Good morning, everybody. Happy Friday. Thank you for attending the Credit Suisse Industrials Conference. I'm very pleased to have Norfolk Southern join me today, and very happy to have Alan Shaw, the Chief Marketing Officer, as well as Mark George, who is the CFO. Mark, I think you're going to start out. You have maybe a couple of slides or a few comments, so I will hand it over to you guys, and then we'll dive right into the Q&A.
Sounds great, Alison. Good morning to you and everyone else on the call. Thanks for putting on this event. Alan and I are happy to be here, although we'd rather be in Palm Beach. We're in flip-flops, but we'll take this format. Before we run through a few slides and remarks, let me first remind everyone here on slide two that any forward-looking statements we make are subject to risks and uncertainties, and we invite all of you to look at our annual and quarterly reports that are filed with the SEC for discussion of those uncertainties. Lastly, we've posted a reconciliation of non-GAAP measures on our website in conjunction with this event. If we move on to slide three, you'll see here that we advanced. Yep. Here we have a recap of our performance in the third quarter.
Please recall that this excludes the $99 million non-cash impairment charge that we took, and therefore I'll speak to adjusted numbers. I'll lead with revenues, which was down 12% year- over- year, primarily driven by 7% lower volume on the railroad. Changes in business mix, as well as lower fuel surcharges, also contributed to the decline. However, we enjoyed a strong sequential volume rebound off the Q2 suppressed levels we had by 22%. A very strong recovery in Q3. Throughout the past couple of quarters, while managing through the pandemic to deliver for our customers, we continued to build momentum with our Top 21 operating plan and the advancing implementation of PSR. This is what has driven Q3 operating expenses down by 15% year- over- year, more than double the rate of volume decline.
This included double-digit percentage declines across the board in the expense categories of comp and band, purchase services, fuel, and materials, highlighting that the productivity we're driving is through our entire cost structure, as well as our asset base. The result was an operating ratio improvement of 240 basis points, allowing the operating income decline to be limited to 6% on the 12% lower revenue. Despite the decline in operating income, we delivered record free cash flow of $1.7 billion, thanks to CapEx rationalization. Now, we've got great momentum here in Q4, and I'd expect some level of year-over-year improvement in the OR again this quarter, even with much less real estate gains, as well as some transactional headwinds. Q4 ought to be a continuation of very good results.
Moving now to slide four, here's a snapshot of our service and productivity metrics for the year through September 30th. The team has been tenacious all year and successfully improved each of these metrics, and they're laser-focused on continuing the gains. As you know, Alison, Cindy Sanborn took the helm of operations last quarter and is challenging the team to quicken the pace. She came in, and she accelerated the idling of our sixth hump in the past 18 months and is now working car velocity and train size initiatives to drive further productivity and grow latent capacity on our reconfigured network. As we enter 2021, we're real excited about our ability to absorb incremental volumes, just like we demonstrated here in Q3, where we're focused on keeping our service levels high and pushing the operating ratio lower as we narrow the gap with the industry.
I'll kick it over now to Alan to talk about a volume update.
Thanks, Mark. Alison, as we're moving through the fourth quarter, we are seeing some pressures on our volume, particularly in a couple of specific markets, which I'll note. Intermodal demand is way high. There's no doubt about that, but we are seeing some dislocations and disruptions in the overall North American supply chain, primarily attributable to drayage capacity, kind of slowdowns in warehouse productivity associated with, pardon me, pandemic protocols, as well as just a lot of demand for warehousing as inventories need to get rebuilt. You are also seeing it manifest itself in some port congestion, primarily out on the West Coast. That right now is limiting the upside on our intermodal volumes, although it still is kind of the growth driver for us right now.
Chemicals is also pressured due to the series of weather events and storms that hit the Gulf Coast late in the third quarter, early in the fourth quarter, which sees some production at some specific plants. That too is going to unwind at some point. Auto, we had called that out in the third quarter as something that would be a headwind in the fourth quarter due to planned retooling and, frankly, some plant downtime, which would have normally been scheduled in July but was pushed back into the fourth quarter due to the need to restock auto inventories early in the third quarter. All of those are having an impact on our volumes. Of course, as we've talked repeatedly throughout the year, energy remains pressured. We kind of define that by coal, by NGLs, by frac sand, and crude oil.
If you take those in our fuel surcharge revenue, that's about 20% of our revenue this year, and it's going to account for over 70% of our revenue decline. That is what we're seeing right now. Alison, with respect to RPU, which I know is something that we really focus on, just like we've done consistently, frankly, over the last 15 quarters, most of our commodities are showing RPU growth year over year ex fuel surcharge. We are also seeing some mixed headwinds there. A couple of them are good, though. I mean, one of them is we're enjoying a lot more thermal coal than we export thermal coal than we had been. While we're happy to have that, as you know, Alison, that is generally a shorter length of haul than a metallurgical coal and consequently comes with a lower RPU.
That will be a mixed headwind for us. Overall, with intermodal as your growth driver, that is a drag on overall yield. We do expect, as we exit the fourth quarter, that RPU, both sequentially and year- over- year, is going to kind of look like it did over the previous two quarters. As we just talk about general volume trends, we've always talked about how the consumer was going to lead the recovery, followed by industrial markets, and then energy as a late-phase recovery. Certainly, you're seeing that right now in our volumes, in our trends over the last six months. Frankly, I think that sets us up really well as we move into next year because that's a position of strength for Norfolk Southern.
I want to pivot a little bit, Alison, and move on to slide six and talk about something that is really important to us and our customers, which is our commitment to sustainable growth, as we talked about on our third quarter call. We've got a powerful intermodal franchise unrivaled in the east. We've got a diverse merchandise network, and we serve more short lines than any other railroad in North America. We've got great interline partnerships, and we've got a good network of transload facilities. All of these extend our network reach beyond just our tracks, and it allows us to offer something that's becoming increasingly more important to our customers, which is a low-carbon logistics solution. We've been focused on this for a while.
We've been pioneers in this effort through our decade-long carbon offset programs in both South Carolina and along the Mississippi River, as well as more recent wetlands restoration projects. We've also partnered with our customers on Operation Clean Sweep, which you know about, which is a commitment to eliminate the pollution of plastics while in transit. We are focused on reducing our own carbon footprint through fuel efficiency and energy management solutions. Those are just a few of the examples that I can go through that are important to our customers and our communities and gives our customers an incentive, another incentive to move business off the highway and onto rail. It also helps us with our own economic development and our infrastructure development and local economic development, generating more revenue to the NS. I want to close on this subject on slide seven.
I'm going to provide a specific example. On the left, you see the shoreline along our Lambert's Point terminal in Norfolk, which, as you know, is a critical link between our customers and Norfolk Southern and the global supply chain. What you can see is that the bulkhead had severely deteriorated, so much so that the timbers were visible at low tide. To the left of the picture on the left is our Lambert's Point terminals and our tracks. They were becoming in danger, as well as the local ecosystem, because of the deterioration in the bulkhead. We had a couple of different solutions we looked at. We came up with the most innovative one, and you see that on the right. What we delivered is a living shoreline in which we used native marsh grasses and oysters to control the erosion.
That was preferable to a fully structured bulkhead because it came at a cost. It's more environmentally friendly, and it also came at a cost to us and our shareholders of $2.5 million less. We were able to come up with a solution that benefits us, helps our assets, helps the environment and the local community, and helps our shareholders. That takes innovative thinking. That takes planning. That takes development. That is one of the reasons why The Wall Street Journal recently named Norfolk Southern one of the world's 100 most sustainably managed companies. With that, I'm going to kick it back over to Mark, who's going to wrap it up for us.
Alison, real quick, just touching upon the capital profile here on this next slide. Look, we're really comfortable with our $5 billion of overall accessible liquidity, including cash on the books, which is currently in excess of $1.5 billion, plus another $3.5 billion of undrawn facilities and issuance authority. Meanwhile, we maintain our commitment toward our current credit rating. As we explained before, early in the year, we recalibrated our capital spend with a targeted 25% reduction from the prior year levels without compromising the integrity or safety of our network and protecting near-term revenue opportunities. It's that CapEx rationalization, which certainly augmented our ability to weather the COVID-related storm in Q2, while also driving most of the improvement we realized in our free cash flow conversion rate this year, as well as driving our record-level free cash flow.
Meanwhile, we continue to return capital to shareholders with a sacrosanct dividend and consistent share repurchase activity, including during Q2. With that, we'll hand it back to you for questions.
Okay. Excellent. Thank you for walking through that presentation. Last thought, maybe starting on the demand side, Alan, you highlighted sort of a number of transitory factors that are weighing on volumes, like the auto retools and shutdowns and some congestion in the supply chain. If you sort of think about just sort of the overall trajectory of volumes and also perhaps what you're hearing from customers, what seems to be trending better or worse than expected? As you look to 2021, obviously not full visibility, but just based on your customer conversations, what are the potential growth catalysts as we look to next year?
Yeah, Alison, I think that the thing that's probably trending a little bit better than what we thought is export thermal coal, that's doing pretty darn well for us right now. I noted that you're also seeing the metals market is responding pretty well. In fact, scrap prices right now are at the highest they've been since February of 2019, and hot-rolled and cold-rolled steel is at the high prices have been the highest they've been since late 2018. Those are really good indicators of that product pull through the whole supply chain. As the consumer economy gets picked up, it starts pulling the industrial economy with it. You're also seeing inventory levels, particularly retail, right, at an all-time low. Ultimately, that's going to start moving through the supply chain. Frankly, the demand for our intermodal product is white hot.
We got to get drayage capacity built back up and warehouses a little bit more fluid. We are really confident that our franchise strengths and our focus on customer-facing technology and our market approach are lining up really well with where we see demand in the overall economy as we move into 2021.
Okay. Maybe just on that topic, first, just with intermodal, do you have a sense for how much of the recent improvements is sort of inventory restocking driven? And/or are you starting to see, just with tight TL capacity conditions, are you starting to see conversions on high? I'd love to get your thoughts on just you mentioned the consumer economy. Obviously, there's been a lot of shifts in sort of supply chains even pre-COVID, but now things are changing even more. How do you think that those changes benefit Norfolk's franchise, particularly intermodal? And sort of how do you see just the supply chain evolving?
Great question. You teed it up. Let's talk about the first point, which is inventory. Inventory needs to be rebuilt. As I noted, retail inventory to sales ratio, pardon me, is at an all-time low, right? Retail inventories, the latest data available is September. Retail inventories in September declined 9%, although sales increased 9%. Right there, you can see inventories being drawn down. As much demand as there is out there for transportation right now, we're actually really not keeping inventory levels aren't building. They're not keeping pace with sales. Truck capacity, as you noted, is extremely tight and largely inelastic with demand. As a result of COVID, driver training schools haven't been as productive, and the expectation is the US is going to produce about 40% fewer drivers this year.
You got that new enhanced drug and alcohol screening, which includes random testing in a clearinghouse, preventing drivers from concealing violations, but from moving one company to another. That has pulled about 34,000 drivers out of the overall network as well. That is not a big number of the total drivers, but you are talking about an industry where capital or capacity utilization is usually in the high 90s. Any little piece makes a big difference. Other parts of the economy are doing pretty darn well, like the housing market, which is siphoning off drivers. Frankly, in a pandemic, what we are hearing from our customers is a lot of drivers do not want to be away from home two or three nights a week. They are looking for work in the local markets. We expect the truck market to remain tight.
We expect inventories need to be rebuilt well into 2021. Here's a good example. Demand is so hot right now for imports into the United States that a lot of steamship lines are repositioning empty containers to the ports to move back for new imports, as opposed to waiting to find exports for those empty containers within the United States. Demand for capacity in that whole global supply chain is really tight right now. You move into the industrial market, and you look at PMI, which got released earlier this week. It's up six straight months, right? It's in expansion territory. Even then, that's good news. You peel it apart, and you've got new goods, and customer inventories are really what's driving the strength. All of that kind of supports our outlook and our confidence as we move into next year.
The franchise that we've got, a very powerful and robust intermodal consumer-facing franchise that is parked right where a majority of consumption and manufacturing in the United States occurs, as well as a very diverse merchandise franchise with a good service product, gives us a lot of confidence moving forward.
Okay. Maybe just turning to the cost side. On the Q3 call, we heard Cindy talk about just incremental efficiencies that she's found, at least in her initial days. You talked this morning about just the acceleration of PSR. I was wondering, can you sort of walk through in more detail the specific things that Cindy's working on, what she's found, and how that will translate into closing the OR gap versus your peers? I guess, how fast can you do that?
Yeah, we'll tag team this. I mean, the first thing, and I mentioned it earlier, really she came in, and she knew we were looking at the Southeast plan with our hump profile. Pretty quickly, she decided, "Let's accelerate what you guys are contemplating here, and let's take out that hump in Macon, Georgia, and pull forward some of those benefits. Let's try to do it before we enter peak season, that Thanksgiving and Christmas break e-commerce boom that we have, to make sure that we work out any kinks." That acceleration of pace of change is certainly one thing that she's brought coming in. Again, that's another big change. We're down to four humps now. It's a pretty impressive and bold move. Frankly, we've sorted out a lot of the kinks, and the network is running real smooth as a result.
We were also looking at a lot of satellite yards in the Atlanta area as we redesigned the traffic flows. We have closed six humps now in the past 18 months, and we are down to four in the entire network. We are pretty happy with that. The other thing that she has done is really increased the frequency of reporting of items like car velocity and train size. She is trying to put an emphasis there on turning cars quicker, not just the trains themselves. The whole organization now is pivoting in that direction. I think it is really starting to show benefits. The other thing she talks about extensively is the concept of full PIN, which is basically fully utilizing all the tractive effort of a locomotive, all the horsepower capability that a locomotive has by making sure that you fill up a train.
If you're going to have extra cars that exceed the locomotive effort, rather than put a whole new locomotive on and maybe waste 90% of its capability, perhaps keep those couple extra cars and pick them up with the next train that's going by because you want to fully lever the locomotives to the greatest extent possible. She's bringing in some new concepts and principles that I think are opening the eyes of a lot of people inside this organization. What did I miss, Alan?
Yeah, I want to reinforce two things that you said. Number one, with the Southeast region redesign, we closed Macon. It really was a redesign of the whole Southeast train and switching network designed to move cars faster. She has clearly improved the sophistication and the specificity of our metrics. We are measuring car velocity at the car level, right? Which, frankly, is more important to our customers because that's what we're selling.
That's where their cargo is.
Cars, not trains. I am really encouraged by the ideas that she has brought in, the acceleration and the energy that she has brought, and the buy-in from her team.
Okay. I know you guys talked about you could hit 60 at some point in 2021. Thinking about everything that you just said and even the structural cost reductions that you made in 2020, the improvement in train length, train weight, fuel efficiency, and perhaps now we have at least a little bit of visibility into the industrial economy we're covering. When you put all that together, I mean, is it unrealistic to think just assuming that the macro backdrop is cooperative? I mean, can you potentially hit a 60 for the full year in 2021?
Look, we're building our plan, and we're going to go through it with our board in January, and we'll talk more about it on the Q4 earnings call in late January. We're not going to get into specific scenarios today. I will tell you, Alison, that if not for that dramatic 2020 volume decline that we've suffered through here predominantly in Q2, we were on track to our OR guidance in 2020, which was to get halfway there. I'm pretty confident that we would have been there for the full year in 2021. I have no doubt about it. The reality is COVID created a speed bump on our path to 60. That's a lot of lost volume that we have to make up for.
The market's shifted in different ways, which on top of the structural changes that we're making, we have to adapt to. We are confident, though, that we're still going to continue to march forward with incremental improvements, close the gap with our peers. Along the way, we're going to get to 60. We believe at some point in 2021 will be where we hit it. We are not done. We are going to continue to march forward and really, again, try to close the gap with the peers and create shareholder value. We're going to do it with cost reduction and revenue growth.
Okay. Maybe sort of switching to sort of the longer-term revenue growth. CSX announced earlier this week that it's acquiring the Pan Am. Now, NS has a JV there. Not specifically asking you to comment on that transaction, but just more broadly, how do you think about the potential for short-line M&A on a go-forward basis? Is that a catalyst for driving growth by trenching yourself in customer supply chains? Or is your view that you can sort of achieve the same benefits via collaboration or partnerships? Maybe if you could just talk about the short-line growth strategy.
Yeah. I mean, Alan can talk to the fact we've got more short-line connections than any other Class 1 railroad. And we like those partnerships. They work well for us. At the same time, we're not adverse to looking at other options to structure the railroad. Why don't you?
I think you covered it.
Yeah.
All right. Alan, just going back to rail trends, you talk a lot about a lot of the things that we just discussed. I wanted to touch on technology. You guys have, I think, a partnership or a JV for the Pulse Platform. Could you talk about, number one, what you're doing there and how that sort of addresses shipper complaints that they just do not know where their freight is? They want tracking and tracing and, of course, better reliability and more proactive customer service from the rail marketing department. Maybe if you could address all of those and then specifically highlight the technology initiatives that underpin them.
Yeah. You mentioned Rail Pulse, which is an initiative that was effectively generated out of Mark's department. It is a partnership with a couple short lines and a couple car builders. We fully anticipate it will get much larger over time. It is to provide GPS tracking technology, safety information, open door, closed door, loaded, empty on rail cars. Ultimately, the goal is to get the entire North American railcar fleet equipped with this. It shows the fact that Norfolk Southern came up with it and is driving this innovation shows that we recognize we are just part of a larger supply chain ecosystem, right? 50% of our business either originates or terminates on another railroad. For our customers, we need to make it easier for them to do business with us. That is our goal, primary goal.
We got to stitch all that information together. That is embedded within our customer service approach. NS is so committed to that that we roll customer service up underneath marketing, which is rather unique in the rail industry. It shows that that is a component of our customer approach. We understand that we need to make it easier to do business with us, and we're delivering best-in-class customer experience. As I noted on rail trends, Alison, we're also investing in technology, mobile platforms for our customers so they know on local service. Service is a lot like politics. It's all local, right? If you tell a customer you're going to be there between 10:00 A.M. and 12:00 P.M. on Tuesday, you need to be there between 10:00 A.M. and 12:00 P.M. on Tuesday.
We want our customers to be able to see our local as it is making its way to our customer's dock so that they can make sure that they have got their people ready to unload the car and release it and give it back to us as quickly as possible. It is all about improving visibility and transparency and doing business with NS and across the supply chain ecosystem and making it really easy to do business with us.
Okay. I just want to ask one last question. I think we're just about out of time. Just going back to the network and the Macon yard idling thing, where are you now from a network rationalization standpoint? Is there more to do? Have sort of the big things been completed? What other possibilities are you guys entertaining?
We are down to four humps, and they are all high-volume humps. Each of them process nearly 2,000 cars every day. From a hump perspective, given the current traffic flows we have, we feel we are in a really good spot. We are going to continue to iterate the plans that we have and improve productivity and service, focus as well on the local service as opposed to just the overall road network. We are focusing our efforts right now, as we talked about, on increasing the train weight, increasing the train length at the same time, and that full PIN initiative that I spoke to. Car velocity is another big area. Fuel efficiency is another area where we have made great improvements and great strides. We know we also have runway ahead of us. There is still a gap with our peers there.
We're going to continue all the fuel efficiency initiatives we have, full penetration of energy management on all of our cars, the DC to AC conversion program, which is going to really help us there, distributed power, another avenue that we think can help us not just within train forces, but overall fuel economy. We have a lot of areas where we're focused right now. We feel good about our network. We feel good about our hump profile. We're just going to keep iterating. That is really the principle of PSR, continuous improvement and continually iterating.
All right, guys. Thank you so much. Really appreciate the time. Hope you guys have a great holiday. We'll talk in January.
You too. Stay safe, Alison. Take care.
Take care. Thank you. Bye.