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Norfolk Southern Corp  (NYSE:NSC)
Q3 2018 Earnings Conference Call
Oct. 24, 2018, 8:45 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Norfolk Southern Third Quarter 2018 Earnings Call. At this time, all participants will be in a listen-only one. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to Clay Moore, Director of Investor Relations. Please go ahead, Clay.

Clay Moore -- Director, Investor Relations

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 risks and uncertainties, and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a full discussion of those risks and uncertainties we view as most important.

The slides of the presenters are available on our website at norfolksouthern.com in the Investors section along with our non-GAAP reconciliation. Additionally, a transcript and downloads will be posted after the call.

Now it is my pleasure to introduce Norfolk Southern's Chairman, President and CEO, Jim Squires.

James Squires -- Chairman, President, Chief Executive Officer

Good morning, everyone, and welcome to Norfolk Southern's Third Quarter 2018 Earnings Call. Joining me today are Alan Shaw, Chief Marketing Officer; Mike Wheeler, Chief Operating Officer; and Cindy Earhart, Chief Financial Officer.

Starting with our financial highlights on slide four. We delivered another quarter of record financial results. Income from operations was over $1 billion, an increase of 14%. Net income was $702 million, up 39% over the prior year; and earnings per share was $2.52, a 44% increase.The operating ratio of 65.4% is a third quarter record for our company and marks the 11th consecutive quarter of year-over-year operating ratio improvement.

As 2018 draws to a close, we are poised to achieve another year of solid OR improvement and strong bottom line results. Given the progress we've made in the last three years and the likelihood we will meet our current financial goals well ahead of schedule, we are moving forward on the next round of initiatives to drive shareholder value. We look forward to briefing you on these new initiatives and the associated financial targets at our upcoming Investor Day on February 11 in Atlanta, Georgia. Please save the date.

Now, to provide further insight into our third quarter results: Alan will cover trends in revenue, Mike will give you additional color on the state of operations, and Cindy will detail our financial results.

I'll now turn the call over to Alan.

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Thank you, Jim, and good morning, everyone.

Starting on slide six. The success of our market approach is clearly demonstrated by sustained growth in revenue, revenue per unit and volume. This quarter marks the seventh consecutive quarter of year-over-year revenue gains with seven quarters of strengthening RPU and eight quarters of volume improvement. For five consecutive quarters, we achieved steady year-over-year increases in RPU less fuel, which is hugely important to operating income We have succeeded despite the negative mix impact of continued strong volume growth in intermodal with balanced and consistent RPU increases in all three of our business units. The increase in intermodal RPU coupled with productivity improvements consistently enhances intermodal profitability, all going well for the future, given that intermodal remains one of the fast-growing segments of the freight market.

The strength of our multi-faceted plan generated revenue, RPU and volume growth across most markets in our intermodal and merchandise business units. Our balanced focus on margin, price and volume continues to produce revenue growth benefiting our top line as well as operating income.

Slide seven highlights the results of our plan that generated 10% revenue growth in the third quarter. This gain was a product of sustained volume improvements, higher pricing and increased fuel surcharge revenue.

In merchandise, we achieved record revenue, RPU and RPU excluding fuel in the third quarter. Volume growth was led by gains in ethanol and crude oil. RPU grew year-over-year for the 10th consecutive quarter, highlighting our emphasis on pricing.

For the fourth consecutive quarter, intermodal achieved record revenue with two consecutive quarters of 20% year-over-year growth. This increase was generated by records in volume and RPU less fuel. The strong economic environment coupled with a tight truck market continues to drive demand for Norfolk Southern's intermodal franchise resulting in significant growth. Pricing gains led to substantial improvement and RPU less fuel and RPU during the quarter.

Coal revenue was up 3% in the third quarter with positive pricing and export volume growth that was partially offset by declines in our utility market. Our strategy delivered strong results in the third quarter with revenue and RPU increases in every business group, underscoring our commitment to competitive pricing as well as our ability to capitalize on market conditions. The continued strength and improvement in our top line metrics illustrates the confidence customers have in our approach.

Moving to slide eight. Our outlook for the fourth quarter remains positive. We expect revenue and volume to improve with continued strength in consumer demand and the industrial economy, leading to growth in intermodal and manufacturing markets including automotive and plastics. The favorable differential on oil prices is expected to increase volume in our crude franchise. Coal volumes are projected to be up year-over-year in the fourth quarter, driven by growth in both the utility and export markets. Similar to the third quarter, we anticipate fourth quarter utility volumes to be in the $15 million to $17 million ton range. Export volumes are expected to remain in the $6 million to $8 million ton range.

Pricing to the value of our products remains a key element of our strategy, and we expect that strategy to deliver year-over-year improvement and RPU in the four quarter. Our balanced strategy and franchise have positioned us for growth allowing us to expand with both our existing customers and new customers, maintain a sharp focus on productivity and capacity, and deliver results for our customers and shareholders.

We are integrated in our customer supply chains and consistently work to understand their markets, partnering for their success and enable a long-term value for NS shareholders. This sustained and balanced approach to both revenue and income growth is delivering results and we look forward to a strong finish in 2018.

With that, I'll turn it over to Mike for an update on our operations.

Michael Wheeler -- Executive Vice President, Chief Operating Officer

Thank you, Alan. We are pleased, the velocity of our railroad continues to improve while handling record volume for our third quarter as well as achieving a record third quarter operating ratio for the company.

Moving to slide 10. Our portable injury ratio for the quarter improved year-over-year and sequentially. The safety of our employees and the communities we serve continues to be our top priority and where we focus a lot of attention. Our service levels are improving as evidenced by our service composite, Speed and Dwell all improving sequentially. Additionally, our network velocity as measured at the car level is currently near our highest levels for this year. All four measures are currently pacing at or ahead of our third quarter performance.

Turning to slide 11. In addition to improving service for our customers, we are also driving improvement in our efficiency. A record third quarter train length help drive an all-time record crew productivity for Norfolk Southern. Specifically, we handled 5% more volume with just a 2% increase in crew starts. We also achieved an all-time quarterly record for fuel efficiency. All of these factors combined to help us achieve our record third quarter operating ratio as well as an all-time record OR for the first nine months of the year.

Turning to slide 12. To drive further improvements in the velocity of our operation, we are undertaking the development of a new operating plan. The first step is to streamline the railroad, which will allow us to move assets faster and create capacity for our customers to grow. This process, something we refer to as Clean Sheeting starts in the terminals and local serving yards where cars tend to accumulate as they navigate the first or last mile of their trip. The goal is to increase fluidity by reducing car inventories, accomplished in part by increasing service frequency for customers. We also work cooperatively with the customers to create efficiencies in service. We are encouraged by the results we have seen so far as Clean Sheeting underpins our new operating plan going forward.

As seen on slide 13, our new operating plan will be built on key principles. As mentioned, it starts with Clean Sheeting, which will drive car level velocity higher and lower cars online. This will allow us to build more blocks of traffic in the local serving yards that can be picked up by a through train, bypassing the major classification yards.

We will also work with our customers and short line partners on additional blocking opportunities. The blocks will be integrated into the system using different train types and drive further velocity improvements in efficiency. Lastly, we are continuing to evaluate our Assessorial program to ensure high asset utilization and capacity for growth.

We will provide more details on these operating plans at our upcoming Investor Day in February, including our expectations as to the value we are creating through the new operating plan.

I will now turn it over to Cindy, who will cover the financials.

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

Thank you, Mike and good morning. As Jim said earlier, we've delivered another quarter of record financial results. Let's take a look at the details, starting on slide 15.

As Alan discussed, we had strong revenue growth of 10%, which when combined with the smaller increase in expenses resulted in the second consecutive quarter of income from railway operations of over $1 billion, 14% higher than last year. We also achieved a record third quarter operating ratio of 65.4%, improving our last year's results by 110 basis points. Just as a reminder, 2017 results have been recast to reflect the required reporting reclassification of certain pension and post-retirement costs.

Slide 16 illustrates the component changes to operating expenses. In total, operating expenses increased by $152 million or 9%, primarily driven by higher fuel prices and volume-related costs. Fuel rose by $76 million primarily due to higher prices which added $65 million. Consumption was up 4% over the prior year relative to the 5% increase in shipments. Purchase services and rents increased $73 million or 19%, about half of the increase was attributable to higher expenses for purchase services including volume-related increases, additional transportation and engineering activities, as well as higher technology costs. Higher equipment rents expense reflected slower network velocity, the cost of additional short-term locomotive resources, as well as the growth in traffic volume. We expect about half of these additional equipment rent costs to come out in the fourth quarter. The materials and other category increased $38 million or 23%.

Last year's gains on the sale of property were approximately $36 million more than the current year. We have also incurred increases in derailment related expenses and additional costs associated with the ongoing relocation of our dispatchers to Atlanta. This year also includes higher locomotive material usage cost due to more locomotives in service. These amounts were partially offset by $20 million of rental income associated with operating property, which you will recall is now included in this expense category.

Finally, compensation and benefits decreased by $46 million or 6%. Incentive compensation was $45 million lower than in the third quarter of 2017 based on the timing of accruals which were a headwind in the third quarter last year. Reduced headcount levels saved $10 million over the same quarter last year. Headcount was approximately 320 positions fewer than in the third quarter of 2017, and down about 100 sequentially.

Consistent with the first two quarters, lower health and welfare rates also resulted in savings of approximately $8 million versus last year. Overtime and recrews added $15 million of cost.

By moving to slide 17, you can see a summarized look at our record third quarter results. Income before income taxes increased 14% and we achieved record third quarter net income of $702 million, up 39% from last year. Diluted earnings per share was also a third quarter record of $2.52, a 44% improvement year-over-year.

Wrapping up our financial overview on slide 18. Free cash flow for the first nine months was a record $1.6 billion and over $2.9 billion has been returned to shareholders, via a 19% increase in dividends as well as share repurchases through both the previously announced accelerated share repurchase program and our ongoing open market purchase program. Our share repurchase programs underscore our confidence in the business as we continue to drive growth and create shareholder value.

I'll conclude my remarks by saying that third-quarter financial results demonstrate our continued commitment to deliver on our strategic plan objectives and to drive ongoing improvements.

Thank you for your attention, and I turn the call back to Jim.

James Squires -- Chairman, President, Chief Executive Officer

Thank you, Cindy. Guided by the strategic plan we announced in late 2015, thanks to the hard work of our management team and employees, we have consistently achieve the results we promised shareholders. This year, we are on track for another year of OR improvement and strong bottom line growth, and we are confident, we will make further progress next year and beyond.

In the last few months, we have begun overhauling our railroad from top to bottom, leaving no stone unturned in the quest for efficiency, growth and shareholder value. As we revamp how we operate, we will listen to our customers and find new ways of meeting their needs. We will use our knowledge of our company to innovate from within. We will bring an outsiders where they have experienced or skills we lack. We will collaborate with our supply chain partners, and others to learn their best practices. And yes, as you just heard from Mike, we will implement PSR principles, where they lead to a better result for customers and shareholders. All of the above, we are open to all good ideas that will advance customer service and shareholder value regardless of the source.

In summary, we are excited about the momentum we have today, and intend to deliver on our promises in the future as we have in the past. We look forward to announcing new financial targets at our Investor Day in February and to showing you the path we will take to get there.

Thank you for your attention. We'll now open the line for Q&A. Operator?

Questions and Answers:

Operator

Thank you. At this time, we'll be conducting a question-and-answer session. (Operator Instructions) Our first question is coming from Allison Landry with Credit Suisse.

Allison Landry -- Credit Suisse -- Analyst

Good morning. Thanks for taking my question.

James Squires -- Chairman, President, Chief Executive Officer

Good morning.

Allison Landry -- Credit Suisse -- Analyst

Certainly great to hear about implementing precision railroading. Jim, just on one of your last comments you mentioned that you guys are going to try to implement that as long as that improve customer service and enhances shareholder value. So, is there anything that maybe you see in PSR that may not fulfill those two initiatives.

James Squires -- Chairman, President, Chief Executive Officer

Well. Alison, as I said, our's will be and all of the above approach to improving customer service and productivity. We will implement PSR principles where they can allow us to better serve our customers and shareholders along with ideas we get from our customers, our supply chain partners from those both inside and outside the company today.

We will endeavor to implement a new operating plan while minimizing service disruption, and we're not going to (inaudible) our growth while we do so. This remains an environment very conducive to growth and we are determined to capitalize on it.

Allison Landry -- Credit Suisse -- Analyst

Okay. So just, I guess, thinking about that, does that tell us that maybe you're not fully embracing it like we've seen that at CSX and perhaps maybe you're taking a similar approach as Union Pacific. Is that a fair way to think about it?

James Squires -- Chairman, President, Chief Executive Officer

We're looking at everything out there including elements of PSR that are complementary to our strategy. So, it's too soon to go into the specifics of our new plan, we will give you those specifics in February along with the new financial goals. But suffice to say, our goal is to produce a railroad that provides a more consistent service product at a lower cost.

Allison Landry -- Credit Suisse -- Analyst

Okay, great. And then if I could, just get in my follow-up question. Could you help us to frame or quantify how much the network inefficiencies cost you in the quarter. I know that there were some elevated equipment costs and some derailment cost, and of course the network velocity and whatnot. Maybe if you could, help us to understand what the impact of that was in the quarter. Thank you.

James Squires -- Chairman, President, Chief Executive Officer

Sure. Well, we did have some lingering service related costs as we indicated we -- last quarter. Cindy, can give you some more specifics on the individual line items. But despite the additional expenses, we were able to produce another quarter of year-over-year operating ratio improvement and significant incremental margin from the growth. Cindy?

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

Sir. Alison, you're right. We did continue to have some network velocity costs, we have not quantified those really since the first quarter. We do continue to see them come down somewhat, you did see some elevated equipment at rent. As I pointed out in my comments, we expect about half of the increase of what you saw on equipment rents to come out in the fourth quarter and we expect velocity cost to continue to come down as the service improves.

Allison Landry -- Credit Suisse -- Analyst

Great. Thank you so much for the time.

Operator

Next question comes from Jason Seidl with Cowen and Company.

Jason Seidl -- Cowen and Company -- Analyst

Thank you, operator. Good morning, everyone. I want to switch it up and talk a little bit about intermodal here for a minute. Obviously you've been growing in that area and that's part of your growth plan going forward. We are still in a fairly tight truck market right now but as you guys know, that changes over time. Can you talk about the plan and how much it's predicated on trucking capacity being tight out east and what Norfolk can do to grow that even in, let's say a flat truck market as opposed to a tight truck market?

James Squires -- Chairman, President, Chief Executive Officer

Alan, I will let you take that one. Let me say though that intermodal has been a consistent grower for us through tight and less tight truck markets. Alan?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Jason, we've grown our revenue in intermodal year-over-year for eight consecutive quarters. And as Jim notes, that includes a very loose truck market at the end of 2016 and early 2017 than what we're experiencing right now. We're very encouraged by what we're hearing from our channel partners with respect to the outlook for next year. We still expect truck rates to go up. We still expect the intermodal loadings to go up next year. And there is a gap there between intermodal pricing and truck market pricing that we're going to lean into (inaudible) price into.

Jason Seidl -- Cowen and Company -- Analyst

And I'll link this to your new operating plan, and I understand, the details will be given at the Investor Day. But how crucial is the new operating plan to continuing to grow intermodal and even more importantly, continuing to realize the price resources?

James Squires -- Chairman, President, Chief Executive Officer

Alan?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Jason, we've got -- we have a great intermodal franchise. And we run a lot point to point trains in that franchise, and we're working very closely with our customers and within the operations division on improving the productivity. And you're seeing that reflected in bottom line results and we're going to continue to focus on price. We've talked earlier about the cadence of pricing opportunities within intermodal would last well into 2019. We still expect that to occur and we're going to continue to focus on productivity.

Jason Seidl -- Cowen and Company -- Analyst

(Multiple Speakers) time as always.

Operator

Our next question is from the line of Justin Long with Stephens. Please proceed with your question.

Justin Long -- Stephens, Inc. -- Analyst

Thanks, and good morning . So I was wondering if you could talk about the timing and scale of implementing this new operating plan. Just Wanted to get a better understanding of how we should think about the rollout. And as you go through this process, would you be open to the idea of bringing someone in with PSR experience in some of these operating principles, or do you feel confident with the team you currently have in place?

James Squires -- Chairman, President, Chief Executive Officer

Justin, let me take the second part of that question and then I'll let Mike talk about the sequence of events. Obviously, we're going to give you more detail on the new operating plan in February. We have brought in those with PSR experience and we will continue to do so, recognizing that we don't have a monopoly on good ideas, and that we can benefit from the perspective of those outside the company who have implemented PSR principles and other best practices. Mike?

Michael Wheeler -- Executive Vice President, Chief Operating Officer

Yeah. So talking about our plan, we are currently doing the Clean Sheeting now. We are currently out across the railroad, looking at our local serving yards and terminals and working with customers on how we get that done, and we will be doing that for several months now. And in February at the Investor Day, then we'll start telling you about what we're going to do with the operating plan that's been developed from the Clean Sheeting that we've done across the railroad. But there'll be different cadences to this. We're going to do certain changes to the operating plan, get that in place, get the benefits of that across the supply chain. And then we'll take another step forward, harvest some more benefits.

So it's going have cadence to where we do some -- do some more and that continue to get the benefits.

Justin Long -- Stephens, Inc. -- Analyst

Okay, thanks. And secondly, it seems like one of the areas of focus in the new strategic plan will be reducing equipment on the network, you mentioned cars online. Do you have any initial thoughts on how your locomotive and railcar needs could change over the next couple of years, just curious what you see is the targeted size of your equipment fleet relative to where it is today?

James Squires -- Chairman, President, Chief Executive Officer

We'll give you more information on those kinds of targets in February. Obviously, better locomotives and freight car productivity will be key elements of the plan. As Mike went through, one of the big goals is to drive down cars online and increase overall network velocity. That implies significant productivity in both locomotive and freight car categories.

Justin Long -- Stephens, Inc. -- Analyst

Okay, I'll leave it at that. Thanks for the time.

Operator

Our next question is coming from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your questions.

Amit Mehrotra -- Deutsche Bank -- Analyst

Thanks, operator. Hi, everybody.

So I fully appreciate, I guess the time it takes to form and communicate a new operating plan. So we can certainly wait until February for that, and I look forward to that. But our plan, I think is probably devised with some specific targets in mind or some philosophical view about what the returns in the business should be either on an absolute basis but probably more appropriately relative to what the benchmarks are achieving in the space. So I know I asked this exact same question, last quarter. So forgive me, but Jim as you think about what the company is managing to now actively, are there any structural reasons for the profitability in Norfolk Southern to be any different in CSX and kind of over a mid-term to long-term time frame?

James Squires -- Chairman, President, Chief Executive Officer

Our financial objectives in the next great long range plan will be the same sorts of objectives that we have driven toward in the current long range plan, i.e., both top line growth, and of course, earnings growth through a combination of revenue and margin improvement. The latter being critical to financial success in our industry. We certainly recognize that and we'll be pushing hard for significantly lower operating ratios in the next plan. We will also be focused on return on capital, that too is a critical metric in our industry. The railroads being a capital-intensive business, we focus heavily on return on capital. So you will see objectives in each of those categories in February. And I can assure you, there will be aggressive goals, we're working hard on them and putting in place these specific initiatives that will allow us to drive shareholder value.

Amit Mehrotra -- Deutsche Bank -- Analyst

Okay, thank you for that. And then just one follow-up from me. Last quarter, you and Cindy talked about the balance sheet being evaluated to have an optimal capital structure. I fully understand the operating plan takes maybe a long time to formulate, but the balance sheet actions should be, I think relatively straight forward given your communications with the credit rating agencies. You did raise some debt, you did an accelerated share repurchase relatively recently. Is that all we should expect on that front? Or should we expect some communication or can you update us now on where you think the optimal leverage of the company is?

James Squires -- Chairman, President, Chief Executive Officer

I'll turn it over to Cindy for her thoughts on financial strategy. But let me say again, what we have achieved thus far in 2018 alone, for the year-to-date $2.9 billion in capital return to shareholders via a 19% increase in dividends and the ASR and normal course share buybacks. Cindy?

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

We will continue to evaluate the balance sheet. But I will say that -- so as we said in the last quarter that we feel pretty comfortable with the credit advance that we're in and kind of staying in the middle of that range. We will continue to look at it and we continue to talk about that and we we'll update you again in February. But for now, I think we're comfortable in that range.

Amit Mehrotra -- Deutsche Bank -- Analyst

Got it. Okay, guys. Thanks so much, good luck with everything. I appreciate it.

Operator

The next question is from the line of Chris Wetherbee with Citigroup. Please proceed with your question.

Chris Wetherbee -- Citigroup -- Analyst

Hey, thanks. Good morning, guys. First, I want to start on the pricing side. Alan, you kind of mentioned a little bit of what was going on in the intermodal side. I think you also mentioned some improvements on the coal side too. But as you take, start to think about 2019, presumably there is sort of a bigger percentage of your contracts that may come up in the earlier part of 2019. Just want to get a sense of maybe how we should be thinking about the momentum. Is there an opportunity to get better price in 2019 or some of the factors that you're kind of seeing now potentially with volume we're decelerating, at least growth decelerating a bit. Will that have an impact? Just want to get a sense of maybe how you think that the set up in the context of this sort of new operating plan you're doing with pricing be a tailwind, a greater tailwind in '19?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Chris, great question. Pricing is going to be a key component of our plan moving forward as it is now. The price that we secured in the third quarter was the highest level than it's been in six years, and we set a quarterly record for price within our intermodal franchise. And as I've noted, we see a lot of strength and support for pricing moving well into 2019 particularly in truck-competitive markets. Coal pricing is going to be dictated by seaborne coking coal prices which right now remain elevated, and natural gas prices, which right now are fairly strong. There is a lot of strength in our truck competitive markets. And so, we continue to see opportunity and momentum within pricing for our intermodal and our merchandise franchise.

Chris Wetherbee -- Citigroup -- Analyst

Okay, that's helpful. And then just maybe a detailed question here. When you're thinking about headcount, I guess maybe putting the new operating plan aside for the time being, if you're thinking about the next quarter or two, maybe this is a question for Cindy. How should we thinking about sort of the cadence of headcount growth or contraction. You've had a nice deceleration here, volume growth continues to be pretty decent. Just want to get a sense of where you're getting to the point where you feel like, you might have to start adding resources either sequentially or year-over-year?

James Squires -- Chairman, President, Chief Executive Officer

Cindy?

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

Sure, Chris. So if you looked at headcount and said we were down about 300 year-over-year and down about 100 sequentially. We were hiring T&E in the third quarter and we had actually increases in our T&E headcount, but we were able to reduce other -- the areas other than T&E to kind of keep that number down or relatively flat.

Going into the fourth quarter, we expect to continue to be hiring some T&E particularly in our main corridors, but we will also continue to try to manage the non-T&E headcount. So you can expect to see it flat, maybe up slightly into the fourth quarter. And then into '19, we'll talk a little bit more about that as our plans come together.

Chris Wetherbee -- Citigroup -- Analyst

Flat to up sequentially in 4Q, just want to make sure, I am sure and clear on that.

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

Yeah.

Chris Wetherbee -- Citigroup -- Analyst

Okay. Great, thanks for the time. I appreciate it.

Operator

Our next question is from Walter Spracklin with RBC Capital Markets. Please proceed with your questions.

Walter Spracklin -- RBC Capital Markets -- Analyst

Yeah. Thanks very much, and good morning, everyone. So with regards to the new plan, have you started it now or is it something that you formulated and you plan on implementing and telling us about on February? Just trying to understand, whether the results are something we can see on a continuous basis or is it something that kind of start at a certain period in the future, certain time in the future?

James Squires -- Chairman, President, Chief Executive Officer

We have begun implementing the Clean Sheeting part of the new operating plan. So yes, that has been under way for some time now. We've been going across the railroad from location to location. Clean Sheeting as Mike has described, and we'll continue to push hard on that until we have laid the foundation through the Clean Sheeting process for a new operating plan for the network.

Walter Spracklin -- RBC Capital Markets -- Analyst

And part of prior plans at other railroads entailed a fairly significant headcount reduction and quite a change in the infrastructure within each of the organizations, and we've heard -- would have seen very significant reductions in number of hump yards and so. Your approach in the past has been a little bit more balanced, I think you've termed it Jim. Will this plan be more aggressive on headcount reduction and infrastructure changes or continue to be more on the balance side?

James Squires -- Chairman, President, Chief Executive Officer

Labor productivity, being a key component of overall productivity and a necessary component of further progress on the operating ratio. We will be focusing on that element of the plan certainly. As we rollout a new operating plan, we would expect to achieve greater labor productivity as well as asset productivity through fewer locomotives and freight cars out of the network.

Walter Spracklin -- RBC Capital Markets -- Analyst

But is that incremental or -- in prior plans, we've seen 30% reductions in labor force, we've seen 75% reductions in number of hump yards. Improvement could be a little bit or a lot, I'm trying to get a sense of, are we incremental improvement or is it along the lines of these other very significant changes in infrastructure and labor force?

James Squires -- Chairman, President, Chief Executive Officer

We'll give you more details in February. But as I have said, we do expect to put some aggressive, ambitious goals out there for the operating ratio and for further overall financial improvement. Labor productivity and asset productivity, network productivity will be absolutely part of that and it will be necessary to achieve those goals.

Walter Spracklin -- RBC Capital Markets -- Analyst

Okay. Thank you very much.

Operator

Next question is from the line of Scott Group with Wolfe Research. Please proceed with your questions.

Scott Group -- Wolfe Research -- Analyst

Hey, thanks. Good morning, guys. Can you give us any sort of hurricane impact in the quarter and any sort of guidance on incentive comp year-over-year for the fourth quarter.

James Squires -- Chairman, President, Chief Executive Officer

Okay. Mike, you wanted to take the hurricane question and then Cindy talk a little bit more about incentive compensation.

Michael Wheeler -- Executive Vice President, Chief Operating Officer

Yeah. We weathered the hurricanes really well. Hurricane Florence came on the land and we were able to restore our main lines pretty quickly within 24 hours. We did have some water impact around new (inaudible) and we had some of our bridges under water, but we were able to use short lines to reroute that traffic to some of our major customers. So hurricane Florence was really the short-term impact us, we got the railroad up very quickly.

And same thing with Hurricane Michael, it moved across our network pretty quick. We were responding right behind it as it came in, pretty much removing trees and putting generators out at signals and grade crossings, and again got the railroad up very quickly. So both storms that moved right through our network, we were able to recover quickly, and really that's a testament to our engineering folks who staged a lot of the equipment, assets, generators out in the right location so that we could recover quickly and we did. So we had very, very minimal impact and we're able to get the railroad up very quickly.

James Squires -- Chairman, President, Chief Executive Officer

Cindy?

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

Yeah. In terms of the cost of the hurricane, I mean, I think all of our preparation work really paid-off and the costs were really not significant at all in terms of the hurricane. On your second question around incentive comp, you'll recall and I said in my comments that, in third quarter of 2017, we had a large incentive comp adjustment. We did an adjustment in 2018 in second quarter. Going into the fourth quarter, we will really depend on the company's performance as to whether there's any sort of adjustment to incentive comp. So we'll just have to wait and see how we do as the fourth quarter continues?

Scott Group -- Wolfe Research -- Analyst

But nothing obvious on the year-over-year comp, good or bad for 4Q, Cindy?

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

No.

Scott Group -- Wolfe Research -- Analyst

Okay And then, Jim, you mentioned that you brought in some precision railroading people. Can you maybe add a little bit more color there. Is it senior people or is it people in the yards. Just, how many people -- just, maybe a little bit more there would be helpful?

James Squires -- Chairman, President, Chief Executive Officer

Well. We have people on the ground with PSR experience assisting us as we move through Clean Sheeting. We also have people who are advising us on the new plan as we put it together, the new operating plan, the new strategic plan with that kind of a background. So we feel, we've covered the bases. And as I said before, we know we don't have a monopoly on good ideas. We are open to our best practices, including but not limited to PSR.

Scott Group -- Wolfe Research -- Analyst

But are you sort of open to adding to the C suite or executive sort of levels, if appropriate?

James Squires -- Chairman, President, Chief Executive Officer

I have total confidence in my team. And I believe that we have what we need in that team to deliver the results that we will lay out for you in February, just as we have delivered the results for you up to this point in the last three years.

Scott Group -- Wolfe Research -- Analyst

Okay, thank you guys. I appreciate the time.

Operator

Next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your questions.

Brandon Oglenski -- Barclays -- Analyst

Hey. Good morning, everyone. Alan, I want to come to your revenue outlook, because it looks like you have pretty bullish comments across your three segments here, Merchandise, Intermodal and Coal. As far as if you could balance that in the context of the looming tariffs on a lot of Chinese goods that could be implemented in January, have you heard any concerns from your customer base around what's upcoming in 2019?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Brandon, what we're seeing is a little bit of inventory stockpile or inventory pull ahead. However, if you take a look at the macro data, the inventor sales ratio remains flat and at a pretty low level, which indicates that demand for product is pretty strong. If you take a look at manufacturing, September was up 5.1% year-over-year, one of the strongest gain in almost eight years. Retail sales in the third quarter were up 5.9%.

So, the economy remains very strong. The tariffs adds some uncertainty to what our customers are thinking. However, the underlying economy is, as represented in the macro numbers is very strong, which gives us a lot of confidence in our volumes, in our revenue in the fourth quarter and well into 2019.

Brandon Oglenski -- Barclays -- Analyst

Okay. I appreciate that, Alan. And then, Jim, maybe a little bit more strategic one, and I don't want to focus necessarily on your competitor. But if CSX would have run at a significantly lower operating ratio and we've seen them improve system velocity and I know it's not defined same anymore. But is that a concern for you if you can't get your cost base down equal to your competitor? Is there a lot of traffic that potentially could be at risk as you look out over the next couple of years?

James Squires -- Chairman, President, Chief Executive Officer

Let me state what I think is the obvious. We are focused on enhancing value at Norfolk Southern, leveraging our franchise. And we have, for the last three years, fulfilled our commitments to shareholders. Think about it, think back, over 500 basis points improvement in the operating ratio in three years, double-digit EPS growth, ahead of schedule on both of those metrics which we laid out three years ago, substantial shareholder value delivered.

So we will continue to push for the best possible result at Norfolk Southern. We are very confident in our prospects, and we'll give you the details on the new plan in February.

Brandon Oglenski -- Barclays -- Analyst

Okay, Jim. Thank you.

Operator

The next question is from the line of Turan Quettawala with Scotiabank. Please proceed with your questions.

Turan Quettawala -- Scotiabank -- Analyst

Yes, good morning . Thank you for taking my question. I guess, just talking a little bit about PSR here. One of the other things that does happen is -- quite a bit of an improvement in CapEx and you have talked about, obviously reducing cars online and so on and so forth. Should we assume just sort of directionally that CapEx should be going down here going forward or do you think it sort of stays inline a little bit?

James Squires -- Chairman, President, Chief Executive Officer

We believe that 16% to 18% of revenue is an appropriate range for capital spending. We believe that's necessary in order to sustain our franchise and to invest for growth. In addition, we have significant expenditures now and on the horizon for locomotives, we're in the middle of a substantial locomotive conversion program and we intend to continue layering in new locomotives acquisitions as well.

Turan Quettawala -- Scotiabank -- Analyst

Okay, thank you. And I guess, just one more, I don't know if it's possible to get some early indications on coal here for next year just on the export side. Obviously, this year has been pretty strong on export coal. Just wondering, do you think that there is potential for growth -- further growth in the coal franchise on the export side next year?

James Squires -- Chairman, President, Chief Executive Officer

Certainly the seaborne prices have increased as the year has progressed and if that holds into next year and coal production comes on line, then yes, we could see growth in our export coal franchise next year.

Turan Quettawala -- Scotiabank -- Analyst

Thank you very much.

Operator

Next question is from the line of Bascome Majors with Susquehanna. Please proceed with your question.

Bascome Majors -- Susquehanna Financial Corporation -- Analyst

Yeah, good morning. We've seen some pretty credible press reports about you relocating your headquarters from Norfolk to Atlanta. And this morning, you just announced the February Investor Day to be held in Atlanta. I know, this isn't a done deal but can you talk high level. Is this a synergy play just to get management closer to the operating team, a local talent pool play or really just more about cost reduction and you may be just a little bit about the real estate situation that's creating this opportunity and whether or not you'd expect that to be net cash positive to your investors?

James Squires -- Chairman, President, Chief Executive Officer

We are considering headquarters relocation to Atlanta as has been reported in the press. It is not a done deal, a number of aspects of the relocation still have to come together for it to become a reality for us. The impetus for headquarters relocation is alignment and teamwork. It's our belief that we will function more effectively as a team, we will be more aligned if we are in one place. We do own property in Atlanta, which we have been seeking to sell for sometime now. And that would be one aspect of headquarters relocation that would need to be resolved before we do it. And we will certainly report to you as we report our results, any real estate gains that might accompany that transaction.

Bascome Majors -- Susquehanna Financial Corporation -- Analyst

Thank you.

Operator

The next question is from the line of Tom Wadewitz with UBS. Please proceed with your questions.

Thomas Wadewitz -- UBS Securities -- Analyst

Yeah. Good morning. So I wanted to ask you about the -- I guess, a broader review on the approach on PSR and so forth, then the financial target. As you, in February, if you think about that backdrop, how much does a review of profitability of the segments play in. I think a component, we've tended to see with PSR and other railroads as you look through the book and say, OK, maybe this is a piece of business. We're not making a lot of money on and we can see some of that go away or we pretty significantly change the service that we offer.

So I'm just wondering, is that part of what you're doing here in PSR or the other strategic or do you think the volume you have is a good volume and you don't need to see some of it move away?

James Squires -- Chairman, President, Chief Executive Officer

What you have described, Tom, certainly is a part of the strategic review that we have under way. Now, that's something that we do all the time. We are always looking at our book of business and seeking to optimize its profitability by one means or another. So that's ongoing. That's not necessarily new, but yes, at a high level, we are doing that as part of the new long range plan. Alan?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Tom, you see us continue to take a look at our intermodal franchise. And we've announced some closures over the last year, year and a half, and yet still have shown eight straight quarters of volume improvement. Those actions in the productivity improvements that they generate as well as the pricing opportunity has really helped us improve the profitability of our intermodal franchise and allowed us to reinvest in it. As Jim noted, this is an ongoing effort across all of our business units. So it's nothing new, it's part of good housekeeping that we do every day.

Thomas Wadewitz -- UBS Securities -- Analyst

Okay, good. That's helpful. And then maybe just one on the current dynamic in the truck market, how that affects you. I think, it's hard to tell, it seems like broader freight backdrop is pretty strong. That said, you see an evidence of softening in the truckload spot market, maybe not so much on the contract side. Have you seen some kind of wrinkles of weakness coming in and how do you think about the kind of how tight things are and the kind of outlook for pricing going forward?

James Squires -- Chairman, President, Chief Executive Officer

Tom, our channel partners have indicated to us that they are expecting a very strong fourth quarter. And you know, with consumer confidence being an 18-year high, we expect that to continue well into 2019, our contract structure will allow us to continue the momentum with pricing. So we're very confident about volume opportunities and pricing opportunities in the truck competitive environment for the remainder of this year and in next year.

Thomas Wadewitz -- UBS Securities -- Analyst

Right, OK. So you really haven't seen signs of weakness?

James Squires -- Chairman, President, Chief Executive Officer

No.

Thomas Wadewitz -- UBS Securities -- Analyst

Okay, great. Thank you for the time.

Operator

The next question is coming from the line of Ken Hoexter with Merrill Lynch. Please proceed with your questions.

Ken Hoexter -- Bank of America Merrill Lynch -- Analyst

Great. Good morning. Jim or Mike, I guess, I just want to understand what change through your process and maybe mindset here as you kind of step over to this Clean Sheeting PSR process. You've always talked about, this is the right plan for you in terms of focusing on top line growth. And I guess, maybe just to understand, is this kind of an evolution of that same plan or a complete overhaul and looking at your peers saying we need to kind of shake that up. And I guess within that, Mike, I don't know if you want to maybe walk through the process of Clean Sheeting in terms of what you've been doing so far.

James Squires -- Chairman, President, Chief Executive Officer

Well. Ken, let me respond first and then I'll turn it over to Mike. Certainly, we are looking to change the way we operate, that's necessary. The network has evolved over the years, it's time for a major network overhaul and operating plan overhaul anyway. So that's something that we're focused on as a natural developments in the life of the network as you will -- if you will. It's time for that kind of a bottom-up review of how we operate.

So certainly the underpinnings of it are organic in that sense, driven by our customer base, our mode of operations up to this point and the need to continue to push productivity and efficiency while preserving the capacity for growth. Mike, a little bit more about Clean Sheeting.

Michael Wheeler -- Executive Vice President, Chief Operating Officer

Yeah. This is evolutionary, and as Jim noted, we've optimized our networks in the past and now we're going to take the next step and kind of optimize them together. But Clean Sheeting is really a deep dive at our local serving yards and kind of the nodes to that area and we bring our service design folks in, we bring our customer service folks in, we bring marketing folks in. We look at all the local service schedules and we make sure they're synced-up as good as they can with the main train networks. We talk to customers about how we get traffic in and out of their facilities quicker, get them through our yards quicker. So it's a deep dive at all of these nodes across our network, which are the local serving yards and it's a pretty intense work that we do. We do it over several weeks and then we come out of there with a better, more efficient operating plan and you saw some of the results we showed you.

Ken Hoexter -- Bank of America Merrill Lynch -- Analyst

So does it go so far as to just looking at improving the performance at those yards or does it step back in terms of the Clean Sheeting, in terms of your network structure, right. So when you look at a peer now, that's I guess ripping up the entire hub-and-spoke concept of intermodal. I know, Alan, you mentioned you are closing some lanes, but does it kind of structurally change how you think about even the yards themselves?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

So what happens is, after the Clean Sheeting is done, then you're able to put the train plan network in a more optimal fashion where you get the benefits of what you've done with Clean Sheeting. Does that answer your question?

Ken Hoexter -- Bank of America Merrill Lynch -- Analyst

Yeah. I appreciate the time. Thanks, guys.

Operator

Our next question is from the line of David Vernon with Bernstein. Please proceed with your question.

David Vernon -- Bernstein -- Analyst

Hey, good morning, guys. It is great to get a sense for one of the tenants you plan here is that, you're going be integrating some of the other segments into the merchandise framework (ph). I'm assuming, you're talking about intermodal and merchandise. Exactly, how separate have those networks been running to-date? And when do you -- and can you give us some sense of how much of the networks are actually going to be integrated?

James Squires -- Chairman, President, Chief Executive Officer

Yeah. So our multi-level and intermodal networks have pretty much been integrated for several years and Alan noted the productivity we've got out of those. So those have kind of been integrated. Merchandise has been optimized and developed on its own, and then the both networks kind of been it's -- mainly its own separate network.

So those are the three separate networks. We have done some, integrating different parts of that but not at the level that we're looking at for the next operating plan.

David Vernon -- Bernstein -- Analyst

And I guess, as you start to kind of think about putting that premium traffic and with some of the carload traffic, is that going to have any impact do you think on the services that you're actually able to offer to the marketplace as opposed to having one, two, three day a week service, you are going to be able to offer a broader set of services well kind of going down as we move through the next couple of years.

James Squires -- Chairman, President, Chief Executive Officer

Yeah, absolutely. I mean this is intended to make sure, we actually provide more service to the customer. So yeah that's what we expect.

Alan Shaw -- Executive Vice President, Chief Marketing Officer

The frequency of service certainly can increase under this new operating plan we believe. Our goal, as I said earlier is to achieve this with a minimum of network disruption. That doesn't mean service won't change to some customers, however it will. There will be different service parameters in some cases, our goal is to provide a more consistent lower cost service product.

David Vernon -- Bernstein -- Analyst

I guess, just within your within your markets, Jim, right, obviously in the Eastern part of United States, I would imagine that getting to a more frequency is -- on a day and week basis would give you a significant advantage relative to truck, is that right or am I thinking about that wrong?

James Squires -- Chairman, President, Chief Executive Officer

Yes, that is true, and that also can result in cost reduction because of the increased velocity of the network.

David Vernon -- Bernstein -- Analyst

Excellent. Thank you.

Operator

Next question is from the line of Brian Ossenbeck with JP Morgan. Please proceed with your questions.

Brian Ossenbeck -- JP Morgan -- Analyst

Hey, good morning. Thanks for taking the question. Maybe (inaudible) go to Alan on domestic coal. And you mentioned in the slides, in your prepared marks, there were some increasing demand on utility coal. Can you give us a sense of where the stockpiles are? What the winter set of books like from a network and equipment perspective -- excuse me. And then just any sort of outlook with natural gas here cracking above $3 for the first time in a long time?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Hi. Good morning, Brian. Stockpiles have largely declined over the last year. In the North, there are about 50 days, they have declined about 30 days in the last 12 months; and in the South, there are about 65 days, 66 days and we estimate they've declined about 22 days within the last year. And so you see that set up for increase in demand for our services in the fourth quarter and in the first quarter of next year obviously with natural gas prices closer to $325 or $320, that helps too. Because as you noted, that's up about $0.22 per million BTUs, where it was this time last year.

Brian Ossenbeck -- JP Morgan -- Analyst

Okay, got it. And then on the export side, I know you gave some color on that already. But was there any impact from the hurricanes as they came through the network and they don't really have any storage capacity at the Lamberts Point, but is there any sort of catch-up that you would expect to hit the fourth quarter?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

We had a force majeure within our coal fields for about three days earlier this month as a result of the hurricanes. And so, you'll see a little bit of catch-up associated with that. We also did some maintenance at our Lamberts Point facility as well. So we fully expect that assuming good production that export volumes will ramp up sequentially week over week as the quarter progresses.

Brian Ossenbeck -- JP Morgan -- Analyst

Okay. Thanks, Alan. I appreciate it.

Operator

Our final question is from the line of Matt Russell with Goldman Sachs. Please proceed with your questions.

Matthew Russell -- Goldman Sachs -- Analyst

Yeah, thanks for taking my questions here. Just first, on the PSR initiatives, can you differentiate how much of this is an opportunity for you to just improve your own results, how well you run your business versus how much of this is something that you need to do to bring down the cost structure to fend-off competition as the trucking market eventually does recover and as you're -- as your peer in the East has brought down its own cost structure?

James Squires -- Chairman, President, Chief Executive Officer

We believe that, by implementing best practices developed from within, developed with our customers in a consultative process developed with our supply chain partners and including PSR practices can lead to both a better and more consistent service product and a lower cost structure.

Matthew Russell -- Goldman Sachs -- Analyst

Got it, OK. And then just quickly on crude, we're seeing a nice pickup there. Are most of those barrels coming in from Canada or are you seeing any split between the Canadian mix versus the Balkan mix, and if you have contracts or your part of the contracts tied to those barrels?

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Yeah. Matt, most of our increase in crude oil volume is the Western Canadian Select which has -- I'm sure, you're aware is very much in the money. There is a great arbitrage opportunity on the East Coast for that. So that's where we're seeing the volume growth, we expect it to continue in the fourth quarter and continue well into 2019. So we're optimistic about our volume outlook for the remainder of this year, whether it's in coal or intermodal or merchandise, and we expect that to continue in 2019, both -- for demand, for our product and our ability to price.

Matthew Russell -- Goldman Sachs -- Analyst

Great. Thanks very much.

Operator

Thank you. At this time, I'll turn the floor back to Jim Squires for his closing remarks.

James Squires -- Chairman, President, Chief Executive Officer

Thank you everyone for your questions today. We are excited about the momentum we have. We intend to deliver on our promises in the future as we have in the past. We look forward to announcing new financial targets at our Investor Day in February and to showing you the path we will take to get there. Thank you very much.

Operator

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.

Duration: 62 minutes

Call participants:

Clay Moore -- Director, Investor Relations

James Squires -- Chairman, President, Chief Executive Officer

Alan Shaw -- Executive Vice President, Chief Marketing Officer

Michael Wheeler -- Executive Vice President, Chief Operating Officer

Cynthia Earhart -- Chief Financial Officer, Executive Vice President, Finance

Allison Landry -- Credit Suisse -- Analyst

Jason Seidl -- Cowen and Company -- Analyst

Justin Long -- Stephens, Inc. -- Analyst

Amit Mehrotra -- Deutsche Bank -- Analyst

Chris Wetherbee -- Citigroup -- Analyst

Walter Spracklin -- RBC Capital Markets -- Analyst

Scott Group -- Wolfe Research -- Analyst

Brandon Oglenski -- Barclays -- Analyst

Turan Quettawala -- Scotiabank -- Analyst

Bascome Majors -- Susquehanna Financial Corporation -- Analyst

Thomas Wadewitz -- UBS Securities -- Analyst

Ken Hoexter -- Bank of America Merrill Lynch -- Analyst

David Vernon -- Bernstein -- Analyst

Brian Ossenbeck -- JP Morgan -- Analyst

Matthew Russell -- Goldman Sachs -- Analyst

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