Norfolk Southern Corp (NSC) — Q4 2019 Earnings Call Transcript

Thank you, Rob, and good morning, everyone. Please note that during today's call, we may make certain forward-looking statements, which are subject to risks and uncertainties and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a full discussion of those risks and uncertainties we view as most important. Our presentation slides are available at norfolksouthern.com in the Investors Section along with our non-GAAP reconciliation. Additionally, a transcript and downloads will be posted after the call. It is now my pleasure to introduce Norfolk Southern's Chairman, President and CEO, Jim Squires.

Good morning, everyone, and welcome to Norfolk Southern's Fourth Quarter 2019 Earnings Call. Joining me today are Alan Shaw, Chief Marketing Officer; Mike Wheeler, Chief Operating Officer; and Mark George, Chief Financial Officer. 2019 was a remarkable year of transformation at Norfolk Southern. We launched our TOP21 operating plan to transform our railroad while fulfilling our commitment to dramatically improve our service product as we become more efficient. We've made tremendous strides on both of those fronts and delivered progress on our strategic plan. In the face of a challenging volume environment, we're pleased to share our results today that demonstrate this organization's strong momentum in streamlining our operations and making substantial progress toward our long-term commitments, thanks to the hard work and significant efforts by our workforce and leaders. Slide 4 highlights those results. For the quarter, EPS was $2.55, and the operating ratio was 64.2%. For the full year, income from operations reached record levels at nearly $4 billion, resulting in a record operating ratio of 64.7%, a 70 basis point improvement over 2018. Earnings per share increased 8% to $10.25. We've now achieved record operating ratio results for 4 consecutive years. This year's improvement is particularly impressive against the backdrop of contracting volumes. These records demonstrate our commitment to continuous improvement and underscore our steadfast dedication to creating shareholder value. Despite volumes deteriorating throughout the year, culminating in fourth quarter and full year volume declines of 9% and 5%, respectively, we remained focused on running our railroad as efficiently as possible and with a high level of customer service, achieving our locomotive and T&E workforce productivity goals despite having less freight to haul. These efforts contributed to the record full year results I mentioned a moment ago, and the core margin improvement accomplished during the fourth quarter, which Mark will discuss shortly, demonstrates the significant momentum we're carrying into 2020 and beyond. As we enter 2020, we continue to build on the strategic plan initiatives we launched in 2019. While rolling out Phase 3 of our PSR-based operating plan, TOP21, which will drive additional productivity across our resource base, all while maintaining the high-quality service product established in 2019. The team will provide additional details regarding these initiatives as well as further details on our fourth quarter and full year results. Alan will cover trends in revenue, Mike will cover operational performance, and Mark will go over the financial results. I'll now turn the call over to Alan.

Thank you, Jim, and good morning, everyone. Macroeconomic headwinds challenged volume in 2019, particularly in the second half of the year. With these tough conditions, we continued our focus on margin improvement, supported by the value that our outstanding service product creates in the market. On Slide 6, excess truck capacity, trade and economic uncertainty and manufacturing weakness negatively affected our markets, driving a 9% decline in volume. We partially mitigated the impact of declining volumes with stronger revenue per unit excluding fuel in all 3 of our business units, including quarterly records in our Merchandise and intermodal business groups. Norfolk Southern's revenue per unit has increased year-over-year for the last 12 quarters despite the market cycles over that period of time. The weak manufacturing environment and low commodity prices drove down Merchandise volumes in all groups, except chemicals, led by a 17% decline in steel. Import steel tariffs affected the traffic flows and lower steel prices reflected weak demand. Merchandise volume declines were partially offset by an increase in crude oil, which more than doubled its volume year-over-year. Intermodal revenue declined 8% due to excess truck capacity in a weak freight environment. International comparisons were difficult as the inventory pull forward drove a spike in fourth quarter 2018 volume. Coal volume and revenue were down 21% year-over-year, with the largest volume decline in utility coal. Our Northern utility portfolio was impacted by low gas prices and combined cycle capacity. Export was influenced by falling seaborne met prices and Chinese tariffs, while export thermal prices remained at low levels, making it difficult for U.S. coals to compete globally. Turning to Slide 7. In 2019, revenues decreased 1%, despite a 5% decline in total volume, evident from our margin improvement strategy; revenue declines were partially offset by a 3% increase in revenue per unit. Merchandise revenue reached a record $6.8 billion in 2019, while volume declined 3%. Volume headwinds occurred from weakness in the manufacturing economy, the loose truck market and declines in steel and natural gas liquids. We were favored by fuel price differentials that boosted crude oil demand to East Coast refineries, and we secured increased aggregate volume. Intermodal revenue decreased 2% on a 4% volume decline as gains in international were offset by domestic declines. Lower spot truck prices and excess capacity in the trucking industry reduced domestic intermodal demand in this weak freight environment. Turning to coal, revenue declined 8%. Utility volume declines were predominantly in the north, where low natural gas prices suppressed coal burn, while southern utilities benefited from inventory build in the first half of the year. Depressed seaborne coking coal and thermal prices led to lower export volumes and prices that were further impacted by production issues. While uncertain economic conditions negatively impacted revenue and volume in 2019, we maintained our focus on improving our service and creating a product that will enable our customers and Norfolk Southern to grow when the freight environment improves. This approach supports our strategy of margin improvement, which is reflected in our increasing revenue per unit, providing opportunities for operating leverage when demand improves. Moving to our outlook on Slide 8. We are closely monitoring developments in the macro economy and its impact on the industries and business segments in which we compete as well as our customers' expectations as we execute our strategy. GDP growth is expected to be in the 2% range in 2020 with the majority of that growth from personal consumption, creating opportunities in our consumer-driven intermodal and Merchandise markets. Continued weakness in manufacturing and low commodity prices will impact our coal franchise in other segments of our merchandise markets. Overall, we have not seen an inflection point in volume trends and a high degree of uncertainty exists. We see growth potential as we move into the second half of 2020 due to forecasted improvement in the trucking and industrial sectors and easier comparisons. U.S. light vehicle production is forecast to improve more than 5% in 2020. Improved price differentials are predicted to sustain fourth quarter 2019 crude volume levels through 2020. Overall, we expect total Merchandise revenue improvement enabled by our strategy with continued support from our consistent, reliable and quality service product. The truck market remains loose with spot rates leveling off, yet our customers and data providers forecast some tightening later in the year. Based on this information and new business initiatives, our intermodal revenue and volume are expected to grow in 2020. In coal, additional gas and renewable generation capacity continues to erode coal share of electricity generation. Coking and seaborne thermal coal indices are substantially below prior levels, impacting both export volume and pricing. In summary, as headwinds persist in the freight environment, we expect 2020 revenue to be flat with the first quarter similar to the fourth quarter of last year, and conditions improving as the year progresses. We remain focused on a disciplined pursuit of efficiency while recognizing the value our consistent, fast and reliable service product creates for our customers. In light of continued economic uncertainty and with our demonstrated willingness and ability to adjust to market conditions, this approach provides the platform from which we will further enhance value for both our customers and shareholders. I will now turn it over to Mike for an update on operations.

Thank you, Alan. Today, I will update you on the state of our operations. In the fourth quarter, we continued to deliver strong service for our customers and significant cost savings, which drove a record operating ratio for the year. This operational leverage is driven by our relentless execution of the core PSR principles and our TOP21 operating plan. Moving to Slide 10. Our network is running fast and on time. Record train performance and record terminal dwell drove near record car level velocity and strong asset utilization for Norfolk Southern and our customers. These achievements support our strategy to meet our customers' expectations while eliminating costs and prudently managing our assets. Our momentum has continued into 2020 and will be a tailwind to our initiatives this year. As seen on Slide 11, our operational performance is driving strong service levels as evidenced by our customer-facing metrics. Intermodal availability, which measures our customer commitment to the grounding of the box, shipment consistency, which measures trip plan adherence for merchandise traffic, and local operating plan adherence, which measures execution of the critical First Mile and Last Mile of service. All of these metrics were at or near record levels. We have been sharing our metrics with our customers for well over a decade, and we use them to have data-driven discussions to confirm the value of our service product. We remain committed to providing a high level of service for our customers while achieving our productivity goals. Turning to our service and productivity metrics on Slide 12. These metrics align with our strategic plan as they measure key productivity and customer service levels. We have been aggressively reducing our resources to meet our productivity goals despite the drop in our GTMs. Starting with the service delivery index, which is the on-time delivery performance of our scheduled shipments indexed to 2018. This is a customer-facing metric that combines shipment consistency and intermodal availability, which were detailed on the previous slide. We exceeded our 2019 goal and actually achieved our 2021 goal 2 years earlier. We will maintain this high level of service by continuing to execute our TOP21 plan. We exceeded our 2019 T&E productivity goal despite a significant drop in GTMs. We are at our lowest T&E headcount on record while still providing exceptional service. We are realizing the benefit of our TOP21 plan, which has the added benefit of capacity in the train plan to allow for growth on the existing trains. While we missed our 2019 train weight goal for the full year, we actually met the goal in the second half of the year with the implementation of our TOP21 plan. We have, however, taken another look at our 2021 train weight goal in light of the continued change in the coal market. We believe the new goal of 6,700 tons, which is 5% higher than our baseline, reflects the improved productivity of our TOP21 operating plan, while taking into account the projected mix. We also met our goal for locomotive productivity for the year by aggressively rationalizing our locomotive fleet, which is 20% lower than 2018. As mentioned in our previous call, this has allowed us to significantly rationalize the resources associated with the maintenance of these locomotives, including a reduction of 600 positions last year and an additional 135 positions this year. Regarding fuel, we will benefit from our lower locomotive fleet size, our aggressive implementation of energy management technology and our DC to AC conversions. The cars online continues to be a positive story for Norfolk Southern. As we noted throughout the year, we exceeded our original 2021 goal, thanks to our fast and consistent service product. To that end, we have established a new goal of 129,000 cars going forward, which includes cars in storage that can be deployed as market conditions warrant. In summary, we are confident we will meet our productivity goals for this year as we will now have the momentum of full year benefits of our previous rightsizing of our workforce and locomotive fleet. This will get us more than halfway to our 2021 productivity goals this year. As you can see on Slide 13, we accelerated our progress in reducing crew starts during the fourth quarter. We continued to build on the success of TOP21 with phase 2 of the plan, which included an initial consolidation of some bulk movements into the manifest network and dividends from our yearlong Clean Sheeting program. This improved fluidity is allowing for the continued reduction in yard and local assignments. This quarterly year-over-year improvement accelerated in the fourth quarter, with the majority of these improvements being long-term structural gains. As previously mentioned on the other slide, we have capacity in the new plan to accept additional volumes without a commensurate rise in crew starts. We anticipate continued strong year-over-year comparisons as we begin to roll out phase 3 of TOP21, completing delivery of the promised 3 phases of the program in 1.5 years instead of the anticipated 3 years. Going forward, our network planning and operations group will be evaluating the plan and the network for further optimizations. In closing, this has been a critical year for Norfolk Southern. We started the year by detailing our implementation of the core PSR principles. We have successfully executed on these principles despite a challenging market. Our service is at record levels. We achieved a record operating ratio, and our serious injury ratio was the lowest in the last 5 years. We are carrying this momentum into 2020. I will now turn it over to Mark, who will cover the financials.

Thank you, Mike, and good morning, everyone. Before we get into the detailed P&L, I want to point to a chart in the appendix that specifies for you some large and unusual items that impact the results and comparisons versus 2018. I'd like to talk to those impacts upfront on Slide 15 for the sake of clarity. This chart illustrates the effect of those items on the OR and EPS for the quarter as well as for the year. The reported changes to OR and EPS are reflected on the bottom row, and we distill those drivers in the white row above. The first item, as you may recall, relates to a property sale in the Atlanta area in the fourth quarter of 2018. That particular gain was $112 million and creates an OR headwind of 380 basis points in the fourth quarter of 2019 and 100 basis points for the full year, with a headwind to EPS of about $0.30. Next was the $32 million receivable write-off arising from a legal dispute that we called out in the third quarter. This reduced the 2019 OR by 30 basis points and EPS by $0.09. The final headwind involves the non-operating impairment that we booked in the second quarter related to the natural resource assets we have been actively marketing. In the fourth quarter, we took an additional $21 million impairment related to those same assets, and that had a $0.06 impact to EPS in the quarter. And when added to the second quarter impairment loss, the EPS impact for the full year was $0.14. You'll note we had a low effective tax rate in the quarter. This was driven by certain income tax credits authorized by Congress in December of 2019, which were retroactive to 2018. The impact to the fourth quarter EPS was $0.07, and for the full year, it was $0.04. Beyond these unusual items, the core improvement in the OR was 240 basis points for the quarter and 200 basis points for the full year, while core improvement to EPS was $0.28 for the quarter and $1.23 for the year. Now moving to the fourth quarter, Slide 16. Revenue was down 7% in the quarter, driven by a 9% volume contraction, partially offset by RPU improvement. Operating expenses, as reported, were 5% lower, including 5 points of headwind from the absence of the prior year land sale. Drilling into the expense categories on Slide 17. As Mike illustrated earlier, our TOP21 PSR-based operating plan has reduced the amount of resources we need to run the network, resulting in fewer trains and lower crew starts manifesting in substantial cost savings across multiple expense categories. Starting with compensation and benefits. We drove a $127 million reduction in expenses in the fourth quarter. That's a decline of 17% on a 16% reduction in employees. Our employment levels declined throughout the quarter, and this, along with lower overtime, health and welfare benefits as well as fewer recrews, saved us $86 million. This favorability was partially offset by $17 million of additional expense due to inflation in pay rates. In the quarter, incentive compensation expense was lower by $57 million, due largely to last year's higher payout that disproportionately impacted the fourth quarter of 2018. So we drove average headcount down by approximately 1,500 employees from last quarter and have reduced by 4,200 compared to the last year. Run rate benefits from this will continue into 2020 on top of additional efficiency actions. Moving to fuel. Reduced consumption and lower prices drove a $52 million decline in fuel expense. We improved on our fuel efficiency as fuel consumption declined by 11% on the 9% decrease in volumes, despite adverse mix from weaker coal where our fuel efficiency is strongest. Here in 2020, fuel efficiency is getting intense attention through various initiatives, including continued locomotive upgrades and deeper energy management penetration as Mike mentioned. Moving over to purchase services, rents and materials. Our initiatives to improve asset utilization are also driving a reduction in expenses. The increased network velocity, improved fluidity, and fewer locomotives and freight cars on the network drove $15 million in savings associated with equipment rents and $12 million in savings of material cost. These expenses were partially offset by increased detouring costs due to a bridge washout and derailment expenses that amounted to $13 million collectively. The fast response and strong execution by our operations team limited the financial impact of the derailment to only half of the $25 million we signaled at the last earnings call. So when looking at the big picture, the underlying change to our cost structure accelerated in the fourth quarter as we continue to drive resource reductions through the end of the year. The full year effect of those savings will be realized in 2020. Moving to Slide 18. Let's take a look at our summarized fourth quarter financial results. Other income included $31 million of favorability from investment returns on our corporate-owned life insurance, where we had positive returns in Q4 2019 versus losses in Q4 of 2018. We also had $50 million of higher gains on the sale of non-operating properties than prior year. These amounts were partially offset by the additional $21 million asset impairment loss that I mentioned earlier. The lower effective tax rate, 19.6%, was driven by both the retroactive tax credits as well as higher non-taxable returns on the corporate-owned life insurance. Income taxes will represent some headwind in 2020 as we expect the tax rate to be between 23% and 24%. Shifting to the full year on Slide 19. We delivered impressive results for the year in the face of accelerating declines in revenue and the net headwind items we discussed on Slide 15. We reduced railway operating expenses by $192 million. We set company records for operating income and operating ratio. Our railway operating ratio improved 70 basis points over 2018. Net income improved by 2%, but diluted earnings per share grew 8% to $10.25 for the full year aided by a 5% reduction in our average share count. Achieving the cost reductions while pushing delivery performance for our customers to record levels demonstrates our commitment to long-term value creation. Recapping on Slide 20, our full year cash flows from operating activities was $3.9 billion, and free cash flow for the year was a record at nearly $1.9 billion. Dividends and share repurchases for the year totaled over $3 billion. So to close, we clearly have created momentum on the cost side, despite the volume challenges and obstacles that were unforeseen at the beginning of the year. It's that momentum, plus new initiatives, which provides us with strong leverage going into 2020 to continue to drive profit growth and margin expansion. Thank you, and I'll turn the call back over to Jim.

Thank you, Mark. As you've heard on the call today, the Norfolk Southern team made tremendous strides in executing the strategic plan we laid out a year ago. Amid a rapidly changing macroeconomic landscape, we pivoted our productivity initiatives and achieved a locomotive fleet reduction of 20% and a workforce reduction of 8% for the full year average, with those figures accelerating to 22% and 16%, respectively, in the fourth quarter. These resource adjustments significantly outpaced the volume declines, demonstrating strong cost momentum while maintaining exceptionally strong customer service levels. Turning to Slide 22, I'll wrap up with our 2020 expectations. First and foremost, we will continue to execute our strategic plan with the top priority of running the most efficient railroad possible while being a best-in-class supply chain partner for our customers. As you heard, we are modeling net overall revenue to be flat for the year, with persistent headwinds in coal to be offset by improving comparisons in Merchandise and intermodal as the year progresses. Despite this, within that environment, we have confidence that our productivity and efficiency formula will result in significant operating ratio improvement this year that will get us more than halfway to our committed 60% OR in 2021. Lastly, as we continue to execute our highly effective locomotive fleet modernization program, we're targeting a capital expenditures program between 16% and 18% of revenues. We remain committed to returning capital to shareholders through a one-third dividend payout ratio, with remaining cash and borrowing capacity used for share repurchases. This disciplined capital allocation strategy represents our commitment to enhanced shareholder value through returning capital and ensuring Norfolk Southern is positioned for continued success. Before we turn it over to questions, I want to thank each and every NS employee for their hard work and commitment to the strategic transformation of our railroad. Thank you for your attention. We'll now open the line for Q&A.

Mark, you've been in the CFO seat for about three months now and have had some time to get the lay of the land. Could you just take a step back and kind of give us versus your expectations coming in? Kind of what's as expected, maybe what has surprised you? And are there any changes that we should expect to see as investors with you leading the finance organization versus how assets handled things historically?

Thanks for the question. Yes, coming in from the outside, a different industry, a culture that clearly is different than the one I've come from, I would say that I'm surprised that we see a great blend here of long-tenured industry experts, who are very passionate about not just the business, but the industry itself, and the infusion of new talent that come from different walks of life and different industry experiences and that they're actually being welcomed with their new ideas, including my own, frankly, coming from the outside. So that's been a pleasant surprise, I would say. I was not expecting such a welcoming with regard to the new ideas and new concepts being brought in. I'm also kind of impressed by the speed and agility of an old company, so to speak, to react to a very rapidly changing economic environment. You see the charts that Mike showed on how quickly we've taken resources out to respond to volume declines. And then nimbleness, I would say, has surprised me. And coming in, another big observation is just how capital-intensive this business is compared to where I've come from. We, obviously, spend a couple billion dollars a year in CapEx. We've got over $30 billion of fixed assets. And so it's certainly an area that I need to drill into a little bit more on understanding why we spend so much, certainly, half of that is related to maintaining this big infrastructure to serve your customers and to do it safely. But I do want to understand the rationale for the spends that we have. The justification financially for them and the prioritization process. So it's something that I expect to dig into a little bit.

So Mark, I'm hoping you can provide more clarity on some of the numbers here. Can you tell us what the real estate gains above the line were in the fourth quarter? Also, what are the expectations for this year in terms of what is assumed in the guidance? Additionally, regarding incentive compensation, I know it was down in 2019 compared to 2018. Is there a way to determine whether 2020 will be a year of headwinds, tailwinds, or a normal performance? Any insights would be appreciated.

Sorry. The second question, Scott.

Was just on incentive comp, should we think about that as a headwind in '20? Or is it '20 versus '19, sort of just a normal year on incentive comp?

No. We would anticipate that incentive compensation will be a challenge because we are aiming for a better year in 2020 compared to this year, where we fell slightly short. This will certainly be a small hurdle for us. Concerning real estate, excluding the significant transaction we discussed, the gains this year were slightly higher than last year, by less than $20 million. In the fourth quarter, we saw about half of that benefit, translating to around $10 million more in gains in 2019 compared to the fourth quarter of 2018, again excluding the significant transaction. Regarding guidance on real estate, we expect annual gains between $40 million to $60 million. There will be fluctuations, and it may be weighted towards the end of the year. The timing of real estate closings can be unpredictable, so it’s hard to determine when things will finalize. We finished last year, excluding the major gain, within that anticipated range, and the same applies this year as we also concluded within that range.

That's helpful. Could you provide your thoughts on our revenue guidance being flat, considering our volumes are down while yields are up? It seems like you might be losing some share in terms of volume, but you're performing well on the yield front. Are you comfortable with the strategy of prioritizing higher yields at the expense of volume compared to your competitors? Do you believe you've taken this approach too far, or how are you navigating the market?

Jim here. I'll address the market share question, and then I'll let Alan elaborate on our revenue guidance for this year. We are focusing on the truck market, which represents a significant opportunity for growth. Our strategy hinges on transferring truck traffic onto the railroad. There are opportunities for growth in our intermodal sector and within the Merchandise segment as well. We're dedicated to providing value for our services, which are quite strong at the moment. We have an excellent service offering in the market, and we believe we can deliver value to our customers through this. Alan, could you provide more details on the revenue outlook for 2020?

Yes. Scott, coal is going to be a drag throughout the year. And it's going to be a drag both in volume and in price. We've got a great service product out there. And we're taking a long-term view of our markets. We take a long-term view of our approach with our customers as well, and so we're very disciplined in securing the value and understanding the value that our service product creates for our customers. As Jim noted, our eyes are on that $800 billion truck market. And that's where the growth opportunities are. And that's where we're going to see improvement as the year progresses. It requires fierce competition and putting new products out there, new logistics services that our customers value. And we're doing it from a platform in which I'll remind you, we went out in front of our customers, and we told them what we were going to do with our operating changes with PSR. And then we did it. And there we've created a lot of credibility with our customers for our no-surprises approach to our operating plant changes. We implemented it flawlessly. And what's unique about Norfolk Southern is that as we implemented PSR, our service got better. And so we're in a great position to grow as we move forward. And if you think about the truck and the opportunities there, it aligns perfectly with the unique strengths of our franchise. We have a powerful intermodal franchise. And we have a very broad and diverse Merchandise franchise as well, and we're focused on opportunities to take business from truck and merchandise as well.

It's Allison. Just a question, I just want to circle back to the cars online commentary. If I heard you correctly, I think you said that, that number included a level of storage so that there is some flex on flying or expected to up group. Can you just go through that again, sorry?

Yes, that's correct, Allison. That's how we arrive at that figure. We calculate it this way to focus on the overall velocity of our car fleet, including those in storage. This is an asset that remains on our books, and we want to ensure it is considered when we evaluate the utilization of our freight car assets.

Yes. This is Mike. Of that 129,000, we have 17,000 cars in storage that is available to us to flex up when the business arrives, and we're pretty excited about that.

Great. And then just, obviously, you're well into your strategic plan. Looking back over the past few months, what's been your greatest surprise in terms of your ability to perform in this environment?

I think Mark did a good job describing the progress that we have made, the core operating and core earnings improvement that we made in the fourth quarter. So the momentum stands out for all of us, I think, and that's not a surprise, and that we've been driving it. We've been focused on accelerating the improvements as we move throughout the year, and we did it in the fourth quarter, and that will carry over into 2020 and beyond.

Jim, could you elaborate on the 235 basis points year-over-year target? Does that take into account the challenges from the incentive compensation related to the $40 million to $60 million real estate gains? Also, what are your thoughts on the future of the employee base? Is this the level we can expect moving forward, or do you anticipate further productivity increases from employees?

Mark?

Yes. Ken, look, I think in terms of headcount, we've taken a lot out this year. There's actually more to come. So not only will we enjoy the benefit of the full year effect of those employees that came out in the back half of this year, but there are more to come in the beginning part of this year. And then frankly, we just have to see how volume shakes out and determine how much further we can go and absorb the volume that we're assuming to get returned in the back half of the year. Sorry, the first half of your question, Ken?

Was just to ensure that the 235 basis points improvement, which is great, but does it include the headwind of incentive comp...

It does.

And the real estate gains that you mentioned. That's all baked in, right?

It's all baked in, Ken. So the incentive comp returning to normal and the real estate gains being in that $40 million to $60 million in range. It's all part of the calculus.

It's a big number. And then I guess my follow-up for Mike. Just note, it looked like you had no targeted improvement in the service delivery index. Are you changing it to tighten your range? Or why would there not be given all the moves you're making in, I guess, a target for improvement there?

So overall, we're pretty happy with our customer service levels, and our customers are as well. I will say we are targeting tightening some of our windows for delivery to customer and be better on the consistency part. So that's a part of it, but it doesn't roll up necessarily into changes at the macro level. But yes, we're pleased with our service but we're going to continue to dial it in, get better and better in the trucks.

If I could add something, we work closely with our customers on our service targets. For years, we have been sharing these targets and our performance with them. In 2019, we raised the stakes by presenting our customers with upcoming changes due to PSR implementation and outlined how their service would improve. We followed through on that promise. As our PSR implementation progresses, we are continually making enhancements and offering products that enhance our competitiveness against trucks. As the truck market tightens throughout the year, this will be a growth driver for us. We have strong confidence in the product quality we are providing, and we are pricing accordingly.

I wanted to see if you could offer some thoughts on 2 of the segments where you have not seen improvement yet. So I'm thinking your purchased services, would you expect that line to improve in 2020 or 2021 as a result of phase 3 and TOP21 or the terminal improvement program, how do we think about that line? And also maybe a little more on fuel efficiency.

Mark?

Yes. I'll take that, Tom. So look, purchased services. Clearly, there is intermodal terminal operating costs that are in there. I wouldn't call them strictly volume-variable. There is an element of fixed cost in there as well or committed cost in there. But bear in mind that in our purchase services category, we've also got other things that are not volume-variable. For example, a lot of the maintenance cost for the network that you don't capitalize flows through this line. So when you have repairs to rails and you have to maintain the trees and ensure that the lines are clear. A lot of the costs for maintenance of the infrastructure cannot be capitalized. It goes into this category. Building leases and rental costs are in there. And then the other piece that you have to bear in mind, Tom, is there's a fair amount of technology cost that flows through there, similar to what I described with maintenance. There is a lot of the IT spend that can't be capitalized, runs through this line category. And frankly, it's a growing category. The good news, however, is a lot of those investments we're making in technology are delivering returns in the P&L, as you saw through the call today. So we're investing in things like automation. It allows us to leave ourselves of some headcount-related to more transactional tasks. And we expect to continue to invest in this technology element as well. So that's, in large part, why purchased services is not moving as quick as we like. All of that said, I've got to dig in there a little bit, and we've talked about it quite a bit. We've got to look at this bucket for opportunities in 2020. It is an area where I think it's right for us to dig into a little bit more. Your second question on fuel. We made progress in Q4 with some levels of efficiency, and we're really relying on a step-change improvement going into 2020 in fuel. The team has organized well. We continue the upgrades from DC to AC. That provides a lot of benefits to us in many ways, including fuel, but on top of that, we're having deeper energy management penetration. And so it's clearly an area in 2020 that we hope to see significant progress on.

Could I get a brief follow-up? Jim, I think there may be an increase in discussion in December regarding the volume sensitivity of the $60 million operational target for 2021. Your guidance for 2020 suggests that there isn't much concern about volume. How should we approach the volume sensitivity related to reaching $60 million? Will you need to enhance volume growth in 2021? How should we generally consider this?

Well, let me say first, this is a cost-structure, cost-reduction based plan, particularly in 2020, where we forecast flat revenue. So it's always all about achieving the efficiencies that we've tried to lay out for you that we have achieved already in 2019 and then rolling into this year and next. As far as 2021 is concerned, maybe get a little bit of a tailwind from some growth at that point. But we're not factoring in a lot. It remains fundamentally in an efficiency-oriented financial plan even as we move into 2021.

I wanted to discuss the coal outlook, particularly regarding exports. Alan, could you provide some clarity on how we should approach this? There seem to be two main impacts to consider: one on the volume side and another on the yield side. Specifically, regarding yield, should we anticipate a decrease in the first quarter as some contracts are adjusted based on commodity prices? Additionally, how should we approach the volume aspect? I'm trying to estimate the coal challenges we may face in 2020.

Sure, Chris, let's take a look back at 2019, particularly the first and second quarters. During that time, net coal prices were above $205 per metric ton, but then they dropped to about $160 in the third quarter and closer to $140 or $145 in the fourth quarter. We've frequently mentioned the sequential declines in both volume and price for our met coal export business, which represents about two-thirds of our exports and roughly 25% of our overall coal volume. Currently, coal prices are in the low $150s, which is putting considerable pressure on prices. Remember that our revenue per unit for export met coal was highest in the first quarter of last year when prices peaked, so comparatives are more challenging early in the year. There's limited demand in Europe, leading to increased coal supply from other global sources, intensifying competition for us. Additionally, developments in the thermal coal sector will impact export thermal volumes. Therefore, we anticipate volume pressures in both met and thermal exports, along with notable price pressures on net exports.

Okay. And the yield pressure is toughest in the first part of the year 2020?

Relative to last year, yes.

Got it. Okay. All right. No, that's helpful. And then, Jim, maybe a bigger picture question, coming back to the last one about OR in 2021 and some of your thoughts there. So some significant improvement this year and expectations for 2020. When we think about maybe some of those tailwinds that you could get from revenue growth, potentially returning in 2021. And given the progress you've made so far, how do you think about sort of the potential of the business? So I think a lot of us spend time focusing on your performance relative to peers. Is that the right way we should be thinking about it? So some of the numbers that we're seeing from some of the other rails out there. Are those the types of potential ORs we can expect from Norfolk over time? Just want to get a sense of how you're feeling about it kind of partway through this PSR initiative.

Should we see upside in the top line, we would expect much of it to flow through operating income and to the bottom line because there will be significant operating leverage in that growth. That's not our base case as we've been through, but the growth will return and resume at some point. We think we get a lot of operating leverage because we have restructured our costs and believe that we can handle volume growth with the resources on hand. Now there will be areas where we have to increase spending to handle the volume growth depending on how much it is. But by and large, we believe we can handle the volume when it returns with our existing resources.

I guess, Jim, maybe following off that line of questions. As we look at phase 3 of the TOP21 plan, is that going to drive pretty significant operational changes here, and that's why you guys have the confidence on the cost outlook and the OR improvement in 2020?

That will contribute to it and for all the reasons that the last major iteration of TOP21 drove efficiencies. Yes, that's a part of this. In the next iteration of TOP21, we will continue focusing on train consolidations, reducing circuity, and operating longer, heavier trains to meet the goals we set. This aligns with the goals we pursued in previous versions of the plan. Going forward, this becomes a process of continuous improvement, and in a way, we are already there. We are evaluating shorter trains every day and developing a plan in consultation with our customers in the field to integrate those trains into the network and achieve ongoing efficiencies.

Okay. I appreciate that response. And not to get too specific on this call. But Mark, can you talk to the other expense line item? Because I think if we look at it, the last few quarters, it was running around a $60 million run rate. Is that the right level to think in 2020?

Other expense?

Yes.

Hang on. Yes, that's about the right level to be thinking about it, Brandon.

I want to go back to international intermodal. Clearly, there were some headwind pull-forward in 4Q. But if I recall that actually pushed into 1Q a little bit. When should we see the inflection point of those volumes turning up? And does the uncertainty of the coronavirus actually impact you guys at all? Or is that too early to tell yet.

Alan?

Jason, you're absolutely correct. We did see elevated international intermodal volumes in the first couple of months of 2019. And so as the year progresses, comps will get a little bit easier for us. And then that's where we're expecting to start seeing growth. With respect to the coronavirus, it doesn't help. There's no doubt about that. We've talked to our customers about that and the level of impact that they're anticipating is unknown at this point. It's all speculation. So we're paying close attention to it as are the steamship lines that we serve.

Okay. And my follow up is going to be on the domestic side of things. A couple of railroads, let's call it, the last 1.5 years, pulled back a little bit on some of the lanes that they serve with PSR. Do you think that there is a need for more lanes going forward once the market does tighten up in the U.S. truckload? Or do you think the lanes that the industry currently has are good enough to service and get that freight back from the highways onto the railroads?

Well, Jason, I think there's both. I think we're going to see, as the truck market tightens, we're going to see the benefits of our powerful intermodal franchise and organic growth in the lanes that we serve. And then as I noted, we're working feverishly with our interline partners and with our customers to look at new lanes that offer value to our customers and offer value to our shareholders. So this is not static. It's a dynamic review of our overall franchise, finding areas where we can provide value, and we can support our channel partner's growth. And as I noted, we're aligned with the best channel partners in the industry. So I'm pretty confident that collaborating together, we're going to find avenues for growth.

I wanted to ask a little bit about where we should be expecting headcount to come in, in 2020? Ended the year down pretty considerably. And should we be expecting that kind of run rate level? Or should we be expecting further reductions from that from where we ended the year on headcount.

Mark?

We're not going to provide a specific headcount number. We are reducing our counts again compared to where we ended 2019. However, we will keep evaluating the situation and monitoring volume trends. As mentioned, we anticipate that volume will begin to shift for us in the latter half of the year. If that doesn't happen, we will continue to adjust our employment levels. But at this time, we do not have a specific figure to share with you.

Nothing in the budget that you could give us a sense for how much additional sort of headcount reduction there should be in the year?

No, I mean we clearly have a budget, but it is not going to be something that we talk about because we will flex, just like this year, depending on where volume is, we may go heavier.

So you certainly saw, David, in the fourth quarter when we had to flex we do, and we did. And we pick up the pace throughout the second half, particularly in the fourth quarter. So we will do what's necessary.

Okay. And then, I guess, maybe just kind of sequentially, Mark, the other expense line came in at $11 million for the fourth quarter from $95 million in 3Q, 60s in 1 and 2Q. Is there anything that explains that sort of sequential step down in the other expense line for 4Q?

Yes, it's a little bit of the land sale, is the gains that we had that were back-end loaded from the property sales that we talked about. So we had more land sales that came through in the fourth quarter compared to the prior 3.

I have a quick question. There's been a lot of discussion about domestic intermodal. Could you share details about the international aspect? What percentage of your intermodal business is international in terms of volume or revenue? How do you view this as we move towards 2020, considering the ongoing concerns about tariffs? I'm also interested in how the international segment performed in 2019, just for context as we look ahead.

Jordan, our International Intermodal franchise makes up about 35% of our overall intermodal business in terms of volume. As I mentioned earlier, we are facing some challenging comparisons to start the year due to the increase in activity in the fourth quarter of 2018 that carried into the first quarter of 2019. We anticipate that the comparisons will improve as the year continues. However, similar to other markets, we do not expect to see growth until the second half of the year.

Thank you, everyone. We appreciate your questions this morning and look forward to talking with you again when we announce our first quarter 2020 earnings.