just everybody said it was going to drop off, and it hasn't. That's had a big part in the change in our outlook. Plus, as I said at the very beginning, all of our business units are growing. The economy is very strong. All of our customers are very optimistic about the outlook. Forest products, pulpboard, paper, lumber, metals, you name it, plastics. Mark can probably add. He's talked to all the customer markets, much more comments, more color.
I think we can talk about export coal and the strength of export coal all day long. What's really pleasing me these days is just the strength of our service product. Our customers are taking notice, and we're gaining market share and growing this volume on the merchandise side. We'll let you say to that, we're doing really well on merchandise. We're doing good in intermodal. We announced 7% lane rationalizations at the end of last year, and we're growing intermodal. Things are healthy out there. People want to do business with CSX, and somebody said north of the border last quarter, it's a good time to be in the rail business, I think it's an even better time to be at CSX right now.
That's great. Similar vein here, Jim, on your operating ratio target of 60, two years ahead of schedule, you said it came in better than you expected. What area would you say really blew out the lights in terms of what you were expecting at the beginning of the year and what actually happened here three quarters through?
Just across the board, I think we're just doing, it's not just one thing that suddenly was like, "Oh, wow, look at this." It's across the board. It was a massive re-engineering of CSX. The question was not in my mind, as I said at the beginning, about a year ago or a little less than a year ago, it was not that this company couldn't get to a 60 operating ratio. It was a question of when. Yes, there has been, from, as Mark just talked about, major changes on the revenue side of the business, restructuring that side of the business, getting rid of the intermodal standalone business. It's a whole new management team, really bright, energetic people.
You go down into the operating side of the business, in every facet and just in every measurement that we have out there, in terms of velocity, dwell, train delays, crew utilization. We get down into the, I'm sure you've heard us talk about our taxi and hotel, Fred's talking about taxi and hotel expense. We got people around here that are probably counting how many Dixie cups we're using because we are constantly focusing on improving the way we run the business, in every area, we are doing better, but faster
Than I think all of us thought we could do.
I just want to clarify what we heard from Mark there in September. It's not that you've hit 60, now you're done. My impression from Mark was you're still early days of implementing Precision Scheduled Railroading. If you hit 60, there's still plenty more to go. Is that a fair assessment?
Mark's a Canadian, so he thinks in hockey terms. Mark's still in the first period, I think in baseball terms, and we're in the early innings.
Got it. Okay.
We have a lot of improvement to do, a lot of things to get done. I don't know where this whole idea came, but all of a sudden you hit a number and now everybody says, "Oh, we pivot." I certainly haven't. I've been working really hard here to grow this business since the day I walked in the door. How do you grow the business? By running a better railroad. Simple as that. It's not like, oh, forget the customer, to hell with the customer, just focus on ripping out costs. That's not what Precision Scheduled Railroading is about, and that's not the way we've run the business since the day I walked in here.
Okay. Thanks for the color. Appreciate it.
Thank you. Next question comes from Ravi Shanker with Morgan Stanley. You may ask your question.
Thanks. Good evening, guys. Just a couple left here. Your service levels have improved significantly, obviously, since this time last year. Can you just remind us what level of STB supervision still exists and when that will lift, given that you guys have proven that last year's issues no longer exist?
None. I think we might be the only one. When the STB said, and that was in March, I believe, that said that we no longer had to make weekly calls with the STB, and in my using my words, took us off the watchlist. They put everybody else on the watchlist, and I know that a few other railroads are still on it today. We're by far, if not the best, one of the best running railroads. There's no reason whatsoever that we would be under any kind of added supervision.
Got it. Understood. Just speaking of other railroads, can you just give us a little more color on this lawsuit that you filed versus your regional peer about access to the Port of Virginia?
Sure, yeah. What it is, it's a corporate governance issue, where CSX and NS jointly own this third-party entity that provides switching access to the Port of Virginia. Over time, in all the things in the railroad business, it evolves over time into the situation where we have a minority representation on this company, which used to be 50/50. We don't feel we are being provided the appropriate access to the terminals in Virginia. We believe that that's as a result of the other guy's disproportionate ownership. We're going to defend ourselves in court, simple as that.
Got it. If you guys do see a favorable resolution there, does that result in more coal volumes or better pricing? How do we see that in the numbers?
Access to the intermodal terminals in Virginia fits in that.
Got it. Thank you so much.
Sure.
Thank you. Next question comes from Bascome Majors with Susquehanna Financial Group. You may ask your question.
Yes, good afternoon. It's very clear that the network is running really well right now. Can you give us an update on where you are in the process of perhaps naming a permanent COO, and sort of what you guys in the board want to see before you're comfortable making that decision?
Oh, Chief Operating Officer? COO?
Yes, Chief Operating Officer.
It's not on my radar at all. I got an extremely solid team right now. Mark, in just one quarter, has done I knew he'd do an extremely good job, and he's done even better than I expected. Mr. Harris is overseeing the operating function, where we have a great talent. I'm very comfortable with the way the company's structured today. Now that is not to say that we are not always cognizant of the fact that myself, as a member of the board of directors, need to make sure that we're doing the appropriate due diligence on succession planning. That's all part of this process that we're going through, putting in, again, Ed's working really hard to develop, and we have an extremely talented group of individuals on the operating side of the business.
Now Mark's leadership, we have really a stellar group of people in the sales side of the business. Along with Frank and the finance people, Deanna and Nathan, the other executive leadership team around here, we are rock solid. People go like, "Hey, are you going to hire somebody?" No, we're not going to hire anybody. There's nobody out there that's better than we are. Now, are we going to find who can be the future leader of the company? Yeah. Hopefully, that comes from inside. That's what we're working on developing.
Thank you for the detailed response there. Just one more really high level, then I'll pass it on. If you look back to the last two quarters, CSX earned more than the prior regime did in its best full year. It looks like you're going to end this year pretty close to the margin target you laid out this spring for 2020. You said you're exceeding your own expectations, not just ours here. All good news, but clearly the pace that you're on this year can't continue forever. How do you think about and what do you consider when managing investor expectations going forward? You keep talking to January, more on January. Are we going to hear a comprehensive revisit of the long-term plan there given the progress you made? Is it going to be more about, here's how we're looking for 2019?
Again, we're not planning on doing another investor day to reboot sort of a thing. There's no need to. We are nowhere near the finish line here. We've got a lot of opportunity ahead of us. We'll try to give you as much visibility towards that as we're comfortable doing at the end of the year.
Thank you for the time.
Yep.
Thank you. Our next question comes from Cherilyn Radbourne with TD Securities. You may ask your question.
Thanks very much, and good afternoon. Wanted to ask about trip plan compliance, because that strikes me as more of a customer-facing operating metric. I think you indicated last quarter that trip plan compliance was around 60%. I was just wondering if you could update us on that metric this quarter and talk about what the upper limit is. In other words, I assume that 100% is impractical, but what's best in class on trip compliance?
Trip plan compliance, yes. It's a critical component. It does two things. It measures how well the railroad is running. It measures reliability, because when we fail, the car's not going to get there when we said it was going to get there, simple as that. When we say we're at 60%-65% of the cars met their trip plans, that means that 30%-35% of them didn't. 30%-35% of them, we said they were going to be there by Thursday at 11:00. The clock weren't. That number is huge. When we miss, not only do we disappoint the customer and not have a delivery when we said we were going to do, we then have to go back and we have to handle that car again. If we missed it, we have to handle it again.
Therefore, there's where the dual costs come in. That's why this measure is so significant because it shows that, hey, you didn't need to do it two or three times to get it there on time, and you got it there on time. The customer was happy, and we did it in the most efficient manner, and that's why trip plan compliance is so critical. If we were at 60%-65% at the end of the first quarter, we're up 28% or whatever the number was. I said 26% improved from there. Something to do in the mid-70s, the high 70s kind of range right now. We need to get that number, obviously, we want to get that number to 100.
What's reasonable in this kind of a business where you've got all kinds of things that go bump in the night and you have a problem occasionally. It's not 75, it's closer to 95. We'll get there, and we'll get there as quickly as we possibly can. If we continue to see these 10 sequentially every quarter, 10% improvement in that metric, that's going to show how well we're doing.
Great. That's helpful. Very quickly, just wondered if you could update us on domestic coal stockpiles post the end of the summer.
They're low in the south. The predominance of our coal, domestic coal, utility coal, is for the south, and the stockpiles are low heading into the winter here. That's a good story for Q4 for us. I think this is probably one of the only one of the quarters that I've seen in a long time that I think our domestic utility coal is actually going to be up in a quarter.
Thank you. That's all for me.
Thank you. Our final question comes from Benjamin Hartford with Robert W. Baird. You may ask your question.
Thanks. Jim, just come back to the beginning of the call. When you had made a comment about train accident rates needing to improve, I am just looking for some perspective, your experience here relative to PSR implementation at your prior rails. Is the issue now just constructive dissatisfaction as it relates to safety and train accidents specifically? Has it been weather or is it something else that you see specific to this experience that perhaps is causing that to operate on a lag, if it is fair to characterize it as that metric operating on a bit of a lag? Some perspective there would be helpful. Thanks.
In terms of the implementation of scheduled railroading and its impact on safety, if you look at the past railroads that have implemented PSR, they have always been the safest, whether it was Canadian National and then Canadian Pacific. It is not related to that we have changed some kind of an operating practice and it has resulted in an issue. The vast majority of those incidents are extremely small, isolated incidents that take place in one of our yards, and they normally involve an engineering defect, where something happens to the track structure. They are all basically derailments. There is a few, one car gets banged into another. On train accidents, it is mostly a derailment caused by an engineering situation or a human mistake.
Obviously we can work on the engineering end of that, which we are aggressively, to make sure that our infrastructure and everything is up to speed in our yards to avoid that. Secondarily, work with our employees to make sure they understand what the rules are and make sure that they do not do something that causes a car to go on the ground, something like that.
Okay. That is helpful. Thank you.
All right. That wraps up our call tonight. Jim, do you have any final thoughts?
No. Thank you so much for your interest, as always, and we'll be back to talk to you at the end of the year and try to give you a little flavor for what the future looks like. Thank you so much.
All right. Thanks, everyone.
This concludes today's teleconference. Thank you for your participation in today's call. You may disconnect your line.