CSX Corp (CSX) — Q4 2015 Earnings Call Transcript

Thank you, Carlos, and good morning, everyone. And again, welcome to CSX Corporation’s fourth quarter 2015 earnings presentation. The presentation material that we’ll be reviewing this morning along with our quarterly financial report and our safety and service measurements are available on our website at CSX.com under the Investors section. In addition, following the presentation, a webcast replay will be available on that same website. This morning, our presentation will be led by Michael Ward, the Company’s Chairman and Chief Executive Officer, and Frank Lonegro, our Chief Financial Officer. In addition, Cindy Sanborn, our Chief Operating Officer; and Fredrik Eliasson, our Chief Sales and Marketing Officer along with Clarence Gooden, our President, will be available during the question-and-answer session. Now, before I turn the presentation over to Michael, let me remind everyone that the presentation and other statements made by the Company contain forward-looking statements. You are encouraged to review the Company’s disclosure on the accompanying presentation on slide two. This disclosure identifies forward-looking statements, as well as the uncertainties and risks that could cause actual performance to differ materially from the results anticipated by these statements. In addition, at the end of the presentation, we will conduct a question-and-answer session with the research analysts. With nearly 30 analysts covering CSX and out of respect for everyone’s time, including our investors, I would ask as a courtesy for you to please limit your inquiries to one question and if necessary, a clarifying question on that same topic. And with that, let me turn the presentation over to CSX Corporation’s Chairman and Chief Executive Officer, Michael Ward.

Thank you, David. Good morning, everyone. Yesterday, CSX reported fourth quarter net earnings of $466 million or $0.48 per share, down 2% from the same period in 2014. Revenue declined 13% in the quarter. Strong pricing was more than offset by the impact of lower fuel recovery, a 6% volume decline and the continued transition in the Company’s business mix. Expenses also decreased 13%, primarily the result of lower fuel prices, lower volume-related cost and efficiency gains. As a result, operating income decreased 12% to $791 million while the operating ratio improved 20 basis points to 71.6%. In addition, CSX remains an industry leader in safety and service measures continue to progress well as we enter 2016. In fact, Chicago operations have now been fluid for nearly 12 straight months. Now, turning to the next slide, I’ll discuss full-year performance. Over the past five years, CSX has transformed its business to continue delivering solid results despite the global energy transition. As you can see on the left side of the chart, during that period, CSX coal revenue alone declined from $3.7 billion to $2.3 billion—a cumulative reduction of $1.4 billion. CSX has overcome that loss by significantly diversifying its market mix, improving service, and investing in long-term growth opportunities. As a result, in 2015, coal represented only 19% of CSX’s revenue, down from more than 30% in 2011. During that same period, shareholder returns including dividends and repurchases have continued to reward the owners of our Company, reflecting the steady growth in earnings per share which reached $2 in 2015. Our 2015 performance was achieved despite the challenges in the energy market, low commodity prices, and a strong U.S. dollar that impacted many of our markets. Revenue of $11.8 billion reflected growth in intermodal, automotive, and minerals that partially offset the continued declines in coal. Improving service, aligning resources and costs against the lower demand environment and driving efficiency gains of more than $180 million helped generate operating income of nearly $3.6 billion, and our first sub-70 full-year operating ratio at 69.7%. Those results reflect the employees’ relentless focus on safety and delivering service that supports strong pricing and ever-increasing operational efficiency, as well as the benefit of lower fuel prices. We will continue to leverage our core strategy, superior network reach, and diverse market mix to create long-term value for our shareholders. Now I’ll turn the presentation over to Frank who will take us through the quarterly results and future outlook in more detail, Frank?

Thank you, Michael, and good morning everyone. Let me begin by providing some more detail on our fourth quarter results. As Michael mentioned, revenue was down 13% or $411 million versus the prior year. This was driven mainly by a $198 million decline in fuel surcharge recoveries and about $175 million from the impact of lower volume. At the same time, core pricing gains were more than offset by the impact of negative business mix. Volume decreased 6% from last year with coal driving the majority of the decline. Low natural gas prices coupled with the impact of significant flooding in South Carolina impacted domestic coal volumes, while low commodity prices and the strong U.S. dollar challenged export coal in many of our merchandise markets. We continue to see strong core pricing, which for the fourth quarter was up 4.1% overall and 4.5% excluding coal. Other revenue increased $19 million from last year, driven primarily by unfavorable adjustments to revenue reserves in the prior year period. Expenses decreased 13% versus the prior year, driven mainly by $117 million in lower fuel prices, $107 million in lower volume-related costs, and $59 million in efficiency gains. In order to further drive efficiency, we closed two facilities in our coal network and completed a new union labor agreement in the fourth quarter. As a result of these actions, we incurred a $48 million or $0.03 EPS impact in the quarter. These short-term restructuring costs will drive future benefits as we gain greater workforce flexibility and continue to adjust to lower demand in our coal market. Operating income was $791 million in the fourth quarter, down 12% versus the prior year. Looking below the line, interest expense was up slightly from last year with higher debt levels partially offset by lower rates. As we highlighted on our last earnings call, a property sale closed in the fourth quarter for a gain of $80 million or a $0.05 benefit to earnings per share. This gain was associated with a non-operating property and was booked below the line in other income. And finally, income taxes were $275 million in the quarter with an effective tax rate of about 37%. Overall, net earnings were $466 million, down 5% versus the prior year and EPS was $0.48 per share, down 2% versus last year. Now, let me turn to the market outlook for the first quarter. Looking forward, we expect volumes to decline in the first quarter. We expect the challenging freight environment to continue as the headwinds associated with coal, low commodity prices, and a strong U.S. dollar more than offset the markets that will show growth. Automotive is expected to grow consistent with light vehicle production and especially in comparison to a year ago when the auto network experienced weather and service-related congestion. Minerals will benefit from continued highway and non-residential construction activity and new business. Intermodal is neutral as continued secular domestic growth and our strategic network investments that support highway to rail conversion are essentially offset by customer losses in international. Agricultural products is unfavorable due to low corn prices coupled with weakness in export grain and import sourcing in ethanol driven by a strong U.S. dollar. While core chemicals are expected to again be flat, the overall chemicals market is expected to be down as energy markets continue to reset to an environment marked by low crude oil prices and challenging spreads. Domestic coal will continue to be unfavorably impacted by low natural gas prices and an inventory overhang due to mild weather. For 2016, we expect domestic coal volume to be around 19 million tons per quarter. Export coal will continue to be pressured by the strong U.S. dollar and global oversupply. Our full-year outlook for export coal volume is around 20 million tons with some downside sensitivity. Metals is unfavorable as the strong U.S. dollar and high levels of imports continue to negatively impact steel production levels. Overall, despite a slow-growing economy, the freight environment continues to have pronounced challenges with low commodity prices, low natural gas, and a strong U.S. dollar. Turning to the next slide, let me talk about our expectations for expenses. Overall, we expect first quarter expense to benefit from the low fuel price environment as well as continued productivity and volume-related cost savings. Looking at labor and fringe, we expect the first quarter average headcount to be down approximately 2% on a sequential basis, driven primarily by the structural changes in our coal network that we announced in the fourth quarter. This reflects about a 10% reduction from the prior year. We expect labor inflation to be around $25 million per quarter throughout 2016, in line with the level seen here in the fourth quarter. Looking at MS&O expense, we expect inflation to be offset by efficiency gains and volume-related savings, in line with the trends we have seen in the second half of 2015. In addition, the first quarter will reflect a shift in our northern Ohio coal operations. Here, we took action early in the fourth quarter to consolidate freight from a facility in Ashtabula to CSX’s Toledo Docks, which further streamlines our coal operations. Fuel expense in the first quarter will be driven by lower cost per gallon, reflecting the current price environment, volume-related savings, and continued focus on fuel efficiency. We expect depreciation in the first quarter to increase around $15 million versus the prior year, reflecting the ongoing investment in the business. Finally, equipment and other rents in the first quarter are expected to stay relatively flat from last year, with higher freight car rates offset by improved car cycle times. Now, let me talk about our capital investment plan for this year. In 2016, CSX’s total capital investment will decline over $100 million from the 2015 level to $2.4 billion, which includes $300 million for PTC. Similar to 2015, we expect 2016 core capital investment to be higher than our long-term guidance of 16% to 17% of revenue due to our locomotive purchase commitment. This investment in new locomotives expands our ability to run longer trains and we’ll continue to store older locomotives to maximize the efficiency of the fleet. Looking at our capital allocation for 2016, you can see that over half of the investment will be used to maintain infrastructure to help ensure a safe and fluid network. The majority of our 2016 equipment investment is focused on upgrading our locomotive fleet. We took delivery of 200 new locomotives in 2015 and expect to receive another 100 new locomotives in 2016 which will complete our existing locomotive purchase commitment. In addition, we will continue to focus on strategic investments that support long-term profitable growth and productivity initiatives. Here we are prioritizing these investments in our intermodal business, infrastructure projects that support network fluidity, and technology initiatives to enable productivity. Finally, looking at our investment in Positive Train Control, we have invested $1.5 billion through the end of 2015, and we plan to invest an additional $300 million in 2016. CSX is committed to meeting a new legislative timeline for PTC. As we look at the path to achieving this goal and with PTC now extending over a longer period of time, we now believe the total cost of PTC implementation will be about $2.2 billion. Now, let me wrap up on the next slide. Overall, CSX delivered solid financial performance in 2015 despite significant market challenges. Full-year EPS increased 4% from the prior year, while our operating ratio improved 180 basis points to 69.7%. Revenue in 2015 was lower than we initially expected with volume declining 2% for the full year. But our continued focus on pricing for the relative value of rail service, driving efficiency gains and aligning resources to the softer demand environment helped to offset those volume headwinds. Looking ahead, we expect the coal headwinds to continue in 2016. As I mentioned earlier, domestic coal volume in 2016 is expected to be around 19 million tons per quarter, while full-year export coal volume is expected to be around 20 million tons, again with some downside to the export estimate. In addition, for the full year, we’ll be operating in a more challenging freight environment than we saw in 2015. Natural gas and broader commodity prices are expected to remain at low levels and the strength in the U.S. dollar is expected to persist during the year. Furthermore, in 2016, we’ll be cycling a couple of large items that benefited our 2015 results; mainly, we received about $100 million in liquidated damages and had an $80 million property gain in 2015 which are not expected to recur in 2016. As a result, we currently believe that 2016 earnings per share will be down from last year. Looking at our expectations for 2016, we will continue to right-size resources with lower demand and pursue structural cost opportunities across our network. In addition, we expect to deliver productivity savings of around $200 million in 2016, which builds on the $184 million of productivity that we achieved in 2015. Overall, we remain intensely focused this year on delivering a service product that meets or exceeds our customers’ expectations, achieving strong pricing to support reinvestment in the business and driving efficiencies across our entire cost structure. With that, let me turn the presentation back to Michael for his closing remarks.

Well, thank you, Frank. CSX has continued to deliver solid results for shareholders, despite the transformational decline in the energy environment and the challenging market conditions. The efforts of our dedicated employees combined with the diversified business mix and the premier network in the east have helped us to overcome the significant losses in coal. As Frank mentioned, 2016 will be a more challenging year. Volume in the first quarter and for the full year will decline as growth in some markets continues to be offset by the significant impact of continued coal declines, low commodity prices, and the strong U.S. dollar. We are taking necessary actions to manage our business in that environment, including making structural and network-wide changes to manage resources and cost with business demand, driving further efficiency gains and remaining focused on strong pricing that reflects the value of CSX’s service. In response to the further challenges expected in 2016, we have also decreased the capital budget by more than $100 million. We expect to invest $2.4 billion this year, as we remain competitive in reserving safety, service, and efficiency for customers and communities alike while positioning CSX for the future. As we look to the future, this Company will continue to transition its business toward long-term profitable growth opportunities in the merchandise and intermodal markets. In that regard, we remain focused on achieving a mid-60s operating ratio longer term as we execute our core strategy of meeting or exceeding customer needs to support strong pricing for the value of our rail service, and continuously improving operational efficiency. With those efforts, we are confident that CSX will continue to be a preferred service provider for customers who face a growing population of more integrated global economy and the need for more reliable, more sustainable supply chains. Now, we would be glad to take your questions.

Michael, you've done well in a challenging environment. Regarding the outlook, as you consider the decline in earnings, how confident are you about the economy? It seems that coal and intermodal rates have dropped by over 8%. I realize fuel and mix played a significant role in that. Could you discuss the competitive losses? Are you experiencing increasing price pressure, and is there a heightened focus from competitors on pricing to secure some of the intermodal contracts that you mentioned were lost? It appears that the volume of those lost contracts is accelerating. Please share your thoughts on that and the overall outlook.

Good broad question there, Ken. So, Fred, maybe address some of the market conditions.

In terms of the pricing for the quarter, as you saw, our ex-coal pricing actually improved from the third quarter; went from 4.4% in the third quarter to 4.5% here in the fourth quarter. All-in went down, and that really is the reflection of what we did in the export coal market here as we’re now in a position to actually have some surplus assets, and again, as we get the network running a lot better and very strong service performance, we do have some excess locomotives. We’ve seen the export market deteriorate, and as a result of that we felt this is the time when we went back and revisited what we could do to optimize our bottom line. And this is one market where we actually don’t have a fuel surcharge in. And as a result, the fuel prices have declined throughout the year. We did feel that it was still an opportunity to do a little bit more there and still make money on it. So, what you’re seeing in the pricing side in the all-in is really a reflection of what we do in the export coal market. The core pricing actually sequentially improved quarter-over-quarter.

Ken, on the EPS, for the year, you’re right, we did guide to EPS being down on a reported basis versus the record $2 a share that we delivered in 2015. We tried to give you guidance in terms of the one-time items that we’re cycling in terms of the liquidated damages in the property sale, the continued transformation in the energy sector. So, we updated the coal guides, both on the domestic side and the export side and then tried to give you some view into the broader economy. And clearly, those are on the industrial side being suppressed by the combination of low commodity prices and the strong U.S. dollar. But this Company has remained relentlessly focused on driving the things that are most within our control, as you saw our performance this year, or 2015 I should say, in terms of the rightsizing that we did and the efficiency gains that we delivered in 2015 and the projections of 200 million as we get into 2016. We’ve got an improving service product, and Fredrik just mentioned the strong pricing for our shareholders. So, it’s likely going to be a unique year for us in 2016, and after that, we fully anticipate EPS growth toward that path of mid-60s longer term.

And then Ken, in this one very broad question that you asked, I’ll come back to the international losses that we referred to. We’ve had several now over a period of time with us throughout 2016, and as we think about where we are, we’re growing with our existing customers very well but there have been some customers that we’ve lost. And clearly from our perspective, we feel that we have a very strong service product right now. We have what we think is a superior network reach. So, the only thing we can assume is that there are factors outside of our control that have allowed us to lose that traffic.

Thanks for taking my question, and similarly, pretty good results in a difficult environment. So, can we talk more broadly about what could become a manageable level of volume declines where we could think earnings get back to flat; we can get back to operating ratio improvement, or maybe you’re not even suggesting, you can’t get operating ratio improvement this year? But can you talk to levels in the network where you would feel comfortable saying our cost performance and our efficiency plan can get earnings to right-size if not even go up a little bit?

I think on a 2016 basis, obviously, as I mentioned, it’s going to be a bit of a unique year, continuing resets in the energy environment. And on the operating ratio question for 2016, obviously, it’s going to be difficult to sustain a sub-70 performance especially giving what we’re cycling and the coal projections that we’ve given you and the uncertainty in the industrial economy. But then again, it’s January the 14th, it’s the middle of the first month of the year. We got a great network, as Fredrik’s mentioned we got a track record of success, we have improving service products. So, we’re going to be relentless in terms of our focus on the things that are most within our control. And so those are the things that give us confidence that the future beyond 2016 is a positive one.

Is there a way to broadly quantify for everyone on the call? If volume decreases in the low single digits or mid single digits, will that create more issues than determining where the loss in earnings occurs?

Well Brandon, not to be repetitive but obviously the one-timers, clearly those could be easily defined. I think we’ve given very strong guidance as to where we see the coal market this year. Obviously, a little bit of potential downside in the export; it’s a little hard to gauge this early. I think probably the wildcard is the rest of the economy. And it is very early in the year to try to gauge that. Obviously, I think if you look at most prognosticators, they’re saying the first half of the year probably looks weak on the industrial side but potentially it recovers. And I guess we don’t really have a better crystal ball than that a couple of weeks into the year, and that’s probably the wildcard in the entire thing. And we’re going to drive the efficiencies over $200 million; we will take actions to also reflect lower volumes which would be in addition to what we do on the productivity side. And I think with those parameters, this should be able to give you some relative idea of what the expectations could be.

I was curious in the 19 million tons per quarter guidance we have in domestic, what level of destocking from inventories do you have reflected in there and whether you’ve outlined some downside risk to export coal? I was just wondering what your thinking is on the domestic side from the utility stockpile and also what level you think natural gas will be?

We don’t expect natural gas prices to recover significantly from current levels. As a result, for the remainder of the year, our coal plants will likely be used last. We're currently facing excess stockpiles, with levels around the 110s in the southern region and about 80 in the northern part of our network, where ideally we should be between 55 and 70. The 19 million tons of domestic coal breaks down into approximately 14 million tons for utility use and around 5 million tons for steel industrial uses. In the fourth quarter, we handled about 13.6 million tons, and we anticipate maintaining that rate. While some destocking is expected, the extent will depend on the weather since we are now dispatching last and are heavily reliant on weather conditions. Favorable weather could lead to more significant destocking, but if we experience weather patterns similar to the fourth quarter, where heating degree days were 25% to 30% below normal, that could pose challenges. We hope to see some destocking within the guidance we've provided.

And the other one related to gas, that would be coal to gas switching, difficult to tell but from a structural perspective, are there any pockets of the network perhaps in the north near the Marcellus and Utica shale where you would expect to see some more gas plants being built that could perhaps provide a little bit of incremental pressure on the rest of the networks?

No, I think that all the switching that can occur already occurred back in March or April of last year. What we have seen is in some instances we are seeing some of the coal burners actually now burning some natural gas in conjunction with coal firing it with natural gas that has to have a little bit of incremental additional negative impact on us. But all the switching that can occur has already occurred. And we are being dispatched last, or the utility that we serve are being dispatched last.

I wanted to ask about the coal network and sort of where you are in terms of potential structural changes that you’re doing. You took some actions in the fourth quarter. I guess I’m curious what else can be done as you move forward to 2016, given the outlook. And then maybe how that ties into productivity and benefits that you’re getting as a great run rate in the fourth quarter. I’m kind of curious what could potentially give upside to that $200 million number in 2015.

This is Cindy. Regarding structural costs, we did take actions in the fourth quarter. As I mentioned in our third quarter release, we are exploring all options, not only within our coal network but across our entire operations. Our goal is to increase efficiency, optimize asset use, and reduce costs. There may still be opportunities with our facilities, but changes to line segments will take more time due to the involvement of customers and other stakeholders, making those adjustments a longer-term focus. We are examining all these areas, and we will publicly share any opportunities we identify and announcements we make. We remain committed to aligning our operations with demand. You asked another question about productivity; could you please repeat that?

Sure, just wanted to get a sense of maybe how the coal network ties into the productivity, the $200 million of productivity, and then given the run rate that you had in the fourth quarter which was a bit above that level, how do you think about maybe potential upside; is there more that maybe we could see from productivity in 2016? Thanks.

We believe we can achieve $200 million in productivity savings, alongside the right-sizing actions we are implementing. Of this $200 million, approximately $100 million has already been completed, and we are pleased with that progress. The remaining initiatives are on track, and we feel optimistic about them. This productivity effort is broad and not specifically tied to the coal network. Regarding the right-sizing initiatives, while it may not be your specific question, it could be on your mind. As we reflect on the fourth quarter, we will continue to focus on reducing costs associated with decreased demand. Conversely, as demand increases again, as Michael mentioned, we will be ready to reinstate these resources.

I wanted to ask about train starts and then touch on pricing. Can you provide a brief update on how train starts were down in the fourth quarter and what you expect for 2016? Regarding pricing, have you shared any details on what core price and same store price might be in 2016, or is that something you cannot address? Thank you.

Let me just take the pricing question because that’s probably the simplest one. We don’t forecast pricing; we’re going to provide you each and every quarter where we come out. The key thing is that you should know that we always focus on pricing and make sure that we get the appropriate value, so we continue to reinvest in our business. As we think about our pricing right now, we have an incredibly strong service product; it’s improved significantly over the last six months as we now have the resources in place. There are a lot of contracts that we still haven’t been able to touch since really the step function change that occurred in early 2014. The contract side on the trucking side is still holding up, even the spot market is very soft. And the key thing for our team is to continue to sell through this down cycle and make sure we provide value to our customers by selling a longer term commitment in terms of making sure they have access to our network. And so that we work through this down cycle right now and sell for the long-term.

And Tom on starts, I would say probably about a thousand scheduled starts per week are out. Obviously, starts will come out that are more related to volume on the unit train side.

Can you provide the percentage of how many train starts were down in the fourth quarter and what they might be in 2016?

I don’t have a percentage right in front of me there, Tom. But I can tell you that our train length initiatives have obviously driven a lot of this opportunity.

From the beginning of the year, Cindy, about 15%.

For the total year of 2015, they’re up 8% from ‘14 versus ‘15, and in the fourth quarter, they are up 14% from the fourth quarter of ‘14 to the fourth quarter of ‘15.

The decline year-over-year in train starts, you’re saying.

I’m saying train lengths in terms of... Which then translates into the thousands starts per week which we talk about. It gives you percentage and gives you some sense of where we stand on a percentage basis.

Okay, yes. I mean those are strong gains, especially given the volume headwind. So, okay, alright. Thank you for the time.

So, given all the debate surrounding M&A and both of the eastern rails talking about getting to a 65 OR over the next few years and some others saying 60 should be bogie. First, could you help to look in the timeframe for when do you think you can achieve the 65 and what if any your plan is from a longer-term perspective to close the gap with your peers to ultimately achieve a 60 OR.

Allison, it’s Frank. Obviously we can’t comment on what other railroads are projecting into the future. But the challenging environment that we see in 2016 does not in any way diminish our confidence and the ability to deliver the mid-60s operating ratio longer term that we have guided you toward in the past. And again today, as you know, we’ve got an awfully good network, a world-class network in the east. And you’ve seen our success over time, both in terms of delivering margin improvement and the cost takeout that Cindy referenced in addition to the operating side, on the G&A side. So, the effort that we’re taking now especially in an improving environment in the future is going to help us improve margins in a meaningful basis, as that improves. But as we sit here today, based on the forward view of 2016, it just seems a little inappropriate for us to guide on a specific timeframe right now.

And I guess just sort of a clarification question, do you think that at some point in the future, is there anything structural that would prevent CSX from achieving a 60-OR?

We don’t see anything structural that would impede us from getting to the mid-60s and through the mid-60s. Obviously it’s going to depend on a whole host of things. And again as Michael said, the crystal ball is a little cloudy in ‘16. And obviously as that clarity improves, we’ll be able to give you more guidance around that.

Fred, if I could take it back to the intermodal discussion, you had alluded to some international contract losses that have happened through the year. In the guidance, it’s implying roughly 70,000-unit sequential decline which is much more than normal we would see in Q1 versus Q4. Was there an incremental contract loss in the fourth quarter or are you guys contemplating additional inventory destocking that we should be thinking about in the first quarter?

We have the intermodal business flat, is that what you’re referring to? Sequentially fourth quarter to first quarter is a very different story obviously with the peak that we’re seeing in the fourth quarter, especially around some of our partial business and so forth. So, I think that’s more of a normal thing. If you think about our intermodal business, there are two components to it. We’ve talked about the international side where we have had some competitive losses and you can continue to see that throughout ‘16. However, on the domestic side, we are having good continued success with our H2R initiative, and we’re also seeing some additional outsized growth here over the last probably six months and will probably continue in the first half of next year. But we have one domestic customer that is continuing to shift additional traffic to us which is really a decision that they had made; it’s nothing that we have done to incentivize that. They seem to have wanted to diversify their portfolio. And as a result, we think the domestic business will continue to be strong, at least for the first half of the year, and probably beyond that we still think there is an opportunity to grow even if that shift subsides.

And as a follow-up, when do you lap the final piece of the international competitor losses, should I think about that as Q4 of ‘16, or earlier?

Yes, that is correct, Q4 of ‘16.

And is that the end or beginning?

No, so we will have one account that we’re just really kicking and having lost here in the first quarter, so you will see it hold through all of ‘16.

My question is with respect to the guidance for earnings to be down next year. You guys had called out about $180 million of tailwinds in 2015 from property gains and liquidated damages, which is roughly $0.11 to $0.12 a share. So my question is if we were to normalize for those numbers, would you still expect your core, if you will, EPS to be down in 2016 or would it be roughly flat, if we were to normalize for those figures?

So, I think we gave you a couple other data points to look at. Clearly, we gave you a new coal guidance today that is down from what we had telegraphed on the third quarter call. So that’s clearly something to think through. And then on the broader merchandise side with the industrial sector a little sluggish here, so that’s in thoughts. But then again on the other side, continued strong pricing for an improved service product and efficiencies and rightsizing, so there are going to be some pluses and minuses as we go forward. But in terms of your original way of thinking about it, I mean you do have to normalize it and then really look at the pluses and minuses from there.

And the other thing I would add to that Alex is obviously over the last couple of years, we’ve been able to grow our other markets to offset the declining coal. So, we’re going to have continuing declining coal here and as uncertain industrial economy. So again, that’s the piece that’s least clear but I think it really depends on what happens with the rest of that market. We know we’ll get the productivity; we know we’ll continue to network size properly; we know we’re doing the pricing. So really, the wildcard in that question would be what does the rest of the economy do.

Yes, so obviously on the incentive comp, the plan resets at the beginning of every year. So, we had favorability in the back half of 2015 as the year played out differently than we had originally projected. And we disclosed that to you on a quarterly basis. So, be on the lookout for that one. In terms of the Q1 EPS, obviously based on the cycling of the $100 million in liquidated damages in a different demand environment of the first quarter of ‘15 versus the first quarter of ‘16 especially in coal, that’s going to impact us and the demand environment that we talked about. But again, you’re going to have to look at the improved service and the rightsizing and the efficiencies and the pricing performance, and that will ultimately help us give some guidance in terms of how far quarter one of ‘16 will be down versus reported ‘15.

Fred, I want to go back to something I think you commented about your truck competitor pricing. You mentioned that although truck spot pricing was down, contract was holding up. If contract starts to roll over to sort of meet where spot is, how much pressure is that going to put on intermodal pricing; how should we look at that?

I do think that we are seeing holdings up okay; it’s clearly gotten softer throughout the year on the contract side. And intermodal side, it’s where we do see most of that direct pressure. Now you know that still we have probably a 10% to 15% gap between what the truck prices are and what our prices are. And one of the key things in intermodal space is the strong service product. And as we think about our service product here this year entering into ‘16, it is clear that it’s very different than it was a year ago and that is also going to be very helpful as we approach contract season and we put new contracts in place.

Okay, but in terms of if you just say you make some service improvements and you see the truck pricing take a step down, is it going to be tougher to maintain your pricing even with a superior service product?

I think we’ve tried to stay away from forecasting pricing but directionally you’re right. Obviously the longer this softness is there, the harder it’s going to be to maintain the key challenge for our team is to make sure that our customers are aware that while there’s a softness here right now in ‘16, I think all of us still know that the macro drivers that we talked about for a long time are still prevalent. If we think about some of the productivity challenges that the trucking industry will face as we get to ‘17 with the electronic logs, as unemployment continues to come down, it’s going to be harder to retain the drivers without outsized increases in driver pay. So, we are facing softness; I think also, though our customers are acknowledging that that is probably temporary, as some of these macro factors will come back into play.

That’s a very timely and difficult question to answer, Jason. As you know, there hasn’t been any mergers under the current regulatory environment. That is a really complicated question; it’s probably better addressed by the STB. But as you saw by their letter last week, they’re going to be very focused on one, the public interest of the potential merger, potential downstream effects. And I think the thing that’s probably the most uncertain but probably going to be there for sure, the question to the extent is what regulatory costs will be put on this merger.

I just wanted to ask with respect to pricing obviously, rail’s peripherally or tangentially tied to the commodity super cycle which is winding down; you’ve got some more bearish people out there talking about rail pricing being vulnerable, anecdotes of carriers cutting price to incent volume. I just wanted to hear from you or confirm with you that you still remain committed to inflation plus type pricing, consistent with similar years and that there hasn’t been in change in thought or philosophy that perhaps price might be a lever you might use to incent volume in 2016.

No. I think our philosophy has not changed regarding ensuring that we provide value pricing to our customers while continuing to reinvest in our business. Ultimately, it comes down to identifying the next best option for our customers in terms of service and pricing. We believe there is still an opportunity to achieve the necessary pricing to reinvest in our business, which benefits both our shareholders and our customers as we enhance our infrastructure. We have consistently mentioned the need for flexibility in our export coal market during this commodity downturn, as it has led to increased demand. We have taken additional steps in the fourth quarter to address the challenging environment in that market. In other markets, we will collaborate with our customers to determine the best service product while also ensuring appropriate pricing. I would say our philosophy at CSX has remained unchanged for over a decade.

And then I guess my quick follow-up would be the intermodal growth, obviously you spoke at length about the loss in international but the domestic of ‘14 was a fantastic number. You kind of have the tale of two railroads when you look at average volumes in the fourth quarter, you guys were up mid-single digits; your competitors were down. So, obviously domestic, you alluded to a contract moving over on its own, not you incenting it. Just wondering if you could talk about that 14% really high-level directionally, how much of that growth would be that singular contract which you have seen shift and how much of it would be what I’d refer to as more organic highway to rail conversion? Thank you.

A significant portion of that growth can be attributed to our domestic intermodal business, which has been growing at about 7% prior to last year. We've set a long-term growth target of 5% to 10%. Given the current softer market, we are likely at the lower end of that target, excluding the impact of a recent shift. However, our ability to convert over 9 million units in our network to a rail-based solution, in collaboration with our truckers, remains unchanged. While the situation is softer at the moment, the macro environment continues to support a rail-based solution in the long run.

My first question is on your variable train scheduling initiative and just how much of an impact that had in the increase in train lengths that you saw and what inning you think we’re in, in terms of realizing all the benefit?

I believe that regarding variable trains, which pertain to our merchandise network, we've observed the most significant growth in train size on the merchandise side. In the fourth quarter, we experienced a 23% increase in train size. The variable schedule will allow us to adapt our network more efficiently as we face softer demand. While we have most of the components for variable trains already implemented, this approach enables us to shift, expand, and contract our operations in a way that is more effective than in the past within our merchandise network.

And you’re doing a lot more in the bulk.

Yes, we’re also continuing train length initiatives on the bulk side. We’ve seen increases in train lengths across coal, grain, and other commodities in the 5% to 10% range over the quarter. So, it's not exclusively a merchandise initiative; it also applies to others, but merchandise has experienced the largest benefits.

Well, thank you everyone for joining us and we will talk to you again next quarter. Thank you.