Greetings, and welcome to the Norfolk Southern Corporation 4th Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. At this time, it is my pleasure to introduce Pete Charbel, Director of Investor Relations.
Mr. Charbel, you may now begin.
Thank you, Rob, and good morning, everyone. Please note that 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 SEC for a full discussion of those risks and uncertainties we view as most important. Our presentation slides are available at norfucksouthern.com in the Investors 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 4th quarter 2019 earnings call. Joining me today are Alan Shaw, Chief Marketing Officer Mike Wheeler, Chief Operating Officer and Mark George, Chief Financial Officer. 2019 was a remarkable year of transformation at Norfolk Southern. We launched our Top 21 operating plan to transform our railroad, while fulfilling our commitment to dramatically improve our service product as we become more efficient. We've made tremendous strides on both of those fronts and delivered progress on our strategic plan.
In the face of a challenging volume environment, we are pleased to share results today that demonstrate this organization's strong momentum in streamlining our operations and making substantial progress toward our long term commitments, thanks to the hard work and significant efforts by our workforce and leaders. Slide 4 highlights those results. For the quarter, EPS was $2.55 and the operating ratio was 64.2%. For the full year, income from operations reached record levels at nearly $4,000,000,000 resulting in a record operating ratio of 64.7%, a 70 basis point improvement over 2018. Earnings per share increased 8% to 10.25 dollars We've now achieved record operating ratio results for 4 consecutive years.
This year's improvement is particularly impressive against continuous improvement and underscore our steadfast dedication to creating shareholder value. Despite volumes deteriorating throughout the year, culminating in 4th quarter and full year volume declines of 9% 5% respectively, we remained focused on running our railroad as efficiently as possible and with a high level of customer service, achieving our locomotive and T and E workforce productivity goals despite having less freight to haul. These efforts contributed to the record full year results I mentioned a moment ago and the core margin improvement accomplished during the Q4, which Mark will discuss shortly, demonstrates the significant momentum we're carrying into 2020 and beyond. As we enter 2020, we continue to build on the strategic plan initiatives we launched in 2019, while rolling out Phase 3 of our PSR based operating plan, TOP21, which will drive additional productivity across our resource base, all while maintaining the high quality service product established in 2019. The team will provide additional details regarding initiatives as well as further details on our Q4 and full year results.
Alan will cover trends in revenue, Mike will cover operational performance and Mark will go over the financial results. I'll now turn the call over to Alan.
Thank you, Jim, and good morning, everyone. Macroeconomic headwinds challenged volume in 2019, particularly in the second half of the year. With these tough conditions, we continued our focus on margin improvement, supported by the value that our outstanding service product creates in the market. On Slide 6, excess truck capacity, trade and economic uncertainty and manufacturing weakness negatively affected our markets, driving a 9% decline in volume. We partially mitigated the impact of declining volumes with stronger revenue per unit excluding fuel in all three of our business units, including quarterly records in our merchandise and intermodal business groups.
Norfolk Southern's revenue per unit has increased year over year for the last 12 quarters despite the market cycles over that period of time. The weak manufacturing environment and low commodity prices drove down merchandise volumes in all groups except chemicals, led by a 17% decline in steel. Import steel tariffs affected the traffic flows and lower steel prices reflected weak demand. Merchandise volume declines were partially offset by an increase in crude oil, which more than doubled its volume year over year. Aeromotal revenue declined 8% due to excess truck capacity in a weak freight environment.
International comparisons were difficult as the inventory pull forward drove a spike in Q4 2018 volume. Coal volume and revenue were down 21% year over year with the largest volume decline in utility coal. Our Northern utility portfolio was impacted by low gas prices and combined cycle capacity. Export was influenced by falling seaborne met prices and Chinese tariffs, while export thermal prices remained at low levels, making it difficult for U. S.
Coals to compete globally. Turning to Slide 7. In 2019, revenues decreased 1% despite a 5% decline in total volume. Evident from our margin improvement strategy, revenue declines were partially offset by a 3% increase in revenue per unit. Merchandise revenue reached a record $6,800,000,000 in 2019, while volume declined 3%.
Volume headwinds occurred from weakness in the manufacturing economy, the loose truck market and declines in steel and natural gas liquids. We were favored by fuel price differentials that boosted crude oil demand to East Coast refineries and we secured increased aggregate volume. Intermodal revenue decreased 2% on a 4% volume decline as gains in international were offset by domestic declines. Lower spot truck prices and excess capacity in the trucking industry reduced domestic intermodal demand in weak freight environment. Turning to coal, revenue declined 8%.
Utility volume declines were predominantly in the North, where low natural gas prices suppressed coal burn, while Southern utilities benefited from inventory build in the first half of the year. Depressed seaborne coking coal and thermal prices led to lower export volumes and prices that were further impacted by production issues. While uncertain economic conditions negatively impacted revenue and volume in 2019, we maintained our focus on improving our service and creating a product that will enable our customers and Norfolk Southern to grow when the freight environment improves. This approach supports our strategy of margin improvement, which is reflected in our increasing revenue per unit, providing opportunities for operating leverage when demand improves. Moving to our outlook on Slide 8.
We are closely monitoring developments in the macro economy and its impact on the industries and business segments in which we compete, as well as our customers' expectations as we execute our strategy. GDP growth is expected to be in the 2% range in 2020, with the majority of that growth from personal consumption, creating opportunities in our consumer driven intermodal and merchandise markets. Continued weakness in manufacturing and low commodity prices will impact our coal franchise and other segments of our merchandise markets. Overall, we have not seen an inflection point in volume trends and a high degree of uncertainty exists. We see growth potential as we move into the second half of twenty twenty due to forecasted improvement in the trucking and industrial sectors and easier comparisons.
U. S. Light vehicle production is forecast to improve more than 5% in 2020. Improved price differentials are predicted to sustain Q4 2019 crude volume levels through 2020. Overall, we expect total merchandise revenue improvement enabled by our strategy with continued support from our consistent, reliable and quality service product.
The truck market remains loose with spot rates leveling off, yet our customers and data providers forecast some tightening later in the year. Based on this information and new business initiatives, our intermodal revenue and volume are expected to grow in 2020. In coal, additional gas and renewable generation capacity continues to erode coal share of electricity generation. Coking and seaborne thermal coal indices are substantially below prior levels, impacting both export volume and pricing. In summary, as headwinds persist in the freight environment, we expect 2020 revenue to be flat with the Q1 similar to the Q4 of last year and conditions improving as the year progresses.
We remain focused on a disciplined pursuit of efficiency, while recognizing the value our consistent, fast and reliable service product creates for our customers. In light of continued economic uncertainty and with our demonstrated willingness and ability to adjust to market conditions, this approach provides the platform from which we will further enhance value for both our customers and shareholders. I will now turn it over to Mike for an update on operations.
Thank you, Alan. Today, I will update you on the state of our operations. In the Q4, we continued to deliver strong service for our customers and significant cost savings, which drove a record operating ratio for the year. This operational leverage is driven by a relentless execution of the core PSR principles and our top 21 operating plan. Moving to Slide 10.
Our network is running fast and on time. Record train performance and record terminal dwell drove near record car level velocity and strong asset utilization for Norfolk Southern and our customers. These achievements support our strategy to meet our customers' expectations while eliminating costs and prudently managing our assets. Our momentum has continued into 2020 and will be a tailwind to our initiatives this year. As seen on Slide 11, our operational performance is driving strong service levels as evidenced by our customer facing metrics.
Intermodal availability, which measures our customer commitment to grounding of the box shipment consistency, which measures trip plan adherence for merchandise traffic and local operating plan adherence, which measures execution of the critical first mile and last mile of service. All of these metrics were at or near record levels. We have been sharing our metrics with our customers for well over a decade, and we use them to have data driven discussions to confirm the value of our service product. We remain committed to providing a high level of service for our customers while achieving our productivity goals. Turning to our service and productivity metrics on Slide 12.
These metrics align with our strategic plan as they measure key productivity and customer service levels. We are aggressively reducing our resources to meet our productivity goals despite the drop in our GTMs. Starting with the service delivery index, which is the on time delivery performance of our scheduled shipments indexed to 2018. This is a customer facing metric that combines shipment consistency and intermodal availability, which were detailed on the previous slide. We exceeded our 2019 goal and actually achieved our 2021 goal 2 years earlier.
We will maintain this high level of service by continuing to execute our Top 21 plan. We exceeded our 2019 T and E productivity goal despite a significant drop in GTMs. We are at our lowest T and E headcount on record, while still providing exceptional service. We are realizing the benefit of our TOP21 plan, which has the added benefit of capacity in the train plan to allow for growth on the existing trains. While we missed our 2019 train weight goal for the full year, we actually met the goal in the second half of the year with the implementation of our Top 21 plan.
We have, however, taken another look at our 2021 train weight goal in light of the continued change in the coal market. We believe the new goal of 6,700 tons, which is 5% higher than our baseline, reflects the improved productivity of our top 20 1 operating plan while taking into account the projected mix. We also met our goal for locomotive productivity for the year by aggressively rationalizing our locomotive fleet, which is 20% lower than 2018. As mentioned in our previous call, this has allowed us to significantly rationalize the resources associated with the maintenance of these locomotives, including a reduction of 600 positions last year and an additional 135 positions this year. Regarding fuel, we will benefit from our lower locomotive fleet size, our aggressive implementation of energy management technology and our DC to AC conversions.
And the cars online continues to be a positive story for Norfolk Southern. As we noted throughout the year, we exceeded our original 2021 goal, thanks to our fast and consistent service product. To that end, we have established a new goal of 129,000 cars going forward, which includes cars in storage that can be deployed as market conditions warrant. In summary, we are confident we will meet our productivity goals for this year as we will now have the momentum of full year benefits of our previous rightsizing of our workforce and locomotive fleet. This will get us more than halfway to our 2021 productivity goals this year.
As you can see on Slide 13, we accelerated our progress in reducing crew starts during the Q4. We continued to build on the success of TOP 21 with Phase 2 of the plan, which included initial consolidation of some bulk movements into the manifest network and dividends from our year long clean sheeting program. This improved fluidity is allowing for the continued reduction in yard and local assignments. This quarterly year over year improvement accelerated in the Q4 with the majority of these improvements being long term structural gains. As previously mentioned on the other slide, we have capacity in the new plan to accept additional volumes without a commensurate rise in crew starts.
We anticipate continued strong year over year comparisons as we begin to roll out Phase 3 of TOP21, completing delivery of the promised 3 phases of the program in a year and a half instead of the anticipated 3 years. Going forward, our network planning and operations groups will be evaluating the plan and the network for further optimizations. In closing, this has been a critical year for Norfolk Southern. We started the year by detailing our implementation of the core PSR principles. We have successfully executed on these principles despite a challenging market.
Our service is at record levels. We achieved a record operating ratio and our serious injury ratio was the lowest in the last 5 years. We are carrying this momentum into 2020. I will now turn it over to Mark, who will cover the financials.
Thank you, Mike, and good morning, everyone. Before we get into the detailed P and L, I want to point to a chart in the appendix that specifies for you some large and unusual items that impact the results and comparisons versus 2018. I'd like to talk to those impacts upfront on Slide 15 for the sake of clarity. This chart illustrates the effect of those items on the OR and EPS for the quarter as well as for the year. The reported changes to OR and EPS are reflected on the bottom row, and we distill those drivers in the white rows above.
The first item, as you may recall, relates to a property sale in the Atlanta area in the Q4 of 2018. That particular gain was $112,000,000 and creates an OR headwind of 3.80 basis points in the Q4 of 2019 and 100 basis points for the full year, with a headwind to EPS of about $0.30 Next was the $32,000,000 receivable write off arising from a legal dispute that we called out in the Q3. This reduced the 2019 OR by 30 basis points and EPS by $0.09 The final headwind involves the non operating impairment that we booked in the 2nd quarter related to the natural resource assets we have been actively marketing. In the 4th quarter, we took an additional $21,000,000 impairment related to those same assets, and that had a $0.06 impact to EPS in the quarter. And when added to the 2nd quarter impairment loss, the EPS impact for the full year was $0.14 You'll note we had a low effective tax rate in the quarter.
This was driven by certain income tax credits authorized by Congress in December of 2019, which were retroactive to 2018. The impact to the 4th quarter EPS was $0.07 and for the full year, it was 0 point 0 $4 Beyond these unusual items, the core improvement in the OR was 240 basis points for the quarter and 200 basis points for the full year, while core improvement to EPS was $0.28 for the quarter and $1.23 for the year. Now moving to the Q4 Slide 16, revenue was down 7% in the quarter, driven by a 9% volume contraction, partially offset by RPU improvement. Operating expenses, as reported, were 5% lower, including 5 points of headwind from the absence of the prior year land sale. Drilling into the expense categories on Slide 17.
As Mike illustrated earlier, our top 21 PSR based operating plan has reduced the amount of resources we need to run the network, resulting in fewer trains and lower crew starts, manifesting in substantial cost savings across multiple expense categories. Starting with compensation and benefits, we drove a $127,000,000 reduction in expenses in the 4th quarter. That's a decline of 17% on employment levels declined throughout the quarter and this, along with lower overtime, health and welfare benefits as well as less re crews, saved us $86,000,000 This favorability was partially offset by $17,000,000 of additional expense due to inflation in pay rates. In the quarter, incentive compensation expense was lower by $57,000,000 due largely to last year's higher payout that disproportionately impacted the Q4 of 2018. So we drove average headcount down by approximately 1500 employees from last quarter and have reduced by 4,200 compared to last year.
Run rate benefits from this will continue into 2020 on top of additional efficiency actions. Moving to fuel, reduced consumption and lower prices drove a $52,000,000 decline in fuel expense. We improved on our fuel efficiency as fuel consumption declined by 11% on the 9% decrease in volumes, despite adverse mix from weaker coal where our fuel efficiency is strongest. Here in 2020, fuel efficiency is getting intense attention through various initiatives, including continued locomotive upgrades and deeper energy management penetration, as Mike mentioned. Moving over to purchase services, rents and materials.
Our initiatives to improve asset utilization are also driving a reduction in expenses. The increased network velocity, improved fluidity and fewer locomotives and freight cars on the network drove $15,000,000 in savings associated with equipment rents and $12,000,000 in savings of material costs. These expenses sorry, these savings were partially offset by increased detouring costs due to a bridge washout and derailment expenses that amounted to $13,000,000 collectively. The fast response and strong execution by our operations team limited the financial impact of the derailment to only half of the $25,000,000 we signaled at the last earnings call. So when looking at the big picture, the underlying change to our cost structure accelerated in the Q4 as we continued to drive resource reductions through the end of the year.
The full year effect of those savings will be realized in 2020. Moving to Slide 18. Let's take a look at our summarized 4th quarter financial results. Other income included $31,000,000 of favorability from investment returns on our corporate owned life insurance, where we had positive returns in Q4 2019 versus losses in Q4 of 2018. We also had $5,000,000 of higher gains on the sale of non operating properties than prior year.
These amounts were partially offset by the additional $21,000,000 asset impairment loss that I mentioned earlier. The lower effective tax rate of 19.6% was driven by both the retroactive tax credits as well as higher nontaxable returns on the corporate owned life insurance. Income taxes will represent some headwind in 2020 as we expect the tax rate to be between 23% and 24%. Shifting to the full year on Slide 19. We delivered impressive results for the year in the face of accelerating declines in revenue and the net headwind items we discussed on Slide 15.
We reduced railway operating expenses by $192,000,000 We set company records for operating income and operating ratio. Our railway operating ratio improved 70 basis points over 2018. Net income improved by 2%, but diluted earnings per share grew 8% to $10.25 for the full year, aided by a 5% reduction in our average share count. Achieving the cost reductions while pushing delivery performance for our customers to record levels demonstrates our commitment to long term value creation. Recapping on Slide 20, our full year cash flows from operating activities was $3,900,000,000 and free cash flow for the year was a record at nearly $1,900,000,000 Dividends and share repurchases for the year totaled over $3,000,000,000 So to close, we clearly have created momentum on the cost side despite the volume challenges and obstacles that were unforeseen at the beginning of the year.
It's that momentum plus new initiatives, which provides us with strong leverage going into 2020 to continue to drive profit growth and margin expansion. Thank you, and I'll turn the call back over to Jim.
Thank you, Mark. As you've heard on
the call today, the Norfolk Southern team made tremendous strides in executing the strategic plan we laid out a year ago. Amid a rapidly changing macroeconomic landscape, we pivoted our productivity initiatives and achieved a locomotive fleet reduction of 20% and a workforce reduction of 8% for the full year average. With those figures accelerating to 22% 16%, respectively, in the 4th quarter. These resource adjustments significantly outpaced the volume declines, demonstrating strong cost momentum, while maintaining exceptionally strong customer service levels. Turning to Slide 22, I'll wrap up with our 2020 expectations.
1st and foremost, we will continue to execute our strategic plan with the top priority of running the most efficient railroad possible, while being a best in class supply chain partner for our customers. As you heard, we are modeling net overall revenue to be flat for the year, with persistent headwinds in coal to be offset by improving comparisons in merchandise and intermodal as the year progresses. Despite and within that environment, we have confidence that our productivity and efficiency formula will result in significant operating ratio improvement this year that will get us more than halfway to our committed 60% OR in 2021. Lastly, as we continue to execute our highly effective locomotive fleet modernization program, we are targeting a capital expenditures program between 16% 18% of revenues. We remain committed to returning capital to shareholders through a 1 third dividend payout ratio with remaining cash and borrowing capacity used for share repurchases.
This disciplined capital allocation strategy represents our commitment to enhanced shareholder value through returning capital and ensuring Norfolk Southern is positioned for continued success. Before we turn it over to questions, I want to thank each and every NS employee for their hard work and commitment to the strategic transformation of our railroad. Thank you for your attention. We'll now open the line for Q and A.
Operator? Thank you. We'll now be conducting a question and answer Thank you. And our first question comes from the line of Bascome Majors with Susquehanna.
Yes. Thanks for taking my question here. Mark, you've been in the CFO seat for about 3 months now and have had some time to get the lay of the land. Can you just take a step back and kind of give us versus your expectations coming in, kind of what's as expected, maybe what has surprised you? And are there any changes that we should expect to see as investors with you leading the finance organization versus how ANS has handled things historically?
Thanks. Thanks for the question. Yes, coming in from the outside, a different industry, a culture that clearly is different than the one I've come from, I would say that I'm surprised that we see a great blend here of long tenured industry experts who are very passionate about not just the business, but the industry itself and the infusion of new talent that come from different walks of life and different industry experiences and that they are actually being welcomed with their new ideas, including my own, frankly, coming from the outside. So that's been kind of a pleasant surprise, I would say. I was not expecting such a welcoming with regard to the new ideas and new concepts being brought in.
I am also kind of impressed by the speed and agility of an old company, so to speak, to react to a very rapidly changing economic environment, you see the charts that Mike showed on how quickly we've taken resources out to respond to volume declines. And that nimbleness, I would say, has surprised me. And coming in, another big observation is just how capital intensive this business is compared to where I've come from. Obviously spend a couple of $1,000,000,000 a year in CapEx. We've got over $30,000,000,000 of fixed assets.
And so it's certainly an area that I need to drill into a little bit more. I'm understanding why we spend so much. Certainly, half of that is related to maintaining this big infrastructure to serve your customers and to do it safely. But I do want to understand the rationale for the spends that we have, the justification financially for them and the prioritization process. So it's something that I expect to dig into a little bit.
And maybe you've seen a little bit on this call too. We just want to be transparent with the investment community about the path that we're on, which is to get to a 60% OR by 2021.
Thank you so much for the answer.
Thank you.
Our next question is from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, thanks. Good morning, guys. So Mark, I'm hoping you can help us with a little bit more clarity on some of the numbers here. So can you give us what the real estate gains above the line were in the Q4 and any expectations for this year in terms of what's assumed in the guidance? And then similarly with incentive comp, I know it was down in 2019 versus 2018.
Any way to think about is 2020 a year of a headwind, tailwind or normal? Any help there?
Sorry, the second question, Scott?
Was just on incentive comp. Should we think about that as a headwind in 'twenty or is it 'twenty versus 'nineteen sort of just a normal year on incentive comp?
No, we would hope that incentive comp is a headwind because we're hoping to have a better year in 2020 than we did obviously this year where we fell a little bit short. So clearly, that will be a little bit of headwind for us. With regard to the real estate, excluding the big one that we carved out for you, gains in the year were a little bit higher than they were last year, less than $20,000,000 In the Q4, roughly half of that benefit we saw in the Q4 of this year. So we had about $10,000,000 of additional gains in 'nineteen versus the Q4 of 'eighteen, excluding the big one that we carved out. And the guidance, Scott, on real estate, in any given year, we're expecting $40,000,000 to $60,000,000 of gains.
It's going to be lumpy, be back loaded. It could happen middle of the year. With real estate, you never are quite sure when you can get things to close and get over the finish line. But we ended this year excluding sorry, we ended last year excluding the big gain in that range, and the same thing this year, we ended within that range.
Okay. That's helpful. And then so on the revenue guidance of flat, maybe if you have a thought on our volumes down and yields up. And then it does feel like you guys are losing some share on the volume side, but clearly doing well on the yield side. Are you okay with that yield up strategy and the trade off of better yields, but weaker volumes than maybe your peer?
Or do you feel like you've pushed it too far? Just some thoughts how you're approaching the market.
Scott, it's Jim. Let me take the second part of that, the market share question, and then I'll turn it over to Alan to give you some more color on the components of our revenue guidance for this year. We are targeting the truck market. That's the market share opportunity. That's the big opportunity for us.
And that is the linchpin of our growth strategy is getting trucks off the road onto the railroad. So and there are opportunities there when it comes to our growth engine, intermodal and there are also opportunities in the merchandise realm. So and we are also certainly committed to achieving value for the services we provide, which value is quite strong these days. We've got a great service product out in the marketplace and we're very proud of that and think that we can create value for our customers through that service. So Alan, a little bit more color on the 2020 revenue outlook.
Scott, coal is going to be a drag throughout the year, and it's going to be a drag both in volume and in price. We've got a great service product out there. And we're taking a long term view of our markets. We take a long term view of our approach with our customers as well. And so we are very disciplined in securing the value and understanding the value that our service product creates for our customers.
As Jim noted, our eyes are on that $800,000,000,000 truck market and that's where the growth opportunities are And that's where we're going to see improvement as the year progresses. It requires fierce competition and putting new products out there, new logistics services that our customers value. And we're doing it from a platform in which I'll remind you, we went out in front of our customers and we told them what we were going to do with our operating changes with PSR. And then we did it. And there we've created a lot of credibility with our customers for our no surprises approach to our operating plan changes.
We implemented it flawlessly. And what's unique about Norfolk Southern is that as we implemented PSR, our service got better. And so we're in a great position to grow as we move forward. And if you think about truck and the opportunities there, it aligns perfectly with the unique strengths of our franchise. We have a powerful intermodal franchise and we have a very broad and diverse merchandise franchise as well and we are focused on opportunities to take business from truck and merchandise as well.
Okay. Thank you for the time, guys.
Our next question comes from the line of Allison Poliniak with GR Energy Services. Please proceed with your question.
Hi, it's Allison. Just a question, I want to circle back to the Cars Online commentary. If I heard you correctly, I think you said that, that number included a level of storage so that there is some once volume are expected to uproot?
Can you just go through
that again, sorry?
Yes, that's right, Allison. That's how we calculate that number. And we do it that way because we want to focus on the velocity of our entire car fleet, including those that are in storage. So that we're that's an asset that remains on the books and we want to make sure that it too is being taken into account as we think about utilization of the freight car asset.
Yes, this is Mike. Of that 129,000, we have 17 1,000 cars in storage that is available to us to flex up when the business arrives and we're pretty excited about that.
Great. And then just obviously you're well into your strategic plan. Looking back over that in the past few months, what's been your greatest surprise in terms of your ability to perform in this environment?
Well, I think Mark did a good job describing the progress that we have made, the core operating and core earnings improvement that we made in the Q4. So the momentum stands out for all of us, I think, and that's not a surprise and that we've been driving it. We've been focused on accelerating the improvements as we move throughout the year. And we did it in Q4 and that will carry over into 2020 beyond.
Great. Thank you.
Our next question comes from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.
Hey, great. Good morning. Jim, maybe just expanding on that target or of the 2 35 basis points year over year or maybe for Mark, but does that include the headwind of the incentive comp returning the $40,000,000 to $60,000,000 real estate gains? And then maybe just your thoughts on what's going to happen with the employee base moving forward? Is this kind of the run rate level?
Do you still see more productivity on the employee side? Thanks. Mark?
Yes. Ken, look, I think in terms of headcount, we've taken a lot out this year. There's actually more to come. So not only will we enjoy the benefit of the full year effect of those employees that came out in the back half of this year, but there are more to come in the beginning part of this year. And then frankly, we just have to see how volume shakes out and determine how much further we can go and absorb the volume that we are assuming to get returned in the back half of the year.
Sorry, the first half of your question, Ken?
Just to ensure that the 2 35 basis points improvement, which is great, but does it include the headwind of incentive comp and the real estate gains that you mentioned, it's all baked in, right?
It's all baked in, Ken. So the incentive comp returning to normal and the real estate gains being in that 40 to 60 range, it's all part of the calculus.
Yes, it's a big number. Thank you. And then I guess my follow-up for Mike. Just note it looked like you had no targeted improvement in the service delivery index. Are you changing it to tighten your range?
Or why would there not be given all the moves you're making in it, I guess a target for improvement there?
So overall, we're pretty happy with windows for delivery to our customer windows for delivery to our customer and be better on the consistency part. So that's a part of it, but it doesn't roll up necessarily into changes at the macro level. But, yes, we're pleased with our service, but we are going to continue to dial it in, get better and better in
the fleet with trucks. Ken, if I could add something, we collaborate with our customers on our service targets. And Mike noted that for years, we've been putting service targets out there with our for our customers and sharing with them our performance. In 2019, we upped the ante. We went out in front of our customers and said, here's what's going to change with PSR implementation.
Here is how your service is going to improve. And then we delivered it. And as you are going to see, our PSR implementation continues to evolve. We continue to make improvements and we are putting a product out there that helps us compete with truck and as the truck market tightens as we move throughout the year, it's going to be a growth driver for us. We are very confident in the quality of the product that we are delivering and we are pricing to that effect.
Great. Thanks, Alan, Jim, Mike and Mark. Appreciate it.
Thank you.
Our next question is from the line of Tom Wadewitz with UBS. Please proceed with your question.
Yes, good morning and thank you for the detail on the 2020 outlook. It's very helpful in terms of just how to think about things and also the framework on OR progression is very helpful. So thank
you for
that. Wanted to see if you could offer some thoughts on 2 of the segments where you've had have not seen improvement yet. So I'm thinking of purchase services, would you expense would you expect that line to improve in 2020 or 2021 as a result of Phase 3 in TOP21 or the terminal improvement program? How do we think about that line and also maybe a little more on fuel efficiency?
Mark?
Yes, I'll take that, Tom. So look, purchased services, clearly, there is intermodal terminal operating costs that are in there. I wouldn't call them strictly volume variable. There's an element of fixed cost in there as well or committed costs in there. But bear in mind that in our purchased services category, we've also got other things that are not volume variable.
For example, a lot of the maintenance costs for the network that you don't capitalize flow through this line. So when you have repairs to rails and you have to maintain the trees and ensure that the lines are clear, A lot of the costs for maintenance of the infrastructure cannot be capitalized. It goes into this category. Building leases and rental costs are in there. And then the other piece that you have to bear in mind, Tom, is there's a fair amount of technology cost that flows through there similar to what I described with maintenance.
There's a lot of the IT spend that can't be capitalized, runs through this line category, and frankly, it's a growing category. The good news, however, is a lot of those investments we're making in technology are delivering returns in other things in the P and L, as you saw through the call today. So we're investing in things like automation. It allows us to relieve ourselves of some headcount related to more transactional tasks. And we expect to continue to invest in this technology element as well.
So that's in large part why purchased services is not moving as quick as we like. All of that said, I've got to dig in there a little bit, and we've talked about it quite a bit. We've got to look at this bucket for opportunities in 2020. It is an area where I think it's right for us to dig into a little bit more. Your second question on fuel, we made progress in Q4 with some levels of efficiency and we are really relying on a step change improvement going into 2020 in fuel.
The team is organized well. We continue the upgrades from DC to AC. That provides a lot of benefits to us in many ways, including fuel. But on top of that, we're having deeper energy management penetration. And so it's clearly an area in 2020 that we hope to see significant progress.
Just if I can get a brief follow-up. Jim, I think there was maybe a little increase in discussion in December on volume sensitivity of the 60 OR target for 2021. Your guidance for 2020 seems to indicate there's not a lot of concern about volume, but how should we broadly think about volume sensitivity of getting to 60? Do you need to improve volume growth in 2021? Or how do we broadly think about that?
Thank you.
Well, let me say first, this is a cost structure, cost reduction based plan, particularly in 2020 where we forecast flight revenue. So it's almost all about achieving the efficiencies concerned, maybe get a little bit of a tailwind from some growth at that point. Concerned, maybe a little get a little bit of a tailwind from some growth at that point, but we're not factoring in a lot. It remains fundamentally in an efficiency oriented financial plan even as we move into 2021.
Great. Thank you for the time.
Thank you. Our next question is from the line of Chris Wetherbee with Citi. Please proceed with your question.
Hey, thanks. Good morning. I wanted to dig in a little bit on the coal outlook, if we could, specifically maybe exports. Alan, can you help us understand a little bit better how we should be thinking about I think there's 2 impacts here, probably 1 on the volume side and then on the yield side. Maybe sequentially on
the yield, should we see expect to step
down in 1Q as some of these contracts get reset based on commodity prices? And then how should we think about the volume? Just trying to put some numbers around the coal headwinds we're looking at in 2020.
All right, Chris. Let's refresh where we were as we move through 2019. In Q1 and Q2 2019, met coal prices were above $205 a metric ton. And then they started cascading down there around 1 $160,000,000 in the Q3 and closer to $140,000,000 $145,000,000 in the 4th. And so as we've talked about, frequently, we saw sequential declines in both volume and in price in our met coal franchise, which is export franchise, which is about 2 thirds of our export coal, which makes up about 25% of our overall coal volume.
Right now, where coal prices are now, it's in the low 150s. You're going to see a lot of pressure on price. And just recall, Chris, that our RPU in export coal net was at its highest point in the Q1 of last year as prices were at the highest point. So comps are most difficult in the beginning of the year.
There's not
a lot of demand in Europe. And as a result, you're seeing coals sourced from other locations globally are being put out onto the water. And so there's increased competition for us there. And of course, you know what's going on with thermal, that is going to have a market impact on export thermal volumes. So you're going to see volume pressure in both met and thermal exports and you're going to see particular price pressure on met exports.
Okay. And the yield pressure is toughest in the first part of the year 2020?
Relative to last year, yes.
Got it. Okay. All right. Now that's helpful. And then Jim, maybe a bigger picture question coming back to the last one about OR in 2021 and some of your thoughts there.
Some significant improvement this year and expectations for 2020. When we think about maybe some of those tailwinds that you could get from revenue growth potentially returning in 2021 and given the progress you've made so far, how do you think about sort of the potential business? So I think a lot of us spend time focusing on your performance relative to peers. Is that the right way we should be thinking about it? So some of the numbers that we're seeing from some of the other rails out there, are those the types of potential ORs we can expect from Norfolk over time?
Just want to get a sense of how you're feeling about it kind partway through this PSR initiative?
Should we see upside in the top line, we would expect much of it to flow through operating income and to the bottom line because there will be significant operating leverage in that growth. That's not our base case as we've been through, but the growth will return and resume at some point. We think we get a lot of operating leverage because we have restructured our costs and believe that we can handle volume growth with the resources on hand. Now there will be areas where we have to increase spending to handle the volume growth depending on how much it is. But by and large, we believe we can handle the volume when it returns with our existing resources.
Okay. That's helpful. Thanks very much for the time. I appreciate it.
Our next question is from the line of Brandon Oglenski with Barclays. Please proceed with your question.
Hey, good morning, everyone, and thanks for taking my question. I guess, Jim, maybe following off that line of questions, as we look at Phase 3 of the TOP21 plan, is that going to drive pretty significant operational changes here and that's why you guys have the confidence on the cost outlook and the OR improvement in 2020?
That will contribute to it and for all the reasons that the last major iteration of Top 21 drove efficiencies. So yes, that's a piece of this. In the next iteration of Top 21, we will continue to focus on train consolidations, on decreasing circuity, on running longer, heavier trains to meet the goals that we put out there for those things. So it's really it's further to the types of goals that we were pursuing in the previous versions of the plan. I think at some point going forward, this becomes continuous improvement.
And really in a way we're already there. We are looking every day, every week at shorter trains and working on a plan in consultation with our customers and the field to fold those trains into the network and achieve those efficiencies on an ongoing continual basis.
Okay. Appreciate that response. And not to get too specific on this call, but Mark, can you talk to the other expense line item? Because I think if we look at it, the last few quarters, it was running around $60,000,000 run rate. Is that the right level to think in 2020?
Other expense?
Yes.
Yes, that's about the right level to be thinking about it, Brandon.
Okay. Thank
you. The next question is coming from the line of Justin Long with Stephens. Please proceed with your question.
Thanks and good morning. So maybe to start with the quarter, there were some one time items that you called out in the prepared remarks. So I was wondering if you could just help us understand if all of these items were baked into the guidance that you gave for 2019? I just wanted to get a better understanding of how things performed operationally in
the Q4 versus what you expected?
Refer to Mark's opening slide for the components of the OR change and the EPS change, some of which were non recurring, others of which represent core earnings production during the quarter. Mark?
Yes. So when you go back to the appendix chart, basically the property sale in 2018, we knew when we were building the 2019 plan that we wouldn't be having a similar sale of that size. But the receivable write off and the 2 asset impairments that we incurred in Q2 and Q4 were unforeseen. So those impacts are clearly not contemplated when the 2019 guidance was given.
And there were some other things as the taxes were lower and tax rate was lower in the Q4. That was not something that we projected when we gave the guidance on the quarter.
So basically think about it as those three rows, the receivable write off, asset impairment and the retroactive income tax credit were the surprises to us at the time of guidance a year ago.
Okay, great. That's really helpful. And then secondly, I wanted to ask about intermodal. Would love to get your thoughts on intermodal growth this year and what you're expecting. And then just from a margin perspective in intermodal, as PSR gets fully implemented in that network, how do you expect incremental margins within intermodal to stack up relative to the rest of the business?
I know historically you've talked about intermodal incrementals being lower than general merchandising call. I'm just wondering if that rank order could change post PSR?
Justin,
we are expecting some growth in our intermodal franchise as the year progresses. As I noted, we are collaborating with our customers to look for logistics solutions that fit their needs. And we are really fortunate because we are aligned with the best channel partners in the business and they are focused on growth. They understand our network and so we are collaborating to see where we can compete with truck. We are encouraged to see an inflection in spot rates in truck.
We haven't seen like a big uptick in it. So the first order or first derivative isn't all that great, but the second derivative is. I mean, it's certainly stabilized and is improving. And that's going to provide some headroom for incremental volumes for intermodal as the year progresses in addition to new service projects, products that we're launching. And as we go through top 21v3, we're going to look at consolidating some business.
We're also going to look at reopening some lines and introducing new businesses for us.
And Justin, in terms of the incrementals within the intermodal sector, I would say this for the last couple of years, the incrementals have actually been excellent during periods in which we were growing volume. Looking back historically, one of the things that did hold intermodal incrementals back a little bit was fixed costs associated with the intermodal volume growth, I. E. Terminals and equipment costs. There as Mark went through, we're very focused on asset cost in this plan.
And in the case of intermodal, making maximum use of the assets that we have, the terminals, the equipment that we have today, and keeping to a minimum the growth CapEx that we're putting into that business. So lots of initiatives around terminal improvement processes, and particularly in the environment we're in, keeping a lid on equipment costs.
Okay, great. I appreciate the time.
Our next question is from the line of Walter Spracklin with RBC Capital Markets. Please proceed with your question.
Yes, thanks very much. So going back to the materials and other line item, forgetting for now, I just want to be clear, forgetting for now the Q4 2018 impact and just looking at your quarterly run rate through 2019, you were averaging anywhere from 190 to 196 and you stepped down to 130 in the 4th quarter. Is that all due to the gain that you had in the Q4? And can you tell us exactly what the gain was, the amount of the gains in the Q4?
That was the property gain. Right. The absence of the property gain from last year, which was $112,000,000
Yes. No, I'm talking forget last year, I'm just talking the cadence of the materials and other line expense in the through 2019 was $190,000,000 and it stepped down $60,000,000 in the 4th quarter. I'm just trying to understand what caused the quarter sequential step down from what was $190,000,000 per quarter through 2019 to drop to 130?
Some of that was efficiencies that we achieved in material spending in the Q4. As Mark went through, this is one efficiency pickup by virtue of having a smaller locomotive fleet and a car fleet out there where we incur lower equipment maintenance expense.
So what was the gains in the quarter, I guess is the question I'm asking. Mark?
It was around $40,000,000 $45,000,000
So you were guiding at the beginning of the year for $30,000,000 to $40,000,000 for the full year and you did $45,000,000 in the 4th quarter. Is that am I getting that right?
40% to 60%. Well, we're guiding now 40% to 60%. I don't know what was said at the beginning.
I mean, we've always said that this is going to be lumpy and unpredictable. Now you do tend to get more real estate closings at the end of the year. I think that probably is a pattern that you see a little bit better gain in the Q4. But it is we've produced about $40,000,000 to $60,000,000 excluding one off gains like we had in the Q4 of 2018. That's about what we expect to do going forward.
But it will vary by quarter from time to time.
Okay. So you were at 30 40 embedded in your guidance for 2019 at the beginning of the year and now it came in as I understand it 40 to 60 of which 45 was included in the Q4?
Correct. Okay, got it. Okay. So we ended the year kind of at that closer to 60.
60, okay. Of which 45 was all in the 4th quarter?
That's correct.
Got it. Okay. Thank you for clarifying. And then on the side or the tax, I've got is it 2019 of retroactive tax adjustment, which would get your effective tax rate back up to around 22%, still trending fairly quite a bit below where was there anything else in the quarter versus the guidance that you were giving before of 23% to 24% or is that just a lower tax rate?
Yes. We had more benefits than we assumed from the COLI gains, which are tax exempt. In addition, we had the 45 gs tax credits that we just talked about and disclosed, but there was also higher deductions from stock based compensation. So everything kind of just went in the right direction for us this year. So that's why the ETR effect ended a little bit lower than what we would typically guide.
Is there something there you would call out as just kind of an exceptional number because I don't mind lower taxes on lower expenses, but that tax retroactive tax adjustment, is there anything else that was retroactive or was one time in the quarter that would
There was nothing out of period in the quarter, no. Okay.
Okay. And last question here is on the revenue. So you have revenue flat for next year. The guidance that you'd given through the year last year was a little bit more on the optimistic side. Obviously, a lot of things happened unexpectedly.
What confidence do you have that while you're giving flat guidance, it is above your peer? Are you being a little bit more optimistic? Is there just the coal markets that you serve are just a little bit more advantageous? Can you give us a sense of what comfort you have that flat and rebounding off, I think you said Q1 will be the same as Q4, which is coming off a minus 7% base that suggests it's going to be a pretty heavy growth rate offset in the back half of the year? Alan?
Yes. We are Walter, our growth is targeted towards the back half of the year and it's reflecting the strength of our intermodal franchise and some revenue growth within merchandise and it's about launching new products that generate revenue growth with our customers.
We're confident that we're going to
be able to execute it.
Thank you. Our next question is from the line of Brian Ossenbeck with JPMorgan. Please proceed with your question.
Thanks. Good morning. A question for Mike on train weights.
Can you
just clarify if you said the second half met the target when you put in the new operating plan? Was that the new or the old target that you were tracking against? And then if you can just comment on the level of confidence you have in meeting the new target, especially if coal declines more than expected, maybe you have some mix shift that goes towards the wider intermodal or even if volumes come in lower than you would think at this point?
Yes. So that was against our 2019 goal. And the so for the full year, we met that goal for the back half. Like we said, we would on the calls, but just top 21 rolled in and drove train weight increases, particularly in the merchandise market. So our merchandise trains continue to be strong and growing in train length.
Intermodal is not and that's an area we have to continue to focus on. And the Phase 3 of the TOP 21 plan does that.
Okay. So despite the lower mix of coal, the key is really Phase 3 in terms of building bigger and longer trains even if volumes are flat or approximately down?
So it's Phase 3 and it's what Jim talked about this continue optimization of the network. We continually look at trains that aren't running at sizes we want them to and find ways to make them bigger and without affecting service and we're doing that as we speak.
Okay, thanks. A quick follow-up for Mark, if I could, just on the CapEx. You mentioned you're taking a look at some of the line items trying to figure out the spending level. Obviously, it's a short time in the seat for now, but want to make sure I wasn't reading too much into that because clearly Norfolk has a heavy locomotive rebuild program, but clearly your peers are spending, in some cases, quite a bit less from a CapEx intensity. So maybe you can just expand on that a little bit.
Thank you.
Yes. Look, right now, the way we spend our CapEx budget, as Jim said, it's between 16% 18% of revenue. Roughly 60% of that is supporting the core network. It's the maintenance of way and it's the rail replacement ties and ballast. We put roughly 20% for the locomotive upgrades and that's again the DC to AC conversions.
And as I've learned, this replacement approach is actually generating very reliable product that's performing very well in the field and it's actually much cheaper than buying newer locomotives. So that's logical. And then the other 20% bucket is comprised of a lot of other things, but primarily IT spend and digital technology spend. So that's kind of how we break down our CapEx. I'm getting in and I'm just trying to understand it because it's obviously it's a big use of funds for us and we want to just I want to understand the disciplines around it and just pressure test a lot of the assumptions that have been in there on the adequacy and how much we need to spend.
I'm not we're not that's not to say that we're going to change the guidance anytime soon. I'm just letting you know that coming in fresh, because it was in response to that question, what are the things that surprised me, it was looking at this level of spend. And as I learned the industry, I'm understanding it better, but it doesn't mean I'm not going to bring a different lens to it and push a little.
Thank you. Our next question is from the line of Jason Seidl with Cowen and Company. Please proceed with your question.
Thank you, operator. Good morning, gentlemen. I want to go back to international intermodal. Clearly, there were some headwind pull forward in 4Q, but if I recall that actually pushed into 1Q a little bit. When should we see the inflection point of those volumes turning up?
And does the uncertainty of the coronavirus actually impact you guys at all? Or is that too early to tell you?
Alan? Jason, you're absolutely correct. We did see elevated international intermodal volumes in the 1st couple of months of 2019. And so as the year progresses, comps will get a little bit easier for us and then that's when we are expecting to start seeing growth. With respect to the coronavirus, it doesn't help.
There is no doubt about that. We have talked to our customers about that and the level of impact that they are anticipating is unknown at this point. It's all speculation. So we are paying close attention to it as are the steamship lines that we
serve. Okay. And my follow-up is going to be on the domestic side of things. A couple of railroads, let's call it, the last year and a half pulled back a little bit on some of the lanes that they serve with PSR. Do you think that there is a need for more lanes going forward once the market does tighten up in the U.
S. Truckload? Or do you think the lanes that the industry currently has are good enough to service and get that freight back from the highways onto the railroads?
Well, Jason, I think there's both. I think we're going to see as the truck market tightens, we're going to see the benefits of our powerful intermodal franchise and organic growth in the lanes that we serve. And then as I noted, we are working feverishly with our interline partners and with our customers to look at new lanes that offer value to our customers and offer value to our shareholders. So this is not static. It's a dynamic review of our overall franchise, finding areas where we can provide value and we can support our channel partners' growth.
And as I noted, we are aligned with the best channel partners in the industry. So I am pretty confident that collaborating together, we are going to find avenues for growth.
Thank you. Our next question is from the line of David Vernon with Bernstein. Please proceed with your question.
Hey, guys. Thanks for taking the question. I wanted to ask a little bit about where we should be expecting headcount to come in, in 2020, ended the year down pretty considerably. And should we be expecting that kind of run rate level? Or should we be expecting further reductions from that from where we ended the year on headcount?
Mark?
We're not going to provide a specific headcount number. We are coming down again from where we're going to end 2019 for sure. But as I mentioned, we're going to keep pushing it and then we're going to see where volume goes. As we talked about, we're expecting volume to start turning a little bit for us a little bit in the back half. And if it's not there, we're going to continue to push on employment levels.
But we don't have a specific number to share with you.
Nothing that's in the budget that you could give us a sense for how much additional sort of headcount reduction there should be in the year?
No. I mean, we clearly have a budget, but it is not going to be something that we talk about because we will flex just like this year. Depending on where volume is, we may go heavier.
Okay. You certainly saw, David, in the Q4. When we had to flex, we did. And we did. And we picked up the pace throughout the second half, particularly in the Q4.
So we will do what's necessary.
Okay. And then I guess maybe just kind of sequentially, Mark, the other expense line came in at 11% for the Q4 from 95% in 3Q, 60% in 1% in 2Q. Is there anything that explains that sort of sequential step down in the other expense line for 4Q?
I think, yes, it's a little bit of the land sales. It's the gains that we had that were back end loaded from the property sales that we talked about. So we had more of the land sales that came through in the Q4 compared to the prior 3.
Thank you. We've reached the end of our question and answer session. It's time for one final question coming from the line of Jordan Alger with Goldman Sachs. Please go ahead with your question.
Yes, hi, thanks. Just a quick question, a lot of talk on the domestic intermodal front, but I'm just curious, can you talk about international? What proportion of your intermodal franchise is international, whether it be volume or revenue? And how do you think about that as we approach 2020, given still the noise around tariffs? And I'm just sort of curious also what the how that the international franchise actually performed in 2019, just a relative sense for looking forward?
Jordan, our international intermodal franchise is about 35% of our overall intermodal franchise as measured by volume. As I noted earlier, we are running up against some pretty tough comps to start the year with the pull forward of activity in the Q4 of 2018 that bled over into the Q1 of 2019. We are expecting that it will the comps will improve as the year progresses. But as with all of our markets, we are generally not expecting growth until the second half of the year.
Thank you.
Thank you. This concludes our question and answer session. I will now turn the call back over to Mr. Squires for closing comments.
Thank you, everyone. We appreciate your questions this morning and look forward to talking with you again when we announce our Q1 2020 earnings.
Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day.