Greetings, and welcome to the Norfolk Southern Corporation Third 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. It is now my pleasure to introduce your host, Pete Charbel, Director of Investor Relations.
Thank you, Mr. Charbel. You may begin.
Thank you, Melissa, and good morning. Before we begin, 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. The slides of the presenters are available on our website at norfolksouthern.com in the Investors section, along with our non GAAP reconciliation. Additionally, a transcript and download will be posted after the call. Now it's my pleasure to introduce Norfolk Southern's Chairman, President and CEO, Jim Squires.
Good morning, everyone, and welcome to Norfolk Southern's Q3 2019 earnings call. Joining me today are Alan Shaw, Chief Marketing Officer Mike Wheeler, Chief Operating Officer and Cindy Earhart, Chief Financial Officer. Turning to our financial results for the Q3. Income from operations was approximately $1,000,000,000 dollars net income was $657,000,000 EPS was $2.49 and the operating ratio improved to 64.9%. These results include the unfavorable impact of a $32,000,000 write off of a receivable resulting from a legal dispute, which affected the OR by 100 10 basis points and EPS by $0.09 As highlighted on Slide 4, these were record results, including a record Q3 and year to date OR.
Earlier this year, we outlined a dynamic flexible new operating plan, TOP21, capable of creating value in all market conditions. In the month since, particularly in the second half of this year, volumes across the transportation sector, including our volumes, turned sharply lower. In response, leveraging Top 21, our team doubled down on productivity and achieved major resource reductions. For example, in the Q3, we reduced crew starts and we cruise by 11% year over year. That was nearly double the rate of the volume decline, driving a 9% decrease in employment levels.
Following the first phase of TOP21, we swiftly moved to Phase 2, which includes refunding of our yard and local plans, deployment of additional distributed power on road trains and blending of intermodal end unit trains into existing trains wherever feasible. These efforts are producing further reductions in CruiseDart's circuity and road train miles. And we've begun clean sheeting our intermodal terminals and preparing for the 3rd phase of TOP21 using the formula we used to successfully overhaul the carload network while sustaining a high level of network performance in the service.
Earlier in the year, I
spoke about the momentum building across our organization and our commitment to enhancing operational and financial outcomes. This commitment is evidenced by significant expense reduction so far this year, which Cindy will describe in more detail later in the call. With revenue trending below our expectations in the second half and some unusual costs expected in the Q4, we continue to expect operating ratio improvement for the full year, but that improvement now seems likely to be less than our earlier forecast of at least 100 basis points. Nevertheless, we remain confident we can achieve our goal of a 60 OR by 2021 through additional cost structural changes and future revenue growth. For example, we are pursuing savings opportunities in fuel, mechanical and other aspects of operations about which Mike will speak shortly.
And we continue to drive bottom line improvement with pricing increases commensurate with the value of our service with the results evident in the Q3 year to date in revenue per unit and revenue per revenue ton mile trends. Alan will speak further about those trends in a minute. All of us at Norfolk Southern are committed to transforming our company to drive shareholder value creation. As I have said before, we are embracing new ideas and positioning leaders throughout the organization who are champions for chains. We are all working hard to operate as safely and efficiently as possible and deliver what we promised to our customers and shareholders.
The results so far this year improved service levels for our customers, a lower operating ratio and bottom line growth and the return of nearly $2,300,000,000 to shareholders. With that, I'll now turn the call over to Alan.
Thank you, Jim, and good morning, everyone. In the Q3, we continued our focus on pricing to the value of our service product and delivering productivity gains, generating a record Q3 operating ratio despite difficult economic conditions. Trade uncertainty continues to influence the economic environment, which coupled with lower spot truck and commodity pricing negatively impacted volume during the quarter. As we cycle through the headwinds associated with the market, we have and will maintain our focus on margin improvement driven by price, service and productivity while collaborating with our customers to provide a platform for growth. As shown on Slide 6, a 6% decline in volume led to a 4% revenue decline in the quarter.
Increased revenue per unit, which has improved year over year for 11 consecutive quarters, partially offset the volume decrease. The consistent delivery of RPU growth highlights the effectiveness of our pricing strategy. 3rd quarter revenue in our merchandise segment was flat year over year continued strength in pricing offset volume declines. Volume declined 4% resulting from reduced steel and natural gas shipments, while favorable fuel price differentials drove gains in crude oil to East Coast refineries. During the quarter, we experienced growth in automotive and aggregates as a result of increased production at NS served auto plants and improved service respectively.
Intermodal revenue declined 5% due to reduced volume in our domestic franchise. Strong relationships with steamship lines and share shift to East Coast ports produced international volume growth year over year. Domestic intermodal declined due to lower spot truck pricing and of increased international volume and lower fuel surcharge revenue. Turning to coal. Revenue was down 13% in the 3rd quarter.
Our utility portfolio was impacted by additional natural gas capacity and prices that suppress coal burn. Export thermal and metallurgical prices remain at low levels, making it difficult for U. S. Coals to compete globally. Improved pricing drove a revenue per unit increase of 2%.
Moving to Slide 7, we expect the same factors affecting 3rd quarter volume to persist in the 4th quarter. Macroeconomic conditions, tariff uncertainty and global weakness continue to negatively influence business investment, manufacturing and exports. Lower commodity pricing will impact many of our markets, including coal and steel. Truckloadings are expected to be flat for the rest of 2019 with excess capacity keeping spot truck rates low. While we expect a challenging economic environment for the remainder of the year, we remain focused on our strategic plan to drive margin improvement.
We're collaborating with our customers daily to fine tune our service product and identify long term growth opportunities. Our strategic plan is producing pricing and efficiency gains and we are fully committed to the execution of the plan, while meeting our customers' expectations and establishing a platform for future profitable growth. 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 and the efficiencies we are creating with our top 21 plans. In the Q3, we delivered strong service for our customers, made further progress on the next iteration of Top 21 and began implementing initiatives in TOP21 Phase 2 on a rolling basis. Our operational momentum is driving significant cost savings, and we are flexing our dynamic plan in accordance with market conditions. We continue realizing efficiencies while providing a superior service product to our customers.
Moving to Slide 9. We have continued our laser focus on the execution of our plan and principles of precision scheduled railroading. We substantially improved train speed and terminal well compared to last year and delivered record quarterly performance. These achievements support our strategy to meet our customers' expectations while eliminating costs and prudently managing our assets. The operation continues to be resilient as evidenced by our ability to work through 2 recent major incidents in the 4th quarter, a bridge outage and a large derailment with minimal disruption to our customers' supply chains.
This shows the strong resiliency of our operating model. These overall results are due to relentless execution by our operations team and other employees supporting them. We want to thank our field employees for their unwavering focus on safety, service and efficiency. Turning to our service and productivity metrics on Slide 10. These metrics align with our strategic plan as they measure key productivity and customer service levels.
We have been aggressively reducing our resources to meet our productivity goals account GTMs dropping by 9% in the quarter. Consistent with prior quarters, the blue bars represent our goals for 2019. Starting with the service delivery index, which is the on time delivery performance of our scheduled shipments indexed to 2018. This is a customer facing metric that combines intermodal availability and shipment consistency, which measures trip plan adherence for general merchandise as well as automotive traffic. Strong service performance continued in the Q3 and we expect to drive further improvement.
We are trending ahead of where we thought we would be with our T and E productivity goal for 2019, and we anticipate this trend will continue for the remainder of the year. We are at our lowest T and E headcount on record, having reduced by 13% versus Q3 2018, while still providing exceptional service. We are already realizing the benefits of our TOP21 plan. The results are driving the comp and benefit improvements to which Cindy will speak. As mentioned during the last call, we are continuing to work on improving our train weight.
The majority of our goal was back end loaded as the first phase of the Top 21 operating plan was successfully implemented on July 1. We are seeing improvements in our general merchandise trading rates, which were offset by headwinds associated with intermodal and coal volumes. Locomotive productivity continues to be an important metric for NS. We are tracking to meet our goal for this year. We have been rationalizing our locomotive fleet, which is 22% lower than the same period last year.
We also have an aggressive initiative to rationalize resources associated with the maintenance of these locomotives, including a reduction of 525 positions already this year. We will continue to focus on the remaining resources required to maintain this lower fleet size. And the cars online, which is down 20% versus our 2018 baseline, continues to trend very positively, thanks to our fast and consistent service product. This includes cards and storage, which can be deployed as market conditions warrant. Turning to our progress on our top 21 operating plan on Slide 11.
As you may recall, our operating plan has 4 major objectives: operate as one network, execute a balanced train plan between terminals, serve our customers frequently and reduce dependence on major terminals. The first phase of Top 21 primarily focused on our general merchandise, bulk and automotive business and was successfully implemented on July 1. We have been aggressively implementing the next phase, which has an added emphasis on distributed power to drive further train consolidations. We have increased the number of DP trains per day by more than 2.5x with the expansion of this initiative since our Top 21 rollout. We will continue to add VP trains across the network, which will have the benefit of improving train length and fuel efficiency.
Regarding fuel efficiency, we have several other initiatives for improvement. Specifically, 1, ensuring a healthy energy management lead locomotive 2, compliance with horsepower per ton procedures and 3, compliance with usage of energy management technology. We are also syncing up our local schedule and the new train plan. We are implementing these changes on a rolling basis driving significant structural improvements. Specifically, total security for our general merchandise and auto traffic is down 27% versus pre top 21 and road train models are down 13%.
Additionally, we have been working to calibrate our local plan to maximize efficiency while continuing to provide good service to our customers. Together, these changes have helped to continue drive down crew starts, while keeping velocity and customer service high. We have also begun the process of clean sheeting our intermodal terminals and preparing for the 3rd phase, TOP21, which remodels all traffic for additional opportunities. This will drive further cost and resource reductions and improve our fuel efficiency. I will now turn it over to Cindy, who will cover our financials.
Thank you, Mike. Good morning, everyone. I'll begin with our operating results on Slide 13. The continued execution of our strategic plan is delivering tangible results that are flowing through to the bottom line. The structural changes we are making, including the implementation of our PSR based operating plan, generated expense savings and compensation and benefits and equipment rents.
These savings as well as lower fuel prices more than offset the decline in revenues. However, in the Q3, we wrote off a $32,000,000 receivable as a result of a legal dispute, which added 110 basis points to the operating ratio and lowered earnings per share by $0.90 Income from railway operations for the quarter was nearly $1,000,000,000 and we reduced our 3rd quarter operating ratio by 50 basis points, achieving a 3rd quarter record of 64.9%. Moving to Slide 14, we are delivering cost savings as evident in the $82,000,000 decline in operating expenses. Our new operating plans have resulted in fewer trains on the network and reduced crew starts. Compensation and benefit expense declined as a result of the $47,000,000 in savings due to lower employee levels and reduced overtime and recruits.
We drove average headcount down by approximately 1,000 employees from last quarter and have reduced headcount by 2,400 compared to last year. We also remain intensely focused on improving asset utilization. By increasing the velocity of our network and improving fluidity, we have significantly reduced the need for locomotives and freight cars, resulting in equipment rental savings of $35,000,000 We also achieved savings of $10,000,000 in material expense due to fewer locomotives in service and freight cars online, Partially offsetting the efficiency gains that we delivered in the quarter was the $32,000,000 write off that I previously mentioned. We also experienced $17,000,000 of additional expense due to increased pay rates. Finally, lower fuel price and a decrease in consumption drove the $48,000,000 decline in fuel expense.
Fuel efficiency continues to be an area of focus and we know there are opportunities to generate savings through improved efficiency. Slide 15 summarizes our 3rd quarter results. Income from railway operations was slightly under last year's record and non operating items added an additional $16,000,000 in expense. 3rd quarter net income was $657,000,000 and diluted earnings per share was $2.49 Recapping our year to date cash flows on Slide 16. Cash from operating activities was $3,000,000,000 and free cash flow for the 1st 9 months was $1,500,000,000 We continue to return capital to shareholders as evidenced by the 9% increase in the quarterly dividend we announced in July.
Dividends and share in July. Dividends and share repurchases totaled almost $2,300,000,000 for the 1st 9 months. As we head towards the conclusion of the year, I want to highlight a few specific items that will impact the 4th quarter. 1st, starting with headcount. We expect a continuation of position reductions in the Q4.
By year end, we expect headcount to approximate 23,300, which is a reduction of over 3,200 physicians compared to the same time last year. Also, we expect incentive compensation to be favorable over prior year, but the magnitude will depend upon our full year results. However, as Mike mentioned earlier, there has been some specific incidents in the 4th quarter that will result in incremental expenses. We expect additional costs associated with featuring trains due to a bridge outage and lighting damage resulting from a large derailment will approximate $25,000,000 in additional expenses. Additionally, we expect that gains associated with the sales of operating property will be lower than last year.
You recall that Q4 of 2018 included $145,000,000 in gains in the sale of operating properties, whereas we expect the current quarter to be about 1 third of that. The execution of our strategic plan is delivering results and even in the obstacles unforeseen at the outset of this year, we are confident we will improve our full year operating ratio in 2019 and achieve our goal of 60 by 2021. We are seeing the benefits associated with our new operating plan and are actively identifying and implementing further measures that will produce improved financial results and drive shareholder value. Thank you for your attention and I'll turn the call back over to Jim.
Thank you, Cindy. As we've outlined and as our Q3 results demonstrate, we continue to build momentum by executing planned initiatives and pushing well beyond many of the goals we set out earlier this year.
We are hard at work preparing for
the 3rd phase of Top 21, rightsizing our local and yard operations, further consolidating road frames and going after cost savings in fuel and mechanical operations. While pursuing all of these efforts, the Norfolk Southern team continues to provide superior service to our customers, enabling us to price through our value in the marketplace, while ensuring that we are positioned at the leading edge of growth when it returns. These actions give us confidence we'll reach a 60 operating ratio by 2021. Before we open the call for Q and A, I do want to recognize Cindy for her 34 years of service to Norfolk Southern and her support through her final day here at the company on November 1. I have valued the role she has played in pioneering new technologies at our company, developing our strategic plan and delivering shareholder returns.
On behalf of the entire Board and management team, I thank Cindy for her many contributions and wish her well in retirement. We'll now open the line for Q and A. Operator?
Thank you. We will now be conducting a question and answer session. Our first question comes from the line of Justin Long with Stephens. Please proceed with your question.
Thanks. Good morning and congrats Cindy on the retirement. Maybe to start with the OR guidance for 2019, I just wanted to clarify something. Are you excluding the impact of the $32,000,000 write off in 3Q in that guidance? And then Cindy, you mentioned the $25,000,000 of unusual costs in the 4th quarter.
So I'm just curious that if you exclude that $32,000,000 write off and the $25,000,000 of unusual items in the 4th quarter, if that OR guidance of at least 100 basis points that you previously put out there would have been achievable?
Justin, it's Jim. Let me see if I can clarify for you what we have said this morning. Our guidance is that we expect to achieve a full year operating ratio improvement year over year even with the additional expenses and the trend in revenue and even with the receivables write off that we discussed earlier. So but also including those things, we do not expect to be able to hit our goal of at least 100 basis points improvement in the operating ratio. Now with that said, that does not diminish our confidence in any way that we can get to a 60% operating ratio by 2021.
And to back that up, I just want to take a minute to recap what we have achieved to date because those achievements are the foundation of further improvements that we will make to get to the 60 operating ratio. And I'll just touch again on our operating plan because that in many ways is the bedrock of the improvements we have made and we'll continue to make.
All
right. Phase 1, As of July 1, we cut over. It's seamless. We see an immediate reduction in train starts and active trains on the network as we have shown you previously. We see a sharp decline in cruise sales as we showed you today.
There is no disruption to service as a result of the cutover. In Phase 2, we pursue additional freight consolidations. We blend more intermodal bulk and carload traffic. We accelerate distributed power. By now, we have more than doubled the number of DP trains per day operating on the network.
We pursue further rationalization of equipment. We work to sync up the local operating plan with the new network plan. And that results in additional crude start reductions. As you can see on Slide 11, crude start reductions actually accelerate coming out of the initial cutover as we move through Phase 2. And then we pursue intermodal clean sheeting, the analog, if you will, to the clean sheeting we did in the merchandise network.
And we are hard at work on fuel efficiency initiatives where we know we have some ground to make up. So these are the things that are operative today. In Phase 3 of Top 21, we will remodel all traffic to unlock additional efficiencies. Now what have been the results in terms of resources of these various phases of COP21? So let's start with T and E productivity.
As Mike mentioned, T and E down 13% versus Q3 of 2018, giving us the lowest T and E headcount on record for our company. In terms of locomotive productivity, we have reduced the number of locomotives out there by 22% versus last year. And that reduction in locomotives operating on the network, along with the reduction in cars online, yielded an additional reduction of 525 mechanical positions already in this year, which together with the T and E reductions, which together with other employment reductions we have made gave us 9% lower overall headcount in the 3rd quarter with more to come in the 4th quarter. Cars online, down 20% versus the 2018 benchmark, yielding significant equipment rent savings along with the locomotive reductions. Cindy went through the different expense categories, the compensation benefit savings, the material savings, the equipment rent savings that that were the result of these resource reductions.
In top line 1 Phase 3, there will be more of the same. We will see through additional train consolidations, additional reductions in crew starts and we would expect to see T and E reductions follow-up. With continued rationalization of the locomotive fleet, we will see lower maintenance spending and so on and so forth. And lastly, we will stay very focused on our pricing plan, our yield up strategy, which showed excellent results in the Q3 and for the full year to date. We are determined to price to the value of our service in the
Thanks, Jim. That's a great and comprehensive answer. I think secondly, I just wanted to ask a bigger picture question. Obviously, we're dealing with a more challenging demand backdrop right now. As we think about that guidance to get to a 60 OR in 2021, do you think that's still achievable if the demand environment stays around current levels and the coal environment stays around current levels?
Or do we need to see a positive inflection in demand in order to hit that 60 OR?
We are determined to achieve the 60 OR goal by 2021 in any foreseeable revenue environment, including the one that we are in now. But ours is a balanced plan. And we've said that all along. We are pursuing growth. We believe we will see the fruits of our efforts in the form of a growth during the remaining years of our current strategic plan.
But if we don't, we will push even harder on efficiency measures, on productivity measures to get to the
Suisse. So now that you're in Phase 2 of TOP21 and as you move into Phase 3, should we start to expect a meaningful acceleration in the year over year OR improvement? I guess, just as you're talking about all the trains you're eliminating and increasing train rates and adding the DPU, Why wouldn't you be able to move below a 60 OR more quickly as we've seen with many of your peers?
If we can get to a 60 hour sooner, Allison, we will continue to push. We are determined to do all we can to generate shareholder value through growth and through a lower operating ratio. 60% is our goal by 2021. If we can do better than that, we certainly will.
Okay. And then I was hoping maybe you could offer some thoughts on the recent addition to the Board by Claude Mongeau. What role would you expect him to play? And how is that materializing so far? Thank you.
Well, Clive, as you know, brings a great deal of experience in our industry, having served as CEO of Canadian National. He brings in-depth knowledge of railroad operations, of railroad finances. He served as CN's CFO for a number of years. And so he is a most welcome addition to our Board. We are looking forward to having him advise and counsel us as we pursue all of the initiatives that we intend to pursue for the next few years and beyond.
Thank you. Our next question comes from the line of Brian Ossenbeck with JPMorgan. Please proceed with your question.
Hey, thanks. Good morning. Appreciate taking the question. So Alan, maybe one for you on coal. I was a little surprised to see that our view was up sequentially ex fuel.
So maybe you can give some color behind that. And where do you think this goes in 4Q 2019 2020? Obviously, the export markets are telling us things are going to get worse before they get better again. So just wanted to see if there's any other Yes,
absolutely, Brian. As
Yes, absolutely, Brian. As I've noted in my prepared remarks, we continue to deliver strong pricing across all of our business units. Coal is no exception. Coal will be pressured in the Q4 with the reduction in the seaborne coking coal price. And so you should see a sequential decline in export coal pricing as we move into the Q4.
And that's going to be running up against some difficult comps because at the same this time last year, we were seeing a sequential improvement in export coal pricing. So that will be a headwind for us. Throughout all of this, we are continuing to focus on pricing to the value of our product, and we are delivering a very good product to our customers.
Okay. Then one on fuel and train weights for you, Mike. We've seen some pretty good progress on fuel in particular from the rest of the Class Is. But looking at Norfolk, it looks like fuel efficiency, gallons per 1,000 GTMs is actually getting a bit worse sequentially and year over year. So clearly, we're seeing train rates aren't moving up as fast as you think throughout the course of the plan.
But what can you offer on fuel? I know you've got some initiatives there, but it seems to be a pretty big factor for efficiency gains that others have realized, but you haven't been able to hit that sort of stride.
Yes. So on the fuel efficiency side, we are seeing an increase in the general merchandise train rates. So that was part of the Top 21 plan. We're getting those benefits, but they're offset by the headwinds of the lower train weights on the intermodal and bulk trains. And we're making we're taking actions to address that.
You'll see more of that in Phase 2 as we go forward and then some of that in Phase 3 as well. But we also have a very aggressive initiative on utilizing the energy management technology that we've been rolling out. And so this is an all hands on deck thing and we've got folks down in our new consolidated network operation center really staying on top of this. So making sure we got the right locomotive on the head end that's got the working energy management and then making sure that we're using the right horsepower per tonnage for our trains, being very aggressive with that and then making sure that we're complying with the energy management technology. So big initiative and we expect that to be paying off as we go forward.
Brian, I'd like to weigh in on this as well. We benchmark our peers' performance all the time and do so extensively. And we are aware of the ground that we have to make up in fuel efficiency. We have made because we have not made progress, despite our best efforts in the last couple of quarters in particular. That's going to change.
We are focused on all the things that Mike has outlined. Running longer, heavier trains is certainly a part of it. Onboard energy management, real time fuel monitoring, horsepower for trail income, compliance and so forth. A host of initiatives in place, which we believe will bear fruit, which we believe will bear fruit. And I am holding our operations team strictly accountable to that goal.
Thank you. Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, thanks. Good morning, guys. So I want to go back to Justin's first question because I'm not sure if I understood the answer. So you guys said there's $32,000,000 of legal costs in the 3rd and you talked about $25,000,000 of bridge costs in the 4th. So that's 50 basis points to OR.
If we were to exclude those, would you have been hitting the OR targets or not? I get we're all trying to understand, is this a small margin miss that's arguably understandable or is this a bigger margin miss?
Cindy, why don't you give it a try?
Okay. So Scott, as Jim said previously, the $32,000,000 and the additional cost of $25,000,000 were not only bridge costs, but also lading costs associated with DRELIMET. Our guidance to a miss on the 100 basis point OR improvement, we don't exclude either one of those. And we're going to continue to push as hard as we can to improve the OR, but those have not been excluded in that guidance today.
No, no, I understand they're not excluded. I'm just saying as we play with our models, if we were to exclude them, would you be hitting that OR target or not? I think that's what we're all trying to understand.
I think that I would say that we will miss our target. The extent of it is probably not material. It's not a big miss, but it will be a miss.
Again, that does not diminish our confidence in any way that we will get to a 60 operating ratio by 2021.
Okay. And then, Jim, so I mean all the rails are dealing with the same volume issues. I look so far, I think every rail has had better margin improvement than you so far in the Q3, even though you're at a lower starting point. So do you feel like you're going fast enough? Do you feel like you've got the right people to get us here?
So and then another difference is sort of on the capital front, is there with volumes weaker, are there opportunities to sort of change the capital spend?
We are controlling the things that we can control and doing so aggressively. So we've been through all of the expense savings initiatives, which bore through in the Q3 and for the year to date. And we will continue to push on all of those things as hard as we must to get to that 60% operating ratio by 2021. We've got a great team in place and everybody is aligned around our bottom line shareholder value goals. Let's see, the second part of your question, Scott, I'm sorry, was capital, yes.
So we have previously talked about a range of 16% to 18% of revenue for capital spending. What really matters here obviously is shareholder returns and return on capital. That's what we're managing too. That's why we are targeting that level of capital spending because we believe that is the optimal range of capital spending relative to revenue to generate the return on capital and the shareholder returns we're seeking to generate. It's a range and in lead times we may take it down somewhat within that range.
But again, it really gets back to return on capital and our goal of generating superior shareholder value.
Thank you. Our next question comes from the line of Jordan Alliger with Goldman Sachs.
Question, so I know you've reiterated the 60% operating ratio in 2021. I'm just sort of curious if volumes stay kind of soft for at least the 1st part of next year. I mean, can you give some sort of sense for how much you think OR and PSR benefits can push things in 2020 even with, let's say, first half continuing softness environment? Thanks.
We've spent a good deal of time already this morning talking about the efficiency initiatives, those that are well underway in Phase 2 of COP21, those will come to fruition in 2020. So we will see the full year which will result in additional which will result in additional cost structural savings in 2021. And those will be again the drivers of further expense savings on the road to a 60 operating ratio.
Okay. And then just a quick follow-up on intermodal. Comps obviously get pretty easy by middle of next year. If we get some truck capacity tightening and maybe spot pricing turns the other way a little bit, would you expect or can you potentially anticipate some sort of inflection, especially given where your network is on rail intermodal volumes? I mean, is that something that's conceivable as we move through next year?
Again, assuming the economy is reasonably okay.
Alan? Yes, certainly. Jordan, we are aligned with the best channel partners in the business, And we're aligned with the steamship lines that are adding capacity to the East Coast as you see a shift from the West Coast to the East Coast. So we've got some strategic advantages to our intermodal franchise, which make it the best in the East. And so absolutely, as the economy turns and we deliver a very strong service product to our customers, we anticipate that Intermodal is going to remain a growth engine for Norfolk Southern.
Intermodal revenues, as you know, grew by 11% in 2017 and then followed that with an 18% growth last year. We've got a great franchise, great customers. It's going to continue to pay dividends for our shareholders.
Thank you. Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.
Thanks. Good morning, everyone. Can you just clarify your current go to market strategy on price? Are you at a point where you guys can command the price you need to make the yield up targets without losing volume? Or do you think that's more of a 2020 or 2021 thing when there are more changes made to the network?
Robbie, we are very confident in our ability to price through a vastly improved service product. And we're providing our customers with a platform for growth. Take a look at our merchandise network in which the year over year rate of increase in price has improved for 9 consecutive quarters. And you also see it reflected in RPU trends and revenue per ton mile trend. So we are intently focused on price even in this weak economic backdrop because we've got a great franchise and a great service product.
Got it. And as a follow-up, you guys recently appointed Mr. Claude Mongeau to your Board. At this point in your PSR strategy, kind of what are you looking for from him? And kind of what role is he likely to play?
As I mentioned earlier, Claude is an outstanding addition to our Board with his extensive experience in the industry, in-depth operations, knowledge and experience, same on the finance side. So he will be a welcome addition. He is a welcome addition to our Board and we'll bring all of that and more as we proceed through our PSR journey for the next couple of years and beyond.
Thank you. Our next question comes from the line of Fadi Chamoun with BMO Capital Markets. Please proceed with your question.
Good morning. Maybe, Alan, if the pricing in the intermodal business doesn't really improve, like truck pricing competition remains intense, can intermodal margin improve to the level needed to achieve a 60% OR over the next couple of years? And if you're looking on the operating side, are there steps, meaningful steps that can be taken in the intermodal network to improve the ORs, if you can maybe outline those?
Alan? You take a look at the cyclical nature of the trucking industry. We saw weakness in the spot truck market in 2011, 2015 2019. And through all of that, we continue to deliver year over year rate increases in intermodal every single quarter. So we are very confident in the strength, the unique strength of our intermodal franchise, our alignment with the best channel partners in the business.
We're going to cycle through this. As we noted before, we grew revenue by 11% in 2017 and 18% in 2018. We've got a very strong franchise. The spot market will recover, and we're going to be positioned for growth because of the very strong service product that we're delivering.
Okay. And maybe just follow-up on the operational side. You mentioned Clean Sheeting and Intermodal. What does that exactly entails? And if you can describe to us what is going on, on the operating side that would kind of improve the margin performance of that business?
Mike, why don't you take that one? So on the intermodal terminals, just like we did the clean sheeting of our merchandise terminals, we're looking at each terminal and making sure that we have the best practices across all the terminals in our intermodal network. We've got all the right processes and procedures. And then once we do that, we'll sync that up with the train plan for more efficiencies going forward and continue to deliver good service product at the same time. So it's kind of that deep dive into each one of the intermodal terminals using good industrial engineering practices to make them as efficient as possible and more
importantly, consistent best practices across all the intermodal terminals. Mike, I'm very encouraged by this process because we and our customers saw merchandise network as we clean sheeted the merchandise network. You saw it reflected in a reduction in dwell. You saw it reflected in an increase in train speed, and you saw it reflected in an improvement in our SDI or customer facing service metrics. And so I'm confident that we're going to continue to deliver the same as we apply these same principles to our intermodal franchise.
Great point.
Thank you. Our next question comes from the line of Jason Seidl with Cowen and Company. Please proceed with your question.
Thanks, operator. Hey, guys. Good morning. I wanted to talk a little bit about your T and E productivity. You've shown a slight improvement in 2019 and you put a check there saying you're sort of on track.
But if we look out to your 2021 goal, that's a much larger step up. Could you walk us through how you guys plan on getting there?
Mike? Yes. It's going to be the continuation of the things that we've done where we continue to look at increasing the size of the trains and that drives crew starts down. Continuing the distributed power strategy, we're going to do more and more of that and that will drive train consolidation. And then continue to look at our local and yard network and making sure we're as efficient as possible there.
So as we go through all this, we uncover more opportunities. And when we uncover those more opportunities, we get into that, we take the benefits of it and then we go to the next step. So this has been a very good process for us to continue down that path and we will continue to do that. We've got more in the gas tank with all these phases that we're talking about. So, yes, we're going to get there.
Okay. And want to jump a little bit tack on the Scotts CapEx question going forward. Jim, I think you mentioned a range of 16% to 18%. Given what we've seen in the overall demand competitive truck market, should we look at 2020 as probably being towards the lower end of that range?
Jason, we'll give you some more guidance on CapEx, expected CapEx when we meet again in January. But let me say this, the majority of our capital budget, as you well know, the great majority is replenishment capital spending, including our DC to AC conversion program, which is meant to and will rejuvenate our locomotive fleet. So for us, that's a pretty significant line item in and of itself in the capital budget under the category of sustaining capital spending. And then of course, there's everything else that goes into sustaining the franchise, railcars, valves and so on and so forth. The growth piece of it, we will protect.
It's relatively small compared to the sustaining CapEx. But it needs to be part of the plan because we do aspire to grow and we believe we have growth prospects that will generate excellent shareholder returns down the road.
Thank you. Our next question comes from the line of Chris Wetherbee with Citi. Please proceed with your question.
Hey, thanks. Good morning. Wanted to ask about headcount. Obviously, you made some progress here and target further progress in the Q4. Wanted to get a sense of maybe how you feel like the workforce is calibrated to the volume environment.
Assuming some degree of stabilization, how much more is there to go as you kind of run through Phase 2 and Phase 3 of Top 21? How should we be thinking about sort of headcount as we move through the beginning or at least the first half of twenty twenty?
Cindy, why don't you go back over what we're expecting in the Q4 reflecting end of year versus your average average average headcount in Q4 versus Q4 of last year. And then talk a little bit about where we go from.
Yes. Well, Chris, as I said, we expect the year end headcount to be at around 23,300, which is 3,200 less than the end of last year of 2018. So we've made significant progress. I mean our original estimates for headcount reductions this year were 500. So that has really been accelerating.
And obviously, a big part of that structural, there's been reductions associated with volume and you could moderate that as volume goes up or down. But we certainly expect going into next year, you've heard all of the initiatives that Mike has talked about both in terms of T and E as well as mechanical that we expect headcount to continue to come down.
Yes. We also want to be sure we are prepared for when growth resumes. So that's a balancing act and we want to be sure that we operate as optimally as we can in a declining volume environment like we're in now, but we also want to be confident that we can handle the business when it comes back. We believe that we have the right formula for that, for just that. And that responding appropriately in the current volume environment, but we are also protecting our ability to handle the business when it returns down the road.
Okay. Okay, that's helpful. I appreciate it. And then if
I get turn to purchase services,
it was up sequentially, although volumes were down. I wanted to get a sense, the big obviously line item on the cost side for you guys. When you think about sort of plan, if it continues to roll out over the next few phases, how big an opportunity is that? Was there anything specific in the Q3? And kind of how can you go from here?
Cindy? Well, Chris, as we've talked before about purchase services, I will say if you look at purchase services and rents, we have seen big improvements, as I mentioned before, on the equipment rent side, a $35,000,000 improvement year over year. And that's really been associated with just the improved velocity of the network as well as getting a lot of these cars offline. So that has been favorable. We expect that to continue to be favorable going forward.
On purchase services and rents, there's just a lot of different things that are in that category. Some is volume dependent, although not as much as you would think. We have pointed out in the prior quarters that we've had additional spending on the IT side. We're going to continue to invest in IT and we've seen on capital spending as well as in this particular item. We think that that's really prudent investment to be making because it's focused on things that are going to improve the productivity of the workforce, the reliability of our equipment and so forth.
We did have we've had a little bit additional expenditure purchase service and rents associated with freight cars as we've taken freight cars offline and we've had to turn them back in leases. We've had some additional repair costs associated with that. So, there's some puts and takes there, but overall, I you'll see purchase services continue similarly as we move forward sequentially.
Thank you. Our next question comes from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your question.
Thanks. Thanks for squeezing me in. I appreciate it. Just a quick one. The first one at least will be quick.
Was there any impact in the quarter from the strike at General Motors? I know auto volumes were actually up in the quarter and yield was kind of flat. I didn't know if there was anything to call out there with respect to stranded or unabsorbed costs related to that or even in the Q4?
Alan, I'll take that. Yes. The timing of that work stoppage will more impact our volumes in the Q4.
Any stranded costs associated with that, that should think about for the Q4 or not enough to call out? No. Okay. And then Jim, I wanted to just, if I could, just follow-up, I think, on one of the very first questions. I think it's really the most important one with respect to your OR targets for 2021 at least.
And obviously it's in the context of you guys walking back this year's OR improvement. So when we look back in February or February 11th when you did the Investor Day in Atlanta, you guys were very explicit about your revenue targets, 5% compounded annual growth rate for the entire business, 10% revenue growth in intermodal. I was hoping that you could be as specific now, 10 months later or so, or a little bit less than that, given what's happened in the revenue framework, how the revenue side of the business rolls up to your target? I understand you're not going to use revenue as an excuse and there's a lot of productivity. But given how specific you were in February, we'd appreciate it, I think, if you can give us some sense of what that revenue roll up looks like now relative to the 5% 10% growth you did in February to get to that 60% target, 60% by 2021 target?
Yes. Fair enough. Fair enough. I would say this, first of all, about the strategic plan. As with any such plan, the assumptions therein are good for about as long as it takes the ink to dry on the strategic plan.
So conditions change. Business conditions change. The revenue picture, the volume picture has changed rather dramatically since we issued the 3 year plan in February. You adjust. We've always said that one of our hallmarks is flexibility and adjustability.
That's what we did in 2016 when we saw significant volume decline. And we responded with additional productivity initiatives in order to hit our goals. That's what we will do again this time around. Now we will review with you our revised macro assumptions in January when we report out on the 4th quarter results. And we give you our productivity goals, our Tier 1 metrics going forward for the next couple of years and we'll give you some high level assumptions with regard to revenue as part of that plan as well, I'm sure.
Thank you. Our next question comes from the line of Tom Wadewitz with UBS. Please proceed with your question.
Yes, good morning. So Alan, I wanted to get your thoughts on the export coal framework for 2020. Just maybe if you could give us a sense about at current prices, would you expect tonnage to be down pretty meaningfully? Or if you look at seaborne prices, do you think it's more of a hit to your the revenue per ton that you're achieving? Just maybe some broader thoughts about that.
And I don't know if you want to tie it to met coal levels and where you really have the sensitivity to a tonnage decline?
Tom, as I talked about, at current prices, it makes it really difficult for U. S. Coals to compete in both on the with respect to thermal and metallurgical. We've talked before about some of the thermal contracts are effectively hedged, but not the contracts between the producers and the receivers are effectively hedged through 2019. And so you'll see pressure in the thermal market as we roll into 2020.
And the met market is going to follow demand overseas and the global economy and seaborne coking coal pricing. And I'll provide a lot more color on that on our Q4 earnings call as we start talking about 2020.
I guess if you look back just to kind of look at levels of export coal on Norfolk, in the 2015, 2016 area you were kind of 15,000,000, 16000000 tons. I think 2019 you're running at a rate of like something like 24,000,000 tons. So do you think this feels like 'fifteen, 'sixteen or would you say, hey, we haven't fallen to that level, it feels better than that. So just trying to get a sense of the right framework to consider given that there's obviously pressure on the export market?
There is pressure. And we've been pretty clear about that. Let's just talk about coal broadly. Right now, coal is about 12% of our volume. And export coal is about 25% of our coal volume.
So there you're talking about
a little bit less than 3% of our overall volume.
It's important to us. It's important to our franchise. However, we've got a very diverse franchise as we've built out our intermodal network. So it's I'll provide more color and more historical context on the outlook for export coal on the Q4 call. The important thing to consider is that we've got a great merchandise network, a great intermodal franchise and we are securing price, reflecting the value of our product.
Thank you. Our next question comes from the line of Bascome Majors with Susquehanna Financial Group. Please proceed with your question.
Yes, thank you. On the receivables write off you took for the September jury ruling on the drum and coal trach or brace contract, is there any accruing revenue for liquidated damages in that this year? And is there any go forward impact associated with that ruling?
Jenny? Yes, Vasanth, we've recognized what we think is the probable financial impact of that legal dispute.
Was that all backward looking or is there some ongoing impact included in that charge?
No, that was backward.
Thank you.
Thank you. Our next question comes from the line of Ken Hoexter with Bank of America Merrill Lynch. Please proceed with your question.
Hi. Good morning. And I know OR has been hit a lot, but in an environment where you're supposed to be significantly cutting costs and walking away from the 100 basis point improvement and your peer is doing 400 better basis points better excluding the real estate sales And you've got employees down 9%, cars and trains are down. Jim, maybe talk about why is this not getting better? Or Michael, why are we not seeing a stair step improvement at this point given the changes you've made?
Is it just the coal margins are impacting so much, overwhelming the gains? Or is there something else that's constraining the ability to get that stair step improvement?
Well, Ken, certainly, we're dealing with a different sort of revenue and volume context than we were in the first half. So that's been a major change. We have responded aggressively to that change with the resource reductions we've been through this morning. Positions, locomotives, freight cars, materials, all favorable in expenses. So you're seeing the momentum in expense reductions from our acceleration of the various initiatives with more to come.
Now we still do expect to see operating ratio improvement for the full year, but because of the additional expenses that we've been through this morning in the Q4, we don't expect to meet the at least 100 basis points goal. But that does not diminish our confidence. We can get to assist the operating ratio by 2021.
And then I guess maybe, Alan, given that volumes have gotten worse now here sequentially and seemingly at an accelerating pace. I don't know if there was this is related to the derailments that you talked about, but you're now down 8% quarter to date. And I know it's only a couple of weeks in the Q4, but down from 5% to 6%. Coal seems to be staying down mid teens, but Alan, you mentioned things are still ugly, but are things getting worse than an accelerating pace just looking at intermodal and ag and some of the other commodities outside of kind of autos from the strike? It just seems like we're accelerating on the downside, maybe your view on the economic side?
Ken, what we're not really seeing is much of a peak within the intermodal franchise. And so that is certainly having an impact on volumes and year over year comps.
Thank you. Ladies and gentlemen, this does conclude our question and answer session. I'll now turn the floor back to Mr. Squires for any closing comments.
I want to thank you all for your questions and for participating in today's call and we look forward to speaking with you again in January. Thank you.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.