Norfolk Southern Corp (NSC) — Q3 2017 Earnings Call Transcript

Thank you, Rob, and good morning. Before we begin, please note that during today's call, we may make certain forward-looking statements, which are subject to risk and uncertainties and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a 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 Investor Section, along with our non-GAAP reconciliation. Additionally, a transcript and downloads will be posted after the call. Now, it is my pleasure to introduce Norfolk Southern's Chairman, President and CEO, Jim Squires.

Good morning, everyone, and welcome to Norfolk Southern's third quarter 2017 earnings call. Joining me today are Alan Shaw, Chief Marketing Officer; Mike Wheeler, Chief Operating Officer; and Cindy Earhart, Chief Financial Officer. It is with great pleasure that I introduce Cindy to our quarterly calls. She brings a strong diverse background to this role. I look forward to her contributions as we continue to execute our strategies centered on safety, service, stewardship, and growth. Highlighting our third quarter results on slide 4: net income was $506 million, up 10% from the prior year, and earnings per share increased 13% to $1.75. Our third quarter operating ratio decreased by 160 basis points to an all-time quarterly record of 65.9%. Our third quarter results are an extension of the performance delivered throughout the year resulting in a record 67.4% operating ratio and record earnings per share of $4.93 for the nine-month period. These results demonstrate the successful execution of our proactive strategies and initiatives. Our continual focus on delivering results through cost-saving efforts, efficiencies, and asset utilization have us on track to deliver productivity savings of over $100 million in 2017. The unrelenting focus and resolve of our employees on delivering upon the goals we set out in our strategic plan is evident in our achievements to date. As shown on slide 5, for seven consecutive quarters, we have lowered the operating ratio on a year-over-year basis. We continue to make demonstrable progress toward achieving a sub-65% operating ratio. Our team remains committed to ongoing productivity initiatives and the pursuit of additional opportunities for improvement. And for these efforts, I am confident that we will reach that goal by 2020 or sooner. We remain focused on both resource utilization and growth, as we continue to successfully execute our multidimensional strategy. Our third quarter volumes increased by 4%, while average head count was reduced by 4% versus last year's levels. We are resolute in our commitment to deliver a quality service product that our customers value and will provide opportunities for growth. Now, Alan will provide a marketing overview, Mike will detail our operational performance, and Cindy will summarize our financial results. Then we'll take your questions. With that, I'll now turn the program over to Alan.

Thank you, Jim, and good morning, everyone. Our third quarter 2017 revenue growth in all three business units reflects the strength and sustainability of our strategic plan. Total revenue for the quarter was up 6% versus 2016 driven by a combination of volume gains in intermodal, coal, and steel and increased pricing. Merchandise volume was down slightly in the third quarter as gains in steel, sand, and fertilizers were more than offset by lower automotive shipments associated with U.S. vehicle production declines and reduced crude oil shipments. Overall merchandise revenue was up 3% this quarter as negotiated price increases outpaced volume losses. Intermodal revenue increased $46 million, or 8% versus the same period in 2016, resulting from highway conversions, organic growth with our existing customers, and new service offerings. Intermodal achieved record volume for the second consecutive quarter as total units once again topped the 1 million unit mark. Our intermodal growth in the third quarter is the result of our market approach, which aligns our service product with the needs of our customers, enhancing their ability to grow while positioning Norfolk Southern as an integral part of their supply chain. Coal posted year-over-year revenue and volume growth primarily due to increased export coal volume and pricing. Coal RPU was up 1% due to the impact of pricing gains that were partially offset by negative mix. Higher growth rates and lower-rated export steam negatively impacted RPU despite improved pricing in our export markets. Utility volume decreased as mild weather caused an approximate 15% year-over-year decline in overall coal burn in eastern utilities. Turning to slide 8. We look ahead to the remainder of the year with confidence based on current economic trends. In merchandise, we expect low single-digit growth in the fourth quarter. Industrial production is likely to drive demand in steel, while growth in construction will positively impact our aggregate volume. Further, we expect increased drilling activity in the Marcellus/Utica region will continue to drive growth in frac sand. These increases will be offset by declines in automotive and by lower crude oil, which is adversely impacted by pipeline activity. Intermodal expectations remain strong as tight trucking capacity should be further impacted by the ELD implementation in December. We continue to enhance our service offerings, providing growth opportunities with our customers to further drive revenue, volume, and shareholder value. In coal, we expect fourth quarter utility volume to be in the range of 15 million to 17 million tons impacted by the mild summer weather. Export tonnage should continue to exceed last year's with volume in the range of 5 million to 6 million tons. We remain focused on pricing in all of our markets. Current indicators point to higher levels of demand and tighter truck capacity for the remainder of the year continuing into 2018. Such an environment increases our value in the marketplace, and we are confident that improvement will be reflected in our pricing. Moving to slide 9. Our market approach and current opportunities are consistent with our strategic plan, offering a balance of safety, service, productivity, and growth to drive shareholder value. To execute this plan, we deliver customer-centric service products that adapt to the needs of our customers while providing an environment in which it is easy to do business. Our customer-centric service product first focuses on tailoring the right service to our customers. We collaborate with our customers to develop the best product that is beneficial to both our shareholders and customers. We pay close attention to customer feedback and continue to make adjustments to meet their needs, viewing our product through the lens of our customers. Our goal is to enhance the competitiveness of our customers in an evolving marketplace, allowing them to quickly adapt and compete for growth, increasing revenue to Norfolk Southern while strengthening our role in their supply chain. Lastly, we employ a best-in-class industrial development team to help customers locate or expand on our lines, providing a future pipeline for growth. The continuity of our management team, operating philosophy and longstanding customer relationships combined with improving the customer experience and product is the overarching theme of our growth initiatives. We are confident this approach differentiates our service products, allows us to compete with truck, and will continue to provide the revenue and volume growth and shareholder value we delivered this quarter. Thank you. And now, I'll turn it over to Mike for an update on operations.

Thank you, Alan, and good morning. Our service levels are delivering growth consistent with our strategic plan. As shown on slide 11, there were significant milestones achieved in the quarter as well as the first three quarters of the year. Our achievements in reducing train accidents combined with our improvements in train length, locomotive productivity, and fuel efficiency all helped to drive a record operating ratio. Turning to the key drivers of our success on slide 12. The safety of our employees in the communities we serve continues to be our top priority. Our reportable and serious injury ratios are stable and we are on pace to achieve our lowest train accident frequency on record. For service, we achieved sequential improvement in our network performance metrics. Specifically, our service composite metric is back near 80%, which points to resiliency in our operation. This is particularly notable given volume was up sequentially, while we also successfully controlled costs. Our current service levels are allowing us to not only take on short-term opportunities, but also positions us to have more impactful discussions with our customers concerning long-term opportunities. Moving to some of our key productivity initiatives on slide 13. We are driving improvement in all areas. Our continued rationalization of our yard and local fleets has resulted in significant improvements in our locomotive productivity. The third quarter was the highest quarter of locomotive productivity in our company's history and we are on pace to beat last year's record performance. Not only do these improvements result in lower maintenance costs, they also enhance our fuel efficiency, which improved 4% in the quarter and was an all-time quarterly record. As you may recall, 2016 was a record year for this measure and we are on track to set a new record this year. These measures have been driven by optimizing our train plan and improvements in train lengths, which is something we must balance with service. In closing, we are confident we will continue to provide a level of service to our customers that will grow our business while at the same time driving sustainable productivity savings and superior returns for shareholders. We are proud of our accomplishments and continue to identify opportunities to drive additional efficiencies for the benefit of NS shareholders. I will now turn it over to Cindy who will cover our financial achievements.

Thank you, Mike. Good morning everyone. As Mike and Alan have discussed, we continue to execute on our long-term strategy and the operating results from the third quarter show we are: 1) reducing costs; 2) driving productivity; and 3) growing the company. On slide 15, you'll see we delivered a record quarterly operating ratio of 65.9%, a 160 basis point improvement over third quarter 2016. We accomplished this by growing revenues 6% as Alan described, while holding expenses to a 3% increase resulting in an 11% rise in income from railway operations. Now turning to the component changes and operating expenses on slide 16. In total, operating expenses were higher by $55 million or 3%. Notwithstanding the 4% increase in volume, improved productivity helped to offset higher inflation. The area of largest variance in the quarter, Compensation and Benefits rose by $64 million, or 9% year-over-year. There are two primary reasons for the increase. First, improved operating results led to an increase in incentive compensation of $47 million over the third quarter 2016. And second, inflationary increases continue at a quarterly run rate of about $30 million, which is higher than historical inflation. As discussed in previous quarters, the increase is primarily due to the large increase in premiums on union medical plans. Partially offsetting these items were reduced employee levels, which saved $26 million. Headcount was about 1,100 employees lower than the third quarter of 2016 and down over 300 sequentially. Year-over-year, we are handling more shipments with fewer people. We expect to enter 2018 with employment levels flat to slightly higher than where we are now, as we hire and train T&E employees ahead of the 2018 peak demand months in summer and fall. Fuel expense rose $17 million entirely attributable to higher prices which added $20 million. The average price per gallon for locomotive fuel was $1.70 this year versus $1.51 in the third quarter of 2016. Sustained improvements in fuel efficiency resulted in 2% fewer gallons consumed on 4% more volume. As Mike mentioned, we posted record fuel efficiency metrics and we expect our ongoing initiatives to further increase train lengths and reduce fuel consumption to support continued improvement. Purchased Services and Rents decreased $9 million, or 2% year-over-year. Equipment rents decreased by $6 million due to lower automotive traffic and improved equipment utilization. The Materials and Other category decreased $24 million, or 13% year-over-year. Lower equipment and roadway material usage drove over half of the decrease. As we reduced the locomotive fleet in service, locomotive repair costs have decreased. Third quarter 2017 also included $9 million more from gains on the sale of operating properties. Moving to slide 17 which shows the full income statement. You can see the strong operating results fell to the bottom line producing net income of $506 million, up 10% compared with 2016 and diluted earnings per share were $1.75, a 13% improvement. Wrapping up our financial overview on slide 18, we continue to return value to our shareholders through dividends and share repurchases. Free cash flow was $1.2 billion for the first nine months and over $1.2 billion has been returned to shareholders. As we announced last month, the board increased our share repurchase authority by 50 million shares and extended the program through 2022. Our financial results for the quarter demonstrate our continued focus on cost reduction, productivity, and growth. Thanks for your attention. And I'll turn the call back to Jim for closing remarks.

Thank you, Cindy. As we head towards the end of 2017, we remain as committed and energized as we were at the onset of our plan to deliver sustainable changes that will improve bottom line results for shareholders. Our plan is dynamic and flexible and provides an adaptive platform that will be the foundation of success for our employees, customers, and shareholders. We have consistently delivered strong performance and we are confident in our ability to achieve further improvements and reach our objectives that will drive shareholder value. With that, we'll now open the line for Q&A. Operator?

Thanks. Good morning. I was wondering if you could speak to your view on the tightness in the truck market and how you think that could help results in 2018 from both a volume perspective and a price perspective. And then sort of along the same lines, in terms of potential share gains from CSX, could you elaborate or provide some color on what you think you received from them and how much you would expect to keep or give back? Thanks.

Well, let's take the truck capacity question first. It certainly is an encouraging environment. We are seeing truck capacity tight and getting tighter. Alan, why don't you provide some specifics?

Yeah. Allison, as you know, we've clearly stated that our primary form of competition is truck. And within the East, we have a unique opportunity to divert shipments away from the highway to rail. Obviously, within intermodal containers, but also within boxcars and within a multimodal context. As truck capacity tightens—and that's the narrative that we hear from our customers on a daily basis—that has volume implications for us and importantly it has pricing implications. Certainly, I think we're seeing some of that volume matriculate to us now and the pricing will continue into 2018, as our customers and we go through bid season. With respect to share gains, once again our primary form of competition is truck. We are going to put out a very dependable service product and a very consistent approach. We feel like our customers value that approach. And so that has been reflected in our volumes and in our revenue.

Okay. Great. And then just a follow-up, as you think about just sort of the whole pricing umbrella. Are you seeing an underlying acceleration in your core pricing growth, whether – I guess compared to the second quarter?

As we're renegotiating contracts in the third quarter, we see more strength, particularly on the truck competitive business, as you would expect.

Okay. Excellent. Thank you.

Yeah, hi, thanks. Good morning, guys. I want to talk a little bit about sort of operating leverage as we think forward and sort of along the lines of the last question. It seems like there is an opportunity for both price as well as volume as you move into next year, truck markets beginning to tighten up. You put together good incremental margins in the third quarter. Just want to get a rough sense of maybe how you think about sort of that cadence as we go forward with the productivity initiatives you have and sort of the pricing, if you put it all together and similar, how you think about that over the next several quarters?

Good morning, Chris. Yes, we have seen a nice trend in operating leverage and incremental margin thus far this year. Looking out, the cadence will depend to some extent on the mix of volume growth we experienced. Cindy, maybe you could address that a little bit further.

Yes, sure. Hi, Chris. Yeah. As Jim said, we've seen good incremental margins and I think we expect to see those going forward. Just to remind you, I think we've talked about this before, that we see it's sort of a hierarchy in terms of incremental margins in our business. The highest, of course, is merchandise, followed by coal, and then intermodal. So, it really will be dependent upon where we see the incremental growth going forward.

Okay. But the setup that we have in terms of what sort of working and sort of a tighter truck market doesn't lead you one way or another when you think about that?

Well, as Alan said, we do see the opportunity from a tightening truck market not only in our intermodal franchise, but in general merchandise as well and there we do have significant incremental margin opportunity. In addition to the extent we're able to price into a tightening truck market, that too should support incremental margin going forward.

Okay. That's helpful. And just a quick follow up on head count. I just wanted to make sure I was clear on sort of how you think about the progress in both fourth quarter and then maybe going forward, it sounds like there is some incremental heads may be coming to get advance of some peak business in 2018. But I just want to make sure I understood the cadence of that? Thank you.

Cindy, why don't you take that one.

Yes. So, Chris, certainly we've seen good head count reductions. Our year-over-year head count is down about 1,100. Well, I did mention in my prepared remarks that we expect head count in the fourth quarter to be flat or slightly up and that's really all dependent on our T&E hiring. We're hiring kind of ahead of our peak demand month in the summer and fall going in 2018. So, that's where you're seeing the increases.

Perfect. Thank you very much.

Yeah. Good morning and congratulations on the strong results. I wanted to ask you about the pipeline on productivity and just how we might think of drivers of margin expansion if you look out into 2018. So, I think you've had a number of structural cost reductions that you put in place over the last few years and you're putting up nice incremental margins and further productivity gains. How do you think, Jim or Mike, about what's in the pipeline going into next year in terms of structural cost takeout or just what would support operating leverage and margin expansion next year?

Good morning, Tom. Productivity certainly has been a key driver of financial improvements this year and last, and we expect that to continue. We've made a lot of progress in a couple of key areas already. We ticked off some of the records that we achieved in the third quarter as part of Mike's presentation. And yes, there are many additional productivity opportunities in the pipeline. Mike, why don't you comment on that?

Yeah. Okay. So, I would just note that there are some things that are going to run through 2018 that we initiated this year, the reduction or the idling of one of our terminals earlier this year. The 150 locomotives we've taken out of service that was a first half thing that will run through all of next year. And then the division consolidation we told you about before it actually goes into effect next week. So, a lot of those things will run through the full year next year. But, we continue to take a look at optimizing the train plan, and as you saw that we had 4% more volume out there. But we reduced crew starts by 2%. So, we handled 4% more volume with 2% less crews. So, that's optimizing our train plan and train length. So, we continue to take a look at how we can take costs out of the railroad. It may not necessarily be a big terminal or anything like that, but it's taking costs across the railroad out of the network, but still making sure that we're able to provide the service that our customers are looking for. So, there are a lot of initiatives going on, and more to come and we balance out the service, but we're not letting up.

Okay, that's helpful, maybe just a follow up on that. So, if you look at 2018, what do you think will be the bigger driver of margin expansion, would it be volume growth and that's supporting operating leverage for longer trains and so forth? Or do you think a bigger opportunity is from more of the pure cost or productivity, whether that's facility rationalization, changing the train plan, however, you would frame it?

Tom, ours is a balanced plan, it's balanced, it's dynamic, and it's flexible as well and that's why we've been able to consistently deliver strong performance. So our expectation looking into 2018 and beyond is that we will continue to deliver bottom line improvements through a combination of growth and productivity.

Thanks, good morning, everyone. Jim, we saw headlines a couple of weeks ago about the various labor unions coming together to come up with an agreement with the Class 1 rails, which is pending ratification from the rank and file. I was wondering if you had any initial thoughts on how that agreement stacks up versus your expectations. Thanks.

We have reached a tentative agreement with a coalition of unions representing about 60% of our employees. It is out for ratification and we'll await the results of ratification before commenting further on the agreement.

Okay. And just as a follow up, I'm sorry if I missed it, but did you quantify any impact from the hurricane in the third quarter and also given that you mentioned that your primary competition is truck, how much customer overlap do you really have with your eastern partner in that, if you have customers who are unhappy with their service, they could look to you as a long-term alternative? Thanks.

We did not quantify any additional expenses as a result of the hurricanes in the third quarter. Alan, why don't you comment on the competitive landscape?

Yeah. Our primary form of competition is truck, Ravi. We do share some customers with CSX and as I suggested, we're offering a differentiated service product and a long-term approach of a balance between cost-effectiveness and supporting our customers' growth. And so to the extent the customers are looking for a dependable service provider, we're there. Our primary focus is on securing business from the highway and we see that spot rates are up 15% in trucking and drive-in over the last couple of months and are up about 25% year-over-year. That's also buttressed by an improving economy in which consumer confidence and the PMI for manufacturing are at effectively 13-year highs. So our focus is on competing with truck. That's been our thesis. That's the opportunity provided to us by operating in the East and that's where we're going to see a lot of growth.

Great. Thank you.

Thank you, operator. Hey, guys. I want to just focus on freight that you might have won from your Eastern competitor due to their service issues in the quarter. It seems like whatever you did take on didn't negatively disrupt your network, and you kept your service levels high. Could you talk a little bit about the thought process of taking on that freight and how likely it is that you're going to retain it?

Sure. I would emphasize that our goal is to grow while pushing hard on productivity as well. So we believe we have an excellent service product in the marketplace that allows us to compete with both truck and rail. Alan, talk a little bit about the specifics in terms of market share—rail market share in the quarter?

Yeah. Jason, as we've talked before, there is a lot of collaboration within Norfolk Southern about volume opportunities. And our primary focus was on making sure that any volume we brought on was accretive to the bottom line and to our shareholders and did not disrupt the responsibility that we have to our existing customer base to provide a consistent and predictable service product. And so that's how we went into this. We could be judicious with the unit trains that we added, and we look for opportunities to add trains into our scheduled merchandise network and within intermodal. We also make sure that anything we brought on in the short term did not necessarily reduce our ability to handle additional business at higher returns in the long term.

Okay. That's some good color. And I guess my next question is going to be on the incentive comp. Obviously, it was a little bit higher than I expected. It was actually higher than you saw an increase last year in the third quarter. What should we look for incentive comp in 4Q?

Hi, Jason. This is Cindy.

Hey, Cindy.

Yeah, you did notice, we talked about in the prepared remarks that incentive comp was up $47 million year-over-year. And maybe just a little bit of context. If you think back to 2015, we had a zero bonus, then going into 2016 we did have a bonus but it was a lower level bonus. And then this year really based on improving business results, you've seen the incentive comp go up. So when we think about fourth quarter, the expectation was you would see a similar year-over-year increase in incentive comp in the fourth quarter.

Okay. That's perfect. Those are my two. I appreciate the time as always, everyone.

Thanks. Congrats on the good results. I wanted to ask if you could just offer some thoughts on growth. I guess relative to the underlying market, there's obviously some idiosyncratic things happening, whether it's market share opportunities, truckload capacity tightening, pricing. So against that backdrop, just wanted to try to get a sense of your thinking about your volume growth, revenue growth actually potential relative to the actual underlying markets that you're serving? Thanks so much.

Balance is really the key. We are aiming to grow, but while achieving ever-improving productivity as well. So, Alan, why don't you talk a little bit about the major verticals and our growth expectations there as outlined in our current long-range plan?

Sure. Amit, we're pretty excited about the environment in which we're operating right now. We see truck capacity tightening significantly, buttressed by an improving economy, which should certainly assist our intermodal markets. It will also assist many of our merchandise markets, as we implement—we continue to implement our plan of a strong service foundation, schedules that meet our customers' needs, an equipment strategy that supports growth, technology improvements that optimize the distribution of the equipment and make it easier to do business with us. All of that is part of our strategic plan. It's all designed to compete with truck. And so those are positives for us. As I look into the fourth quarter, I'll draw your attention to export; we're still projecting 5 million tons to 6 million tons of export coal. Recognize last year the fourth quarter was our highest export coal quarter. I think through three quarters, we did about—last year we did about 10 million tons of coal, export in the fourth quarter we did 4.6 million tons. So the comps get a little bit more difficult. We also had a much milder summer in the East and the start to the fall has been mild. And so I think we're going to be somewhat limited in our utility volume in the fourth quarter.

Okay. That's helpful. And just one follow-up for me, if I could. And it's really a question about CapEx and cash deployment. The CapEx requirements of the business and really the industry, I guess, are kind of staying where they are today, or if not, going maybe a bit lower over the foreseeable future. Some companies, some of your peers in the U.S. at least have committed to maybe more ambitious share repurchase activity. I wonder if you could talk about that. You've chosen to pay down some debt. I just wanted to see if maybe we should expect a little bit more of a pivot on the cash deployment side towards more of what some of your peers are doing? Thanks.

In terms of capital allocation generally, our approach is very disciplined. We are putting the money back into the business that we need to, to reinvest in the business, to keep our service strong. In terms of shareholder distributions, we're targeting a one-third payout ratio with incremental free cash flow going toward share buybacks. Cindy, talk about the change that we made in the buyback program recently and our expectations for shareholder distributions for the whole year.

Yes. So we did announce the board approved $50 million more in share repurchases through 2022. In terms of the share repurchases, we also increased that this year. We started our guiding at about $800 million repurchases and we're at $1 billion. And so going forward, and as Jim said, we have a very disciplined approach to cash deployment. We'll invest back in the business. Our plans are to distribute back to shareholders via dividends and over the long term get to about a 33% dividend payout ratio, and then we use remaining cash to have share repurchases. So that's our strategy going forward, and I think that's been our approach all along.

Okay, all right. That's very clear, guys. Thanks so much for taking the questions. Appreciate it.

Yeah, good morning. Just wanted to get a split. You talked about 4% volume growth in intermodal. I was wondering if you could provide some detail as to what the growth rates were in domestic versus international.

Yeah. Matt, international was down slightly. Of course, we and the ports that we served were impacted by the hurricanes. And so that was somewhat of a drag, and then domestic was up about 7%, 7.5%.

Okay. And is it fair to think, given all the talk and anticipation about capacity issues in trucking and a better pricing environment potentially emerging next year, is the biggest bite of the apple one way you should think about the cadence of pricing improvement in intermodal, is it still – should we still be kind of bogeying the second quarter is where you really get that biggest bite or is it more spread out now?

Well, that is certainly when bid season typically occurs for our customers. We've already negotiated 85% of the revenue for this year. We've already negotiated about 54% of the revenue for next year. So it does, Matt, as you noted, it is tied to the bid season for our customers, and it's also tied to the contract renewals that we have.

Okay. And my one quick follow-up would be, I know you don't guide to core pricing, but it sounds like it's going to be a better year next year. Can you just give us your expectations for rail inflation in 2018? Thank you.

Right now, all-inclusive less fuel is at 1.9% for next year.

Hey. Good morning, everyone, and thanks for taking my question. And congrats to Jim and team. It's not lost on us that your OR is beating the competition here. But, Jim, I want to ask on those lines. I mean, we've seen a lot of volatility in your company's earnings in the past, especially with swings in export coal. Obviously, that market can shut off and turn on very quickly. But it sounds like you're planning for a higher labor cost outlook, higher head count next year, if I'm not mistaken by the comments you've made. So how could you mitigate the risk that maybe that market turns off quickly? What can be done on the cost structure that would keep the OR trajectory heading lower?

The plan is dynamic and flexible, and that's really been the hallmark of our execution over the last couple of years. As you've seen, the business ebb and flow. We have been able to make adjustments and to react to changes in the marketplace. And that's what we'll continue to do. We will continue to drive hard on productivity and growth, wherever growth is available. If market conditions change, we will again adapt and be flexible.

Okay. And I hate to nitpick on the call but, Cindy, it looks like your other cost line came in at about $40 million. And if I go back the last few quarters, you've been running, let's call it, somewhere between $75 million and $80 million. I know that you've called out $9 million in the landfill gains, but was there something else that favorably impacted the quarter? Or is that the new run rate that we should be looking at going forward?

Yeah. Brandon, as you said, I did call out $9 million increase year-over-year in the gain on sale of operating properties. And, obviously, those things change from quarter to quarter. It's hard to predict when you're going to have gains. In terms of the large number of gains from year-over-year, in the third quarter, I think we talked about—third quarter of 2016 I think we talked about around $28 million worth of large gains. In this quarter in 2017, we had about $38 million worth of large gains. So that has some impact, and that's probably the biggest thing. And, again, it's hard to predict from quarter to quarter.

Okay. That's actually very helpful. Thank you.

Great. Good morning. Jim, I guess, third quarter is typically your best operating ratio and looking at the cost strides you've made, do you need to overhaul ops like counter-suggest to get down to the 60% range? Or can you keep doing the blocking and tackling as you've been doing to get to this point to get that progress? And maybe talk about the—is that a realistic progress for your network to get to over a longer term? I know 65% is your near-term one. And then just your thoughts on the $100 million productivity. You mentioned you beat the target. I guess, maybe thoughts on the potential of scale as you move forward this year.

Sure. Good morning, Ken. So let me begin by emphasizing that we've been making significant progress on our long-term objectives and achieving and exceeding our goals. So you saw in the third quarter, the seventh consecutive quarter of year-over-year operating ratio improvement, and that gives us confidence that we're going to get to that sub-65% OR by 2020 or sooner. In terms of productivity, we've said that we expect at least $100 million this year. Right now we think that'll probably be closer to $150 million for the full year.

Great. And is there—have you set a scale for next year yet or is that still just part of this $650 million total?

Well, I can tell you this. We have the pedal to the metal. We are pushing as hard as we possibly can on all aspects of our strategic plan. And we certainly expect to achieve significant additional productivity savings next year and beyond.

And then just a quick one, I guess, Cindy. Long-term debt went up, rates are climbing, but interest expense went down sequentially. Was there anything in that number that altered that interest expense savings?

Ken, I would say that there was not really anything that would impact that. We did do a payoff of higher-rated debt in the quarter, so that did impact it.

But yet your long-term debt went up sequentially. I guess, I could talk to you offline. It just seems like your long-term debt went up sequentially.

Well, you're seeing older debt at a higher rate roll off and be replaced by new debt at a lower coupon, but...

...as part of the exchange, Ken, we exchanged about $550 million into $750 million worth of debt.

Okay. Thanks for clarifying. Appreciate it. Thanks for the time. Thanks for the insight.

Hey. Thanks. Morning, everyone. So wanted to just kind of revisit the head count and just more broadly the productivity discussion. So obviously nice spread between volume growth and head count this quarter, but we are seeing service issues when we just look at train speeds lower year-over-year. Do you think – are we kind of at the point where we can't cut head count and can't cut locomotives anymore, and it's more just about leverage from volume, or is that not the message? And then if we are sort of at that point where we're seeing some service issues, do you focus more on price than volume next year? I know you're going to say you're going to focus on both, but if you had to kind of prioritize price versus volume next year, how would you answer that?

Okay. Let's talk about service before, and I'll comment generally and then Cindy can go back over our expectations for head count this year. And then, Mike, maybe you can weigh in on kind of the resource balance. With respect to service generally, we are steadfast in our commitment to deliver quality service that our customers value. That's key to the value proposition. For the third quarter as a whole, we saw network performance rebound back to first quarter levels and roughly target composite service metric levels. And in that context, we were able to grow volume and the top line while providing a high-level service product to our customers. So that's the paradigm. That's what we will be looking to do going forward. Now, Mike, why don't you start and talk a little bit about the resource balance, and then Cindy will come back in and talk about where we expect head count to go?

Yeah. So, it's not like we don't have opportunities out there as we continue to look at the network and see what business grows on the network, where we can optimize the cost. We still have resources available to us from the locomotives. We have about almost 400 units stored and available that'll help us handle growth, but it doesn't mean we're not looking at finding ways to reduce the cost structure of the railroad long-term. A lot of initiatives are going on. We've already talked about the ones we've done this year that are rolled through. We're not giving up on any of that. But I'll say that we also make sure that we've got to have a good service product. And Jim noted it did improve sequentially over the quarter and you noted some increases in dwell and train speed. I would just point out that at the end of the third quarter, we had several hurricanes that hit our partners on the West and as well as two of them that impacted us. And we held some traffic in our terminals for that until our customers got back up to speed, or our partners got back up to speed. But really no damage to our railroad and we rebounded quickly. So that's kind of what you're seeing. So we feel comfortable about where we're going on further cost reductions while still making sure that we are taking care of the service.

Now with regard to head count specifically, Cindy did state that we expect head count to be flat to up slightly at the end of this year versus today. But there's a specific reason for that. So, Cindy, go over the training cycle and the onboarding process.

Sure. As I said, the flat to slightly up was really completely dependent upon hiring ahead of what we see peak demand season for crews in the summer and the fall of 2018. As you know, the cycle to hire and train and have those folks available takes several months to get that done. So that's really what's driving the head count. As I said before, 1,100 folks down quarter-over-quarter, that's really across the company in all areas. And productivity is extremely important to us, and we're going to be pushing on that, again, in all areas. And we look very closely at T&E, and you'll note that I think our volumes were up year-to-date about 5%, and we've really held the T&E head count pretty flat throughout the year. So it's something that we look very, very closely at.

Yeah. And that bump up is in the neighborhood of maybe 200 more employees for the next quarter or so until we get them ready to go out there. So it's slightly up, and it's by design.

Okay. And then, if I can just ask one more, Alan. So you talked about some of the weather issues in coal. Any way to give a preliminary view on export and then domestic coal for next year? Meaning, do you think the run rates that you talked about for fourth quarter are sustainable into '18, or do we need to reset those lower for '18?

For export coal, what we're hearing, Scott, is that that market has legs through – potentially through the first half of next year. A lot of the run up in price has been event-driven, which isn't necessarily good, but I think it also supports the theory that the market out there for export coal is fairly tight. Although I can paint the other picture. As you're aware, API 2 is backwardated right now. So that suggests it's going down. But the best I can do, Scott, is kind of tell you what we're hearing, which I just did, and then point you towards the economic metrics that we're looking at or indicators that we're looking at. With respect to utility coal, that's going to be highly dependent upon the weather. Natural gas prices are pretty similar to where they were at this time last year. Stockpiles are down slightly versus last year. I think they're down about where they were at like 79 days, they're off about 22 days from the high, which was May 2016. And really what happens in the first quarter and second quarter next year is going to be dependent upon weather patterns in the East in the winter. Does it make sense?

Okay. Yeah, now it does. Thank you, guys.

Thanks and good morning. Alan, I think you mentioned a little over half of your revenue for 2018 is negotiated at this point. Given that visibility, could you just talk high level about how the price increases for that business compared to the last pricing up-cycle that we saw? I'm just curious if you could provide some perspective on how the pricing environment next year could compare to the acceleration we saw in 2014 and '15?

Sure. So, Justin, the—as I think I noted, the contracts that we renegotiated in the third quarter generally had a higher level of increase than what we were able to secure in the second quarter. So that's a positive for us. I'll note that one of the things that really supported year-over-year rate increases this year within coal was the export market, and we certainly don't expect that level of run up next year. As trucking firms, we've got a lot of business that's transactional, and that is going to offer support for pricing.

Okay. But if you look at those non-coal businesses and where pricing is coming in for next year, I mean is that roughly in line with what you saw when things picked up in 2014 and 2015?

You know there was a lag there too because the uptick was relatively sharp, certainly a lot sharper than folks had anticipated generally in March 2014. We might be a little bit ahead of it this year in terms of the outlook because the commentary about the tightening truck market has been out there for a bit, particularly associated around ELD. So we're certainly factoring that into our conversations with our customers and our bid approach, and frankly our customers are having those same kind of conversations with their customers.

Okay, and maybe as a quick follow-up. On the last call you talked about roughly 50% to 60% of your revenue that's typically renegotiated each year. When you look at what's left, or I guess that other call it 50% or so or a little under 50% for next year, is there any color you can provide on the commodity breakdown of this revenue that's still left for renewal? I'm just curious if it's more weighted towards the specific business or commodity group?

Well, we've moved more towards shorter-term pricing in export so that has to be renegotiated. But once again that's less than 3% of our overall volume. With intermodal, there are defined escalators, but there's also transactional business and that has offered support for us. I note that even this quarter we had RPU growth in all seven of our major groups. Same thing we had in the second quarter. Second quarter, I would say, truck capacity was loose; third quarter truck capacity tightened and we were able to continue that March.

Hi, good morning. So, Alan, just wanted to see if you've thought through some of the contingencies that might need to be put in place if there was trade disruption with Mexico given all the rhetoric and headlines of NAFTA, so if you could give us a sense of how much volume and revenues for Norfolk are really tied to cross-border trade?

Good morning, Brian. Let me say that we are certainly pro-trade as a company and an industry, and in favor of trade regimes that promote cross-border flows. Alan, comment specifically on scenarios for us.

Hey, Brian, it is a very small component of our revenue. We have every intention of growing that and we're working on opportunities to put together products that would improve that. But, it's something that we're monitoring very closely where there have been four negotiations so far and there are three more that are scheduled.

Right. And to clarify small meaning like less than 5%, is there a threshold you would consider putting that below?

Yes.

Good morning. This is Suneel Manhas on for Walter Spracklin. Just wanted to circle back real quickly to CapEx, how should we be thinking of your CapEx here given the volume growth, specifically like at what point could there be a requirement for incremental CapEx to support the growth?

Well, we're working on our capital plan for 2018, even as we speak. We'll have more to say about that early next year. But I will say this, ours is a very disciplined approach to capital spending. We're looking to maximize returns on capital from our capital spending plan going forward. And that will include the usual categories of capital spending, both maintenance spending and growth spending.

And just a quick follow-up, on the savings and the expectation initiatives you noted, are there certain regions of your network or lanes where you see the most opportunity?

I'm sorry. I didn't understand the first part of the question. Could you repeat that?

So, yeah, sorry. So on the productivity savings you're expecting for Q4 and you mentioned expectations for further savings into 2018. Are there certain regions of your network or lanes where you see the most opportunity?

Productivity really is a network-wide opportunity. So we see opportunities to drive productivity throughout our network.

Thanks very much and good morning. I also wanted to dig in on the record train length a little bit. Can you talk about where you're making those gains and what I'm driving at there is – I assume that your coal network is close to optimal. So I'm curious if you're seeing improvement in merchandise or intermodal or both?

Yeah, the answer is both. Intermodal has been the biggest driver, but merchandise as well, and you're right, the coal unit trains have been optimized for a while. I will tell you on some of the other unit trains, stone and agriculture, we have increased those in coordination with our customers. So Intermodal is the big driver, but merchandise is also growing as well.

And just by way of a quick follow-up, you've been seeing some puts and takes in terms of the merchandise volumes, is that creating any challenges in terms of making improvements in the merchandise network?

Well, Alan, why don't you go back over the merchandise growth trend in the quarter and let's use that as the foundation for addressing her question about train sizes and operations and the merchandise network generally?

Yeah, Cherilyn. We started to see some fairly robust growth sequentially as we moved through the third quarter effectively up until the hurricane started to impact our customer base, and so it took a pause; and September has started to rebound in the fourth quarter, and we're seeing strength in steel, we're seeing strength in frac sand, seeing a little bit of crude oil although that will be a year-over-year decline, but it's picking up sequentially. Automotive will post better comps in the fourth quarter year-over-year than it did in the third quarter as U.S. vehicle production declines are year-over-year less. And Ag has kind of got off to a slow start in the quarter due to delayed harvest although within the last seven days we started to see that volume pick up as well. So much of the growth that Alan just went through in the merchandise arena has occurred within our scheduled train network and that's one reason why you're seeing the incrementals you're seeing. We're also seeing some growth in unit trains as well.

Thank you. That's some helpful color, particularly on the volume side. That's all from me.

Hey. My quick question for you on the topics of dwell and train velocity addressed earlier. Is it fair to assume that you're expecting improvements in both of those measures in 2018? Obviously, the hurricane disruptions aside just as volume growth decelerates from peak 2Q levels, one? And then two, if so, what is kind of a longer term target for both of those metrics? Can we view the 2012, 2013 levels as high watermarks and do you have visibility to returning to or perhaps exceeding those in both dwell and velocity?

Yeah. I think, those are both numbers that we feel very comfortable about not only achieving but also very comfortable about—gave us a really good service product that allowed our customers to grow on a railroad. So yeah, we do expect those to improve into 2018. Absolutely.

Okay. Thank you.

Hey. Good morning, guys. And thanks for taking the question. Alan, I want to ask you a little bit about the pricing opportunity in intermodal. If you go back the last 10-years, 15-years, the intermodal RPU for Norfolk hasn't really budged that much despite a 3% inflation in highway cost and a higher oil price and all that. Is there something about the market dynamic or the density you have in your network that's giving you a little bit better leverage to pricing in intermodal over the next 5-years to 10-years. Just wondering how those negotiations are going with shippers and what's giving you a chance to maybe take a little bit more price up relative to truck than you have in the past?

Well, David, what's occurred is that we're starting to see a much tighter truck environment and we've got some market approach that our customers value. We've got a service product with schedules that meet their needs. And so, our conversation with them is how do we grow together. And we firmly believe that negotiated rate increases reflect the value of your service product, and we're leaning in the price. We're not putting new dots on the map. We've got our capacity. We'll continue to invest in the big areas like Chicago and Atlanta, but our focus is on utilizing the existing capacity that we have to—and leaning in the price to drive shareholder return.

Are you passing up on a little bit more of the business that might be out there right now relative to maybe you were 5 years, 10 years ago?

Five years, 10 years ago, we implemented some Corridor strategies which have been very beneficial to us. For instance, the Heartland Corridor, we put in the – handled business between the Ohio Valley and Chicago, and Norfolk. And as volume moves to the East Coast ports, that's something that's going to support our growth. And we've got the capacity in place. Now it's our opportunity to leverage it.

Thank you. Thank you all for your questions. I'd also like to take this opportunity to thank all of our employees for their contributions to a record-breaking quarter. Our balanced and successful approach focused on increasing efficiency and delivering a strong customer service product gives us confidence in our ability to achieve our goals and deliver sustainable value. Thank you.