Good morning, everyone. It's my pleasure to welcome you all to day three of the Goldman Sachs Industrials and Materials Conference. My name is Jordan Alleger. Before we get started, I do have to read some disclosures. As a reminder, this conversation is not intended for the media and is off the record. This webcast is not for the purpose of sharing or receiving nonpublic or otherwise confidential information. Attendees are public-sided market participants who may not receive and should not request nonpublic or otherwise confidential information about issuers of securities or about the markets for securities. In addition, we are required to make certain disclosures in public appearances about Goldman Sachs' relationships with companies that we discuss. The disclosures relate to investment banking relationships, compensation received to 1% or more ownership. We are prepared to read aloud disclosures for any issuer or require request.
However, these disclosures are available in our most recent reports available to you as clients in our firm portals. Disclosures and updates to those disclosures are also available by ticker on the firm's public website at www.gs.com/research. Also, the views stated by non-Goldman Sachs personnel do not necessarily reflect those of Goldman Sachs. Okay. With that out of the way, it is my pleasure to introduce Mark George, Chief Financial Officer of Norfolk Southern. Mark joined the company in 2019 and, frankly, at an opportune time as Norfolk Southern successfully is rolling out PSR for strong operational improvement across many metrics. We look forward to hearing from Mark, his views for Norfolk , both as it navigates these difficult times, but also the expected track for the company once the dust settles and we all can move forward. With that, I'll turn it over to Mark.
Good morning, Jordan. Thank you for hosting me and us today. I've got just a handful of charts to set the stage that I trust the attendees have access to. I'm not sure the vehicle in which they have the slides, but before we get started with them, you'll see a slide titled Forward-Looking Statements. I will have some forward-looking commentary today. I'd like to remind everyone to view our recent SEC filings for a discussion of risk factors and also view the non-GAAP disclosure on our website for this event. Starting here on the chart that's titled First Quarter Operating Ratio, it's really an overview of a very strong first quarter performance that the NS team has delivered. In the face of an 11% volume decline, we posted an operating ratio that was 230 basis points better than the first quarter of 2019.
We removed over $200 million of operating expenses, and that's an 11% reduction enabled by the transformation of our operations that results in us driving out cost while providing record service levels to our customers. That outstanding service product supported a 13th consecutive quarter of revenue per unit growth that limited revenue erosion to 7.6% compared to the 11% decline in volume. I'll talk more about a few of the initiatives we're executing. While we're here, I'd like to remind everyone listening of the success we've had rationalizing our locomotive fleet. We sold 250 units last year, and we've earmarked another 703 as sold or held for sale this past quarter. In fact, as of today, the majority of the 703 units are already sold. We've gone from over 4,100 locomotives at the start of 2019 to a targeted fleet of 3,200 units today.
Our operations team is certain we have the assets we need to absorb a substantial amount of volume in the future thanks to the capacity dividend from our PSR implementation. The designation of 703 excess units in one queue is what drove the $385 million non-cash charge that you'll see referenced in this slide, which is why we provided an adjusted view of first quarter earnings. In addition to the long-term operational benefits of operating a smaller, more efficient, and homogenous fleet, the disposition will also reduce depreciation expense by $25 million on an annualized basis. Also, on this chart, you'll see the long-term trend of margin improvement in a variety of volume environments before the very significant step change improvement this past Q1 from the PSR-related efficiencies despite sharp volume declines.
As many of you know, our volumes in the second quarter are trending down about 30% quarter to date. As I mentioned on the call a few weeks ago, we just won't be able to match that steep of a volume decline with cost reductions. While we will see solid expense reductions here in Q2, it won't be in the 20%+ range. OR will certainly regress in the second quarter. That said, we will continue productivity efforts on our journey to become a 60% OR company while keeping an eye on the eventual recovery and ensuring that we are able to serve it. One thing for sure, when volumes do start to recover, they will bring very healthy incremental margins. The next slide called T&E Productivity provides a great illustration of the success of our TOP 21 operating plan.
We measure productivity of trains and engine and personnel in terms of gross ton miles per employee. You can see that we have been consistently generating 3% annual productivity. With the introduction of PSR early in 2019, as we decongested the network and improved our dwell fluidity metrics and train speed, we enjoyed a step change improvement in terms of productivity, and that accelerated as we launched TOP 21 mid-year. Overall, it is a 20% improvement, and that came despite falling GTMs. I can tell you that additional GTMs would have only helped our productivity further. Now, facing the shock of a 30% volume contraction here in Q2, it will be a significant headwind to productivity this quarter.
That said, we continue to make structural changes to our network, and that will allow us to operate a more efficient railroad and bring volume back onto the network with a very high degree of operating leverage once we get beyond the current market disruption. Now, the precursor to this productivity is really what we will talk about on the next chart, which is the continuous improvement slide. It provides an update on the progress we have been making in removing crew starts from the operating plan as we have executed the phased implementation of TOP 21 and continued blending of traffic into fewer trains. We launched TOP 21 in July of 2019, and every month you see the gap form and expand between crew start reductions and volume. This performance is a key contributor to being able to fully offset the 11% volume decline in Q1 with an 11% expense reduction.
Those crew start reductions translated to the employment reductions as they were from real and lasting productivity changes. You will notice in April, the depth of the volume decline was such that we were not quite able to exceed it with crew start reductions. However, these first couple of weeks in May, the 30% volume decline has been fully matched with 30% reduction in crew starts. While crew starts will come back with volume, we are focused on ensuring we have capacity so that we will be able to grow volumes at a faster pace than crew starts once the recovery commences. Moving on to this illustrative cost structure slide, we talked about the pressure on the OR with such sharp revenue contraction. I want to remind you of this illustration that we shared a couple of weeks ago on our earnings call.
You'll see that with some cost, the variability is pretty intuitive, such as fuel being largely variable and depreciation being largely structural. With others, such as comp and ben, purchase services, materials, there are elements of both volume variable and structural, as well as a gray area that's more semi-variable in nature, meaning it takes decisive management action to adjust those costs with volume. Take purchase services, for example. The portion that is directly volume variable is actually less than half the total category. We will continue to manage all the costs as tightly as possible while we're ensuring, obviously, the safety of our network and the quality of our service product. Hopefully, this is a helpful illustration for you modelers, particularly as we're experiencing a sudden and dramatic decline in volumes as opposed to what we've seen the last few quarters.
On the next slide called Capital Update, just a real brief update. On April 30, we issued $800 million of 30-year notes at a historically low coupon of 3.05%. It was a very successful offering, underscores our continuing robust access to capital markets. You can see here, we have $5 billion of total liquidity and continue to be very confident in our ability to weather the current storm. We have a nice cash cushion. We are taking a more conservative approach to share repurchases right now. As we outlined a few weeks ago, we put a CapEx plan in place that calls for a surgical reduction of 25% over the levels we spent last year. We do that while ensuring we do not compromise network safety and we maintain a robust service product.
Lastly, we continue to remain a very proactive company with regard to our COVID response. We are prioritizing the health and safety of our employees while maintaining excellent customer service and strong financial discipline, like I just outlined. I will wrap, Jordan, just with a comment that the men and women of Norfolk Southern continue to display amazing dedication and professionalism each and every day, doing their job safely and keeping America's freight moving during this crisis. We thank them for that. As a newcomer, I am personally very proud to have the honor of joining this team. That is it, Jordan, for my prepared remarks.
Great. Thank you so much, Mark, for that commentary. Just to sort of kick things off a little bit, thinking about the top line, which is, of course, on many people's minds, can you perhaps share some of your thoughts on what you may be hearing from customers? Obviously, the big industrial base. You also have a consumer-oriented component with Intermodal and any sort of changes in sentiment as you've moved into the first couple of weeks into May, and that would be very helpful. Thoughts on reopening?
Sure. Sure. Look, volumes in the absolute now have been fairly consistent over these past five weeks for us at about 105,000 car loads per week. Hopefully, that represents some kind of bottom. Questions do remain on when the growth will resume, whether it's Q3 or in Q4, hopefully not later than that. Let's walk around a little bit and talk. I mean, automotive, we're seeing some public announcements of plants reopening. I think Mercedes and BMW are already open, but GM and Ford are talking about, I think, the 18th of May. There is going to be somewhat of an uneven ramp-up because of this dislocation we have between supply and demand. The suppliers for the auto manufacturers have to get back up too. We have to get the whole supply chain recoordinated and realigned.
Once those plants open back up, clearly, some volume will return, but ultimately, there needs to be demand for cars, and that will be based on the strength of the consumer. I mean, not to get too dour, but let's take a look at this. This is really, in my view, the significant question that we all have about the overall economy. Just as it reopens, it doesn't guarantee that the demand will be there. That's going to be a function of how much damage has been done to the consumer and to the businesses. This situation is absolutely unprecedented. Baseline it this way: 70% of the U.S. economy is consumer spend. We just went from full employment to over 35 million unemployed people in a matter of weeks. That represents 35 million consumers who are without jobs.
Maybe those unemployed get reemployed real quick with the reopening. If their businesses went bankrupt and they do not reopen, then we are going to be facing a more prolonged demand issue. We do not know how this is going to play out. It is an unprecedented plunge from a forced closure of the economy. Maybe the reopening does result in an unprecedented boom and a rapid reabsorption of those jobs. For context, it took 10 years after the Great Recession to create 22 million jobs, and we just lost 35 million. There is no historical reference point for this situation. We cannot compare it to 2008, 2009, nor 1987, nor even 1929. We have a lot of questions around when the consumer will be back because that drives GDP, and we move GDP. That is, I think, one important backdrop.
Over the long term, though, we still feel good about the business, and autos may start to come back. There will be a tail off in Intermodal international over the next five or six weeks. There is a fair amount of blank sailings, and this is translating into about a 25% capacity reduction coming out of West Coast ports and 20% out of the East Coast ports. I think the next couple of months for International Intermodal are going to hurt a little bit. Over the long term, the Intermodal value proposition is still excellent for NS. We have got an extremely robust network of terminals in the east, and we are aligned with the best channel partners in the industry. We have got all this new capacity thanks to PSR.
Our cost structure is far lower than cost, and we're still a very nimble and innovative company with regard to our service offerings. Do not forget the sustainability angle here. Intermodal, for us, we burn a lot less fuel. One train is the equivalent of 150-200 trucks burning fuel and clogging our highways. We like our position in Intermodal. For industrial products, frankly, it's weak pretty much across the board. We've got some opportunities we're looking at in construction and aggregates. Commercial and infrastructure builds can be beneficial to us with any type of stimulus there. Steel is rough. I mean, only 50% of steel capacity is online right now, and that's a sign of weakness in the industrial economy, which would be running typically in the 70-80% range when the economy is healthy. Now, it's only 50% of capacity is online.
The other area, energy, energy is weak. Crude, natural gas, liquids, frac sand, ethanol, each of those are weak right now, but fortunately, none of them represent more than 1% of our total volume in industrial. We do expect pressure on all these products as we progress through the year. The cadence of recovery, again, it's going to get back to where we see the consumers gaining steam. Ag, automotive, consumer products, that should be the first to really come back. I think the final element we can talk about is coal. It continues to be down over 50% quarter to date. Again, it's in that whole theme of energy. It's very weak, and there's tremendous levels of inventory out there. This is a secular decline for coal, and frankly, we don't see that coming back anytime soon.
Great. Thank you for that very complete answer. Just a quick follow-up on Intermodal, maybe from I know you touched on it from a long-term perspective. Obviously, the near-term is probably impacted too much truck capacity, but long-term growth prospects for Intermodal once things get back on track. I know in the past, I think rails, I think you included, have talked about GDP plus. I mean, is that still sort of a safe longer-term trajectory for Intermodal?
Yeah, we believe so. I mean, I would imagine more and more should shift to rail over time. I mean, we do have a better value proposition, especially if we're providing a good service product. It should be the more attractive option for our customer base. I think Intermodal, you have to look in the future 25, 30 years. If you're not moving Intermodal, what are you moving? It is where we want to be. I do believe it's a GDP plus sector of our business, and that's why I'm really delighted to see the robust network that we have. We really do have a great Intermodal franchise. Again, I think for sure it's a GDP plus going forward.
Great. Question for you. On the whole price or yield front, Norfolk has certainly been a big proponent of a yield-up type strategy, and you certainly have had a gap versus other rails. Is this something that you could continue to deploy in this volume environment? Do you think you could sustain sort of the relative favorable differential versus other rails as well in terms of your strong yield performance at this point? Just trying to get a sense along those lines.
Yeah, it's a good question because the world has changed a lot, right? Everything we're talking about with the economy, we have customers that are obviously going through a lot. Look, we're really close with our customer base. Our marketing organization is extraordinarily plugged in. They're in constant dialogue. What we've got as a railroad is an outstanding service product right now. We've got not just great relationships, but we're delivering. Our availability rates are at record levels. We really are delivering very well. We're serving our customer, and that is an absolute prerequisite for our yield-up strategy. That said, we're mindful of what's happening, and we're going to continue to work given the market forces that are out there right now.
We're going to continue to work with our customers and try to make the right, best decisions that are in the long-term interest of our shareholders and our customers too.
Got it. Maybe flipping a little bit to an operational perspective, and you touched on it in your slides around crew starts. I'm just sort of curious, can you talk a little bit more? Obviously, PSR is one thing, but separate from that, the ability, your operational response to the volume changes. You talked about crew starts. Are there other sort of key things that you've done or still plan to do as you navigate through this volume environment?
Yeah. I mean, we're managing and leveraging these five key principles of PSR: the service to customer, manage our assets, control our costs, work safely, develop people. As we navigate through this, we've created all sorts of capacity and fluidity across our networks that really allow us to respond to this crisis the way we're responding. If we look at crew starts, we're matching it with the volume declines incredibly nimbly. The work that our network planning team is doing to quickly adjust and adapt and work with operations and marketing is, frankly, it's very remarkable. I think part of this is just the way we are structured right now and the leaders we have in place. We're responding quite well to the changes in the marketplace. Part of that is really just the people and the professionals that we have leading the organization.
Part of it is enabled by the PSR principles that we've deployed, I think, just in time. They've allowed us to react nimbly. In large part, I think we have to credit the TOP 21 strategic implementation that we went through last year. It's not just PSR, but it's all those other attributes of it that have helped us respond.
Got it. Question on headcount. Can you talk about your ability to what you're doing to manage headcount in the short run and what perhaps your headcount plans would be moving forward? The ability to call back people to ensure that you could leverage the return to volume growth in the future. Thoughts around the headcount plan.
Yeah. I mean, we've been beneficiaries right now through our implementation of the strategic plan. We've really been able to take out employees through the productivity and efficiency gains that we've been harvesting over this past year. We've had this step change improvement, and it's clear these are permanent productivity changes. Now, we're about to lap all of that stuff, but it doesn't mean we're done. We continue to find opportunities to streamline. We continue to make trains longer. The blending of the networks is a huge key enabler, and it's creating a more fungible product for us. I mean, a train is a train as opposed to having a divided set of networks where you're trying to match the volumes.
Doing all of that has enabled us to continue to streamline and build density and eke out more of these productivity gains that we get through the employee reductions and the T&E. The T&E reductions are translating into employee reductions. Like I said, we're about to lap the big step change parts of it, but this is going to continue in increments on a continuous basis going forward. I think the blending of the networks is really the key enabler right now.
Got it. You put up your slide on the variable costs, semi-variable costs. Is there particular percentage terms you could discuss? How much of that variable is truly variable over the short run?
Yeah. I mean, you can look at the chart, and you can kind of see that comp and ben, it's pretty much in that 50%-60% range of kind of pure variable, crew starts in particular. There is a big gray area where you have to decide you want to make a change because you think volume is going to stay down for a while, you start to attack that gray area. If you think that it's a temporary dislocation in volume, then that's something you may want to be a little bit more judicious over and reserve on. When you look again at each bucket, you can see obviously fuel is nearly 100%, not fully, but it's highly volume variable, while depreciation much less so.
When you blend it all together, it looks to be in that 50% range plus or minus in terms of what's volume variable. That doesn't mean that we don't sit there and attack the structural side. That's really where we're spending a fair amount of time is trying to take a look at what we see as structural, how can we change our structure and streamline ourselves to be more efficient, especially if we're going to be a smaller railroad to some degree if we end up in a prolonged trough and volume doesn't come back.
I had a question on a clarification on the you mentioned volumes were down about 30% so far in the second quarter, and you made some commentary around expenses and it's going to be tough to match, which totally get it when things drop so quickly. Did you put out a did you suggest a percent on the expenses? I think you had mentioned 20%. It's just a clarification question on that comment.
Yeah. I mean, what I said was we're going to continue to have another great quarter of cost reduction, but it's unlikely to be in that 20%+ range.
Got it.
Therefore would not match the volume.
Got it. With what you've been doing so far on the cost reductions, when we come out from the other side of this, do you feel like this has sort of accelerated sort of the operating efficiency? When we come out on the other side, you'll be able to retain some of the things you've been doing with the pandemic and get back on track to sort of the leverage and OR targets that you had talked about prior to all this beginning?
Yeah. It's a great question, Jordan. I do feel like in a way this could be a blessing for us because we are obviously going to have to get more aggressive here with cost this year than we initially thought we'd have to do because we assumed volumes would be somewhat flat. We're going to go obviously more aggressive, and that will just basically allow us to be really coiled up when volume comes back. We're going to keep a lid on costs. I do believe that the incremental margins as volume comes back is going to really allow us to see significant improvement in our OR. I think in a way, the declines that we're dealing with in hindsight a couple of years from now, we're going to look back and realize it was a huge catalyst for us to get to 60.
Yeah. No, that certainly makes sense. Is there a point in time, just sort of curious from a comfort level standpoint, what would it take? Would it take a certain level of volume before you'd be able to feel comfortable coming out and say, "Hey, our target of 60 is now back on track, and here's the time frame for it"? I mean, is it purely a function of volumes getting back closer to zero instead of down so much?
Yeah. I think that's correct. That's what it's going to take. We haven't given up on the 60 yet because we can't be sure that volumes won't come back. It's looking less likely that we'll have a V-shaped type of a recovery. Nevertheless, we didn't feel as though we're ready to put up the white flag and say, "All right, there's no chance with volumes down the way they are, there's no chance it comes back, and therefore it's going to be a permanent obstacle for us." We've got an organization that is incredibly motivated and is driven by goals to try to get us to a 60. We had a path in place. I felt very confident with the work we did in December and January, even in the face of what ended up being softer volume toward the end of last year.
I felt as though we adjusted, and we were still on a good path to get us to 60 by 2021. This speed bump really that's been laid in front of us is unfortunate. It could slow us down a little bit if we do not get some type of significant volume recovery on the back end of this crisis. Time will tell. We will keep reassessing this with each passing quarter. If it looks like it is not going to come back, it is going to be a prolonged U or a Nike swoosh type of recovery, it does not mean we are not going to get to 60. It just may mean it may take a little bit longer to get there. Right now, we are not willing to say that we are coming off the 2021 target.
Got it. That makes sense. Just a question on PSR. I mean, with the pandemic, I know you're planning the tough volumes. You're dealing with things along those lines. With the pandemic, does planning or around further PSR implementation get changed or get altered versus what your plans might have been in 2020? Does any of it have to be sidetracked, or is it pretty much full bore on PSR and what your plans were going into this year?
No, it's full bore. I mean, the team has done an unbelievable job on the first two phases at the end of last year, and now we're in the third phase of our PSR and having great success. You might argue that the lower volume actually makes it easier to execute upon. The team has done a remarkable job here even in phase three that we started this year, blending the intermodal network, optimizing our train sizes, and now really looking at the yard and terminal network again at optimization. When the tide recedes, in this case, it's volume. When the tide recedes, you see all where the rocks are. Everything gets exposed.
The team is really being able to look at that landscape with clearer eyes and decide from a whiteboard clean sheet perspective what we want our yard and terminal network to look like. I think in a way, the volume decline makes this a little bit easier to execute upon. The team has done a great job. Unlike a lot of other companies, when PSR has been implemented in other places, oftentimes they start by just shutting down a bunch of yards, and it creates all sorts of chaos in the network. We have done it in a reverse way. The NS approach to implementing PSR has been really to launch new trip plans first and to attack the network and working with the customers to make sure that we do not disrupt things.
Once we optimize the network, now we can look and really start to see, does our yard footprint make sense anymore? Or were those yards kind of put in place just through legacy, but they're really just not in the right locations, and therefore they're subject to closure? We have done it in a more balanced approach, and I think it's been very, very effective. That is what the team is working on now, and that's been a big component of our phase three.
Thank you. We probably have time for another one or two. One question's come in. On recovery, when things start to reopen, what's your expectations for supply chain fluidity? Do you anticipate any particular difficulties or pinch points or challenges once business comes back with regards to your network, getting back people, bringing back assets, etc.?
This is a great question. I think rooted in it is a history that I've learned coming in from outside that railroads typically struggle when volumes come back. I would say the one thing that we've done a little bit different here is we haven't seen actually a volume recovery for a post-PSR railroad yet, but I suspect that it will be different because we do have all of this excess capacity now. PSR has allowed for this capacity dividend. I do believe we've got surge fleet at the ready with the rail cars and the locomotive fleets. We're trying to be smart about our T&E workforce, trying to find that right balance between keeping people on board and at the ready so when volume comes back, we can handle it versus taking the cost out for good. We're trying to do that.
We also feel as though our network right now is very balanced, and that will allow for less disruption when things start to come back. I am not so worried, even though I have read all the horror stories in the past about how volumes have been difficult for railroads to handle when they come back from downturns. I think being a post-PSR railroad now, we should be able to handle that.
Got it. No, that makes sense. We are sort of bumping against the edge here, but probably at this conference, it makes sense to ask the one final question. Thoughts on capital allocation? Obviously, plenty of liquidity. What are your thoughts on use of cash flow, liquidity, buybacks, debt reduction? What are your thoughts around that?
Yeah. Look, you see that we've shored up our balance sheet a little bit. We've placed the debt. We've got cash levels now that are juiced up around $1.5 billion. You may recall that I mentioned on the Q1 call, we've got pretty light maturities over the next two years. In fact, only $400 million between now and November of 2021. And roughly $5 billion of liquidity. We've got credit revolvers. We haven't tapped AR facilities of $400 million. We haven't tapped $600 million of borrowing capacity. We haven't tapped. We continue to do share repurchase, but we've really dialed it back a bit. We are ready to flex as things come back, and we start to feel comfortable. We'll return like we always do. We'll return cash to shareholders.
Right now is not the time to really engage in anticipating how much that will be, when it will be. Clearly, if things get tougher, we'll dial it back entirely. I think we've got a good cash profile and a good plan on the capital side to make sure we weather the storm and we can flex back up or down as needed.
Great. In the interest of time, I'll just leave it there. Although, Mark, I don't know if you had any quick summation comments. Happy to give you the floor, or else we'll move along.
No, I think that's good, Jordan. I've made my comments at the outset. Thank you for the time.
Great. Thank you very much, guys.
Take care.