Greetings, welcome to the Norfolk Southern fourth quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Katie Cook, Director of Investor Relations. Thank you, Ms. Cook. You may begin.
Thank you, Christine, good morning. Before we begin today's call, I would like to mention a few items. First, the slides of the presenters are available on our website at norfolksouthern.com in the investor section. Additionally, transcripts and downloads of today's call will be posted on our website. Please be advised that during this call, we may make certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties, and our actual results may differ materially from those projected. 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. Additionally, keep in mind that all references to reported results excluding certain adjustments, that is, non-GAAP numbers, have been reconciled on our website in the investor section.
Now it is my pleasure to introduce Norfolk Southern Chairman, President, and CEO, Jim Squires.
Good morning, everyone, welcome to Norfolk Southern's fourth quarter of 2015 earnings conference call. With me today are our Chief Marketing Officer, Alan Shaw, our Senior Vice President of Operations, Mike Wheeler, and our Chief Financial Officer, Marta Stewart. Mark Manion is also with us for his last analyst call after a very successful career. Mark has been instrumental in helping cultivate the best employees in the industry. He has also been at the forefront of promoting safety programs as a critical component of a well-run business. Mark, thank you for your devoted service. With Mike Wheeler's assumption of the Chief Operating Officer role on February 1st, our senior leadership transition will be complete. Since last June, when I took the reins as CEO, my team and I have been single-mindedly focused on shareholder value.
We have responded to a dynamic marketplace and changes in the economic landscape by driving change while building on Norfolk Southern strengths. In conjunction with our leadership transition, we have already completed many key initiatives while simultaneously launching a new five-year plan centered on disciplined cost control and profitability to produce sustainable returns for shareholders. I'm eager to share details regarding our team's plan, but first, I want to briefly address the fourth quarter and full-year results. 2015 was marked by weak commodity markets and a strong dollar that had an adverse impact on Norfolk Southern and the railroad industry as a whole. Norfolk Southern earnings for the fourth quarter were $1.20 per share, which was 27% lower than last year's $1.64 per share. Earnings for the full year were $5.10 per share, which was 20% lower than last year's record of $6.39.
Alan, Mike, and Marta will go into more detail on this shortly. It is against this challenging macroeconomic backdrop that our team has aggressively executed on a number of key initiatives to build a strong foundation for sustainable shareholder value creation. The core of our strategy is this: maintain a high level of service to promote operational efficiency and growth while right-sizing resources to reflect the changing nature of our top line. Here are just a few of the things my team and I have already done to further this strategy. First, we returned service to previous high levels, supporting cost control, asset utilization, and growth. Second, we took action on G&A, closing and putting up for sale our office building in Roanoke, Virginia, while consolidating or relocating approximately 500 back-office jobs. We also streamlined senior management, eliminating three senior management positions.
Third, we restructured an underperforming subsidiary, Triple Crown, to sharpen our intermodal strategy and boost profit. Fourth, we completed the acquisition of the Delaware & Hudson South, giving us full operational control of an important network segment in the Northeast. The transaction has been well received by our customers. Fifth, we cut capital spending by $100 million last year to adapt to the shifting economic environment, and we are committed to reducing it further if necessary. Sixth, reacting to changes in our coal business, we completed an initial round of line rationalizations in the coal fields, the closure of a major coal terminal, and the consolidation of two operating divisions in West Virginia and Virginia. Now, let's turn next to the elements of our strategic plan beginning on slide five.
This plan, begun on June 1st, 2015, when I became CEO, and announced on December 4th, is the result of a comprehensive evaluation of our business model, in particular, our cost structure and top-line growth potential. The plan is built on disciplined cost control and asset utilization. It is also designed to generate, over time, revenue growth through pricing and increased volume in service-sensitive markets where we have made significant investments and have a well-established market presence. The plan is dynamic, allowing us to evolve as required given an ever-changing world. Overall, we expect to achieve annual productivity savings of more than $650 million by 2020, growing from an initial $130 million in 2016, by improving the consistency and reliability of our service and running a faster, more efficient railroad. Turning to our revenue plan on slide seven.
While our expectations are modest for 2016, revenue growth from pricing and volume increases is one component of our strategic plan. We have been deliberate in our analysis, developing a detailed bottom-up roadmap to growth over the next five years. The plan is conservative and flexible in nature and gives us the ability to adjust to changes in the economy. Slide eight shows that over the five-year period, we expect revenue per unit to grow approximately 2.5% on a compound annual basis through 2020, supported by pricing levels exceeding CPI. Consistent with our past experience, volume will grow relatively in line with GDP as growth in intermodal and other consumer-oriented products offsets coal headwinds. Turning to Slide nine, I will now detail our expectations for each major revenue group. We expect coal volume to decline in 2016 and then stabilize.
Overall, our coal forecast is more conservative than estimates from the Department of Energy and other independent experts. We believe growth in our merchandise lines of business will track the economy overall, increasing generally in line with GDP. We are calling for intermodal volume to increase at a rate better than GDP, with compound annual growth of about 4.5%. This will be driven primarily by tighter truck capacity and improved domestic service levels. It will also reflect our close alignment with international steamship lines that are adding capacity in Norfolk Southern served markets as they shift from West Coast to East Coast ports. Turning to our expense reduction and cost control plan. As you see on Slide 11, our strategy is to provide industry-leading service to drive the operating ratio lower. We are committed to achieving a sub 65 OR by 2020. We won't stop there.
Once we achieve this initial goal, we intend to take our operating ratio even lower by focusing relentlessly on four things: headcount, locomotive productivity, fuel efficiency, and our network footprint, all while supporting quality service for our customers. Moving to Slide 12, the current backdrop of low commodity prices and a strong U.S. dollar has created significant headwinds that affected 2015 results across our industry. Our plan will help offset some of these headwinds, actively managing to market dynamics, both downside and upside, in a timely manner. Right now, given current market dynamics, we are aggressively bringing down overtime, headcount, and our locomotive fleet size. We are also pushing on fuel efficiency, closing or scaling back operations in yards and terminals, and rationalizing secondary lines. All of this is being done so that we can achieve target levels of profitability while maintaining strong service and the potential for future growth.
Even given challenging future market conditions, we believe we can achieve a sub 65 operating ratio by 2020. We have the right team and the right plan to address the current headwinds and deliver superior value as we move through 2016 and beyond. With our improved service, we have achieved a faster railroad. Specifically, year-over-year, we achieved a 17% improvement in train speed and a 21% improvement in terminal dwell. These improvements across our network will lower costs while enhancing our service offering and the value of our product. A faster railroad is, simply put, a more profitable railroad. Turning to Slide 14. Our plan is designed to optimize resources and accelerate growth through a variety of disciplined expense control initiatives in compensation and benefits, purchase services and rents, materials, and fuel.
We expect to achieve annual expense savings over $650 million by 2020, growing from an initial $130 million in 2016. Starting with compensation and benefits. Service improvements, traffic shifts, network rationalizations, and cutbacks in yards and terminals will enable Norfolk Southern to reduce headcount in 2016 and beyond, building on initiatives we began in 2015 to rightsize the network. We expect this to result in annual productivity savings of $420 million by 2020. Now to purchase services and rents. We are projecting annual savings of $70 million by 2020 through reduced equipment rental and lease costs, lower payments for third-party switching, leveraging the recent expansion of Moorman Yard in Bellevue, Ohio. Lower trackage rights and haulage payments.
As you can see on slide 15, we expect materials to deliver approximately $80 million in annual savings by 2020 through more productive locomotive maintenance programs and replacement of older, less reliable locomotives. Finally, Norfolk Southern plans to cut fuel expenses by approximately $80 million per year by 2020 through rationalization of our locomotive fleet and full implementation of fuel management technology. In conclusion, on slide 16, we believe we have the right strategic plan to streamline operations, accelerate pricing and growth, and enhance shareholder value. The plan leverages our core competency in providing fast, efficient service while improving network efficiency and consolidating operations. Importantly, through disciplined cost control, we believe we can achieve the expense reduction goals outlined in this plan, and even more.
To be clear, if market conditions worsen more than anticipated, our plan has flexibility built into it so that we can achieve additional cost savings. We are also committed to a capital allocation strategy that returns significant capital to shareholders. Over the past 10 years, Norfolk Southern distributed nearly $15 billion to shareholders through share repurchases and dividends that increased steadily at a 17% compound annual rate. Our plan targets a dividend payout ratio of 33% over the longer term and share repurchases using free cash flow and borrowing capacity. I'll now turn the program over to Alan, Mike, and Marta, who are just as committed as I am to successfully executing our plan. They will provide more details on our 2015 results and our 2016 outlook, and I will then return with some closing comments before taking your questions. Alan?
Thank you, Jim. Good morning to everyone. Thank you for joining us today. I would like to begin by expressing our commitment to the growth plan Jim just reviewed. It is a multidimensional, sustainable plan with a focus on a differentiated service product that the market values, driving pricing and volume growth while improving shareholder return. Moving to slide two, I'll provide some perspective on our 2015 top-line performance. Annual revenue of $10.5 billion declined 10% compared to 2014, with fuel surcharges and coal accounting for the decrease. Fuel losses of $852 million were the result of decreased oil prices. This negative comp will sharply decline in the first quarter, as January 2015 was the last month West Texas Intermediate exceeded the average fuel surcharge trigger point. Overall, 2015 was a challenging year, with low commodity prices and strong U.S.
dollar conditions, which consistently deteriorated each quarter and largely continued unabated. Despite this environment, we did experience upside revenue growth in our merchandise and intermodal markets, excluding fuel. We also posted record revenue in our agriculture franchise and record volume in both chemicals and intermodal. On slide three, our fourth quarter results were impacted by decreased fuel surcharges, low commodity prices, unseasonably warm weather, and high retail inventories. Volume declined in all three of our major business segments. Reduced fuel surcharges and coal revenue combined for 84% of our overall revenue decline. Despite these challenges, positive pricing offset the negative mix impact of several commodities, driving sequential growth in RPU less fuel for each of the last five quarters. Moving to coal, warm weather and lower natural gas prices resulted in declines in utility coal shipments.
Export coal met our 3 million ton guidance for the quarter, but continued to be challenged compared to prior year due to global oversupply and the strong U.S. dollar. Our first quarter target is 2.5 million-3 million tons, with the added uncertainty in the market. Excluding fuel, RPU increased for coal due to positive pricing and increased longer-haul utility volume in the south. Slide five depicts the record high temperatures in our service area that impacted utility coal shipments later in the quarter. In the second and third quarters, our utility coal volumes met guidance and had settled into the low natural gas environment. Similar volume trends existed in October and November. However, the warm weather significantly decreased December deliveries. Stockpiles are 40 days above target, which we anticipate will reduce first quarter volume to 15 million tons.
The inventory overhang is projected to continue into the second quarter. Once stockpiles return to target, we project utility volumes in the range of 17 million-19 million tons per quarter assuming normal weather patterns. As we turn to intermodal, we restructured our Triple Crown franchise effective November 15, with business winding down earlier in the quarter as customers implemented alternative plans before the effective date. This equates to 4% in volume decline and 6% in revenue decline for intermodal. While the Triple Crown restructure will have a negative impact on both volume and revenue in 2016, it will be accretive to our bottom line and improve capital utilization. Excluding Triple Crown, intermodal fell 1% for the quarter. This decline can largely be attributed to increased truck capacity and high retail inventory levels.
As the quarter progressed and service was restored to previous high levels, we experienced volume gains in some key accounts. These improvements will have a positive impact on our domestic franchise moving forward. Lastly, pricing gains throughout the year increased revenue per unit by 4% when excluding Triple Crown and fuel. Consistent improvement in contract pricing creates confidence that this trend will continue and is supportive of our growth plan. Our merchandise markets were impacted by low commodity prices, the strong dollar, and high inventory levels, reducing demand for metals, export grain, crude oil, and lumber. On a positive note, automotive posted a 9% increase in the quarter, exceeding North American vehicle production growth. We also experienced strong growth in natural gas products, as well as ethanol. Losses in higher-rated commodities created a negative mix impact on RPU. However, strong pricing led to RPU less fuel growth of 2%.
NS volumes as reported to the AAR declined by 6.7% in the fourth quarter, in line with other Class Is. Eliminating the impact of the Triple Crown restructuring, NS volume declined 5% during this period. Concluding with our outlook, the impact of the warm weather on our coal franchise, uncertain commodity prices, and continued high retail inventory levels create headwinds for volumes, particularly in the first quarter. Coal volumes will be impacted as utilities work down high stockpiles. Commodity price declines and foreign exchange pressures will affect our merchandise franchise. Volumes in our intermodal franchise will be impacted by the Triple Crown restructuring. Although improved service and reach will benefit our conventional intermodal and automotive networks, pricing increases accelerated throughout 2015, with the strongest pricing in the fourth quarter benefiting our top line through 2016.
The impact of lower fuel surcharges will subside in early 2016. We are actively converting to programs with less variability and greater alignment to expenses. Our longer-term objectives include the continued diversification of our traffic base, a key to maintaining a strong franchise. Service-sensitive business is Norfolk Southern's fastest-growing segment, as evidenced by our automotive and intermodal franchises, which grew at a 7% CAGR, excluding Triple Crown, over the last five years. With return to service levels, we expect volume growth in these markets, mitigating some risk associated with commodity-based products. Domestic intermodal will benefit from our service product and increased regulations in the trucking industry. International intermodal will grow as a result of our network reach and our alignment with shipping partners adding capacity on the East Coast.
In conclusion, a balanced franchise, disciplined market-based pricing, and an improved service product allows our management team to aggressively respond to a changing economic environment. We are confident in our pricing and volume growth plan, developed in concert with operations for our customers and their specific service needs and the unique market opportunities presented by our network. Collectively, we manage this flexible plan to adjust resources as volume levels fluctuate to drive targeted financial results. Next, Mike will describe our improved service levels, which increase the value of our product and generate volume growth.
Yes.
Substantial improvement is the result of deliberate strategic steps we took in 2015. Today, we are taking the next step in strengthening our company from an operational and financial perspective. Let me begin with one of our core principles on Slide two, which is involved in all of our decisions, safety. We achieved a 14% decline in reportable injuries. Even more importantly, a 19% reduction in serious injuries over 2014. We're proud of our position as an industry leader in safety. Our commitment to safety will not waver. Turning to service on Slide three, another of our core principles. As laid out here, our composite service performance continued to improve throughout the fourth quarter. Importantly, the performance of this comprehensive metric remained strong into the first quarter of 2016. Positive change is underway.
Our goal is to maintain this level of service, which we believe provides the optimal balance between delivering a high service product to our customers while running a low-cost operation. We are confident we can continue to provide this level of service as we implement our strategic plan to run a more efficient and more profitable railroad. On a recent service note, NS achieved our most successful peak season ever for our premium accounts with respect to on-time performance and total volume handling. Looking to Slide 4, we continue to deliver significant improvement in our train speed and terminal dwell metrics, which are leading to improvements in our locomotive availability and efficiency of our car utilization. Specifically, year-over-year for the quarter, we achieved a 17% improvement in train speed and a 21% improvement in terminal dwell.
As we've said before, a faster railroad is a less expensive and more profitable railroad. These improvements will translate directly into cost reductions, increased revenue, and improved margins. As a result, increased value for our stakeholders. Increased our focus on using our existing resources more efficiently. While at or near our historic high service levels, we will continue to rightsize our resources, implement and operating expense. During the fourth quarter, we reduced horsepower hours by 24% and reduced crews by 55% versus the same period in 2014. As Jim highlighted earlier, with the plan outlined today, we are projecting $130 million in productivity savings from our better service and efficiency initiatives in 2016. The five-year plan was developed by my team, and we are committed to delivering results. On Slide 6, we have continued the process of rightsizing our manpower to match the current environment.
While the majority of these reductions have also taken the form of furloughs in the transportation department, we have also taken steps within our engineering, mechanical, and network and service management departments. On the locomotive side, aided by both our high velocity and an industry-wide reduction in volumes, we are currently storing high adhesion road locomotives and, in addition, have removed units from our yard and local fleet. We did this through rightsizing against current volumes and fine-tuning our local operating plan. We are also progressing with the DC to AC rebuilds, which will allow us to replace our aging Dash 9 locomotive fleet at a significant discount to purchasing new locomotives. We anticipate these reductions in our fleet to lead to lower maintenance and repair costs while reducing future capital requirements and improving the reliability and fuel efficiency of our locomotive fleet.
As Jim outlined for you earlier on the call, and as you can see on Slide 7, we are also taking a disciplined approach to reducing our operating costs. We recently announced that we are combining our Pocahontas and Virginia divisions, which will reduce the number of operating divisions by close to 10% and will result in a reduction of division-level supervision and back-office functions. We are also progressing with our plans to reduce from three operating regions to two. We are adapting rapidly and consistently. We are also idling our Ashtabula, Ohio, coal terminal and will concentrate our lake coal volumes at our Sandusky, Ohio, coal terminal. We have, however, retained all the business as part of this move. As mentioned in our last earnings call, we are continuing to rationalize investment in coal routes in Central Appalachia.
We are ceasing operation on portions of our West Virginia secondary between Columbus, Ohio, and Charleston, West Virginia, which will result in a 250-mile reduction in maintained right of way. In all, we will rationalize our secondary line network by 1,000 miles this year and 1,500 miles by 2020. In closing, I want to emphasize that we are laser-focused on ensuring Norfolk Southern has the most efficient and appropriate operating plan, which will streamline operations while driving growth and profitability. With that, I'd like to turn the call over to Marta to walk you through the quarter's financials.
Thank you, Mike, and good morning, everyone. Slide two summarizes our operating results compared to last year's record-setting quarter. As Alan already discussed, revenues declined by $352 million or 12% as a result of lower fuel surcharge revenues and lower volumes. Operating expenses decreased by $103 million or 5%, aided by continued low fuel prices, but partially offset by restructuring costs. The net result was a $249 million or a 28% reduction in income from railway operations and a 74.5 operating ratio for the quarter. Restructuring costs added two points to the operating ratio. As was the case in every quarter of 2015, fuel prices had a significant impact on our operating results. We've summarized the net change on slide three. Taking a look at the top of this slide, the line graphs reflect the comparative WTI prices for 2014 and 2015.
As you would expect, the quarters with the biggest gap had the largest reduction in fuel revenue. Also note that we were below most of our WTI-based trigger points throughout 2015. Looking ahead to 2016, the forward curve projection for WTI is well below our most common trigger point of $64 a barrel. The remaining on highway diesel-based surcharges should correlate more closely with our fuel expense this year. Now let's take a look at operating expenses. I'd like to pause here and note that our team has been aggressively seeking to reduce operating costs while maintaining a well-run, service-oriented railroad. We've taken specific actions to reduce costs in the near term and will continue to reduce costs in a manner consistent with the five-year plan Jim described earlier. In the fourth quarter, we decreased expenses by $103 million.
Most of the decline was due to price, as I just discussed. We also had net reductions in purchase services and in compensation and benefits. These reductions were partially offset by increases in depreciation and in materials and other. Before we look at the specific expense line items, let's turn to an update on restructuring costs. Slide five summarizes the expenses, which are related to the significant downsizing of our Triple Crown operations and to the closure of our Roanoke regional offices. The net effect of these costs reduced fourth quarter results by $0.10 a share. As shown on the following slide, our restructuring efforts had a significant impact on depreciation expense, amounting to $37 million and resulting from the disposition of over 5,000 RoadRailer units. The remaining $10 million increase is associated with the growth in our asset base.
Slide seven breaks out the components of our change in fuel expense. We've already covered the price-related component, and the consumption decline is related to the drop in traffic volume. As Mike has already explained, we expect our fuel efficiency metrics to improve in 2016. Slide eight depicts purchased services and rents, which were down $12 million or 3%, reflecting the November 15th cessation of service in most Triple Crown lanes. As you know, this door-to-door service includes a significant amount of drayage and terminal operating costs, most of which went away after November 15th and accounted for an $18 million reduction. Partially offsetting this decline were the aforementioned restructuring costs and somewhat higher equipment rents associated with the increase in automotive traffic. Looking ahead to 2016, we expect purchase service costs to decline due to the Triple Crown restructuring.
Turning to slide nine, we experienced a $12 million or 2% decrease in compensation costs. Lower incentive compensation of $41 million, combined with $13 million of reduced overtime, was partially offset by increased pay rates of $13 million, a labor agreement lump sum payment of $13 million, and $4 million of severance costs associated with the restructuring. In 2016, we expect continued reductions in overtime, as well as a 4% decline in average headcount year-over-year. On the other side of the equation, we expect wage and medical cost inflation of about 3.5% and a more normalized level of incentive comps. As shown on slide 10, the materials and other category increased by $27 million or 12%. Casualty claims costs were $20 million higher due to favorable personal injury development in the prior year, combined with case-specific accruals required in 2015. Turning to income taxes on slide 11.
The effective rate for the quarter was significantly lower at 31.1% versus 35.3% in 2014. This was largely attributable to three factors: the passage of the Tax Extenders Act in late December, which extended certain tax credits, the completion of an IRS audit, and the effect of a state tax law change. Wrapping up our quarterly overview on slide 12, net income was $361 million, a decline of $150 million or 29%, and diluted earnings per share were $1.20, down 27% compared with the prior year. As a reminder, restructuring costs lowered these results by $31 million or $0.10 per share. Turning our focus to the full year on slide 13.
The resulting income from railway operations of $2.9 billion was a 19% decline, which led to an increased operating ratio of 72.6 and a decrease in earnings per share to $5.10. Restructuring costs lowered these results by $58 million or $0.19 a share and added about a point to the operating ratio. Slide 14 summarizes our full-year cash flows. Cash from operations for the year was $2.9 billion, covering capital spending and producing almost $500 million in free cash flow. With respect to stockholders' returns, we repurchased $1.1 billion of stock and paid over $700 million in dividends. In 2016, we plan to resume repurchases at a rate of about $200 million per quarter. Moving on to this year's capital budget on slide 15, we plan to decrease total spending to $2.1 billion.
Similar to the renewed effort on aggressively managing our operating costs, we're also taking a more disciplined approach to capital spending. We are prioritizing capital allocation to our core network and to projects that will fuel key areas of long-term growth. We believe this approach will enable the maintenance of high service levels, as Mike described, and support the areas where Norfolk Southern will grow in the long term, thereby maximizing our return on invested capital. As you can see from the pie on this slide, spending on our right of way, including roadway and infrastructure, is roughly in line with recent years, whereas equipment spending is lower. We've reduced freight car purchases but increased locomotive acquisitions in keeping with the strategy Mike outlined relative to a younger fleet and lower maintenance costs. With that, I thank you for your attention, and I'll turn the program back to Jim.
Thank you, Marta. As you've heard this morning, our results reflect the current challenges in domestic and global markets. Looking to 2016, we are poised to achieve significant annual expense savings without compromising the company's ability to secure volume and revenue growth opportunities. We are executing a clear strategic plan to drive profitability and growth, and we expect to achieve an operating ratio below 65% by 2020. As a management team, we have the right people in place to deliver superior shareholder value through execution of our strategic plan. Before we move on to the Q&A portion of this call, I want to address recent developments with respect to Canadian Pacific. As you know, our board of directors has carefully reviewed and rejected three separate unsolicited proposals. The board and management team are committed to doing what is in the best interest of the company and all NS shareholders.
That said, I want to ask that you focus your questions on today's call on our fourth quarter and full-year earnings, as well as our strategic plan and the additional information we disclosed today. With that, we'll now open the line for Q&A. Operator?
Thank you. We will now be conducting a question-and-answer session. Due to time constraints, we ask that all callers limit themselves to one question and one follow-up. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Our first question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.
Good morning. Thank you. I wanted to ask about your assumption for mix in the roughly 2.5% revenue per unit guidance that you outlined. I guess, should we be thinking about pricing in the roughly 3% range and maybe negative impact of mix of about a half a point? Any color you could provide there would be helpful. Thanks.
Sure. Thanks for the question. I think you have the basic formula about right. I'll turn it over to Alan in a minute, but let me say, the big picture here is growth in intermodal volumes and lower coal volumes. That has, as you point out, a negative mix impact overall. However, more than offset by pricing at a rate above inflation as we went through. Alan?
Yeah, Allison, we are completely focused and committed to disciplined pricing moving forward, reflecting the value of our service product, where we don't anticipate the sharp negative headwinds in fuel surcharge revenue, coal and steel, fractionated crude oil that we've had in the past. We're going to focus primarily on growing our service sensitive business and reflecting the long-term value of that business with our pricing. We've been able to achieve five consecutive quarters of RPU growth ex-fuel, and we believe that will continue.
Okay, great. My follow-up question, thinking about the $420 million of savings on the labor line, what are the specific headcount expectations that are embedded within that? Could you give us a sense of what you're thinking about what that might imply from a GTM per employee or a carload per employee perspective?
Sure. Again, I'll turn it over to Mike to talk about the specifics on the headcount, but we're looking for roughly 2,000 fewer positions by 2020 and 1,200 fewer positions and about a 4% decrease in our overall workforce in 2016. Mike, you want to get into the specifics there a little bit?
Yeah. It is driven by the 2,000 headcount reduction by 2020, as well as aggressive overtime reduction by 2020. We've already started that in 2016 and seen some good headways. As we've said, that's about a 4% reduction for this year in our headcount, and we would expect that to translate directly into the gross ton miles per revenue.
Okay. Thank you.
Our next question comes from the line of Alexander Vecchio with Morgan Stanley. Please proceed with your question.
Good morning. Thanks for taking the questions. Jim, I realize the forecast for coal to decline at a 1% CAGR is more conservative than some other estimates out there. Naturally, a 1% decline over the next 5 years would suggest that the mix headwind from coal decline from a profitability standpoint would moderate pretty drastically versus what you've experienced over the last few years. My question is, if coal volumes do end up declining closer to the mid to high single digits as they have been over the past few years, do you still believe you'll be able to achieve your OR and EPS targets?
What I'd like to do is turn it over to Alan in a minute to give you some of the detail on how we built up the coal volume forecast, which as you point out, we do believe is conservative based on independent experts. Let me just say this about our plan. It is a dynamic, flexible plan. If we do not see the growth in revenue because our coal volumes trend worse than we are expected or for whatever reason, we will push even harder on the cost side. It's a flexible plan. We can dig deeper on the cost if we have to. We are intent on achieving the results we have outlined today.
Alex, we know that coal volume will decline in 2016, that's reflected in most indices. What we've done is we have looked at our individual plants, our individual customers, then anchored that against independent experts. We have come up with what we believe is a conservative plan going forward. Yes, there's risk, there's no doubt about it, at gas prices levels where they are today, coal to gas switching in our service region is effectively saturated. We do feel good about our coal forecast going forward. It's more conservative than outside experts, we will adjust accordingly if we see the market dynamics change.
Okay. That's helpful. My follow-up, you've given a lot more detailed guidance, which is great, and you've spoken a bit more specifically to your expectations for core pricing. I was wondering if maybe you'd be willing to begin disclosing more specifically your same-store sale core pricing metrics on a quarterly basis as other Class 1s have been doing, and maybe if you could provide what that figure was in the fourth quarter. Thank you.
Sure. Listen, let me just say this. With the leadership transition here, everything is on the table, and we are certainly considering changes in a variety of areas, including our disclosure policy. Alan, you want the fourth quarter?
It was above rail inflation. We're going to continue to get improvement in that as we realize the full year benefit of the contract rate increases that we negotiated with our customers this year. With a sharply declined fuel surcharge overhang, we'll see better improvement in RPU throughout the year.
Our next question comes from the line of Thomas Wadewitz with UBS. Please proceed with your question.
Yeah, good morning, thank you for the detail on the five-year plan. That's helpful. Wanted to see if you could give me, this is probably for Mike or Jim, what, broadly speaking, are some of your assumptions on train length, and train starts over the five-year period? I guess typically we think of train starts as driving costs and headcount, and likewise, what you do on train lengths as being an area that you can drive productivity. Are there any kind of broad thoughts you can provide on how you think those two parameters may move over the five-year period?
First, train lengths are obviously an important driver of productivity, and fewer starts per train is also an important driver. Mike, why don't you talk a little bit about the specifics there?
On our train length, this last quarter as well as last year, our train lengths were at our historic highs, and they were at our historic highs at the same time that our service levels were at their historic highs. We feel pretty good about that going forward. Having said that, we continue to tactically look at what are the opportunities to run longer trains, and we do that daily. We got a team looking at that intensely. We also, strategically, long term, looking at longer trains. What we're doing there is, reviewing our operating plan, and we continue to fine-tune it to optimize the operating plan, and it will allow us to not only run longer trains but reduce our car miles and reduce handlings. Those go hand in hand with increased efficiency.
While we feel like we're in a good place, we do see opportunity going forward.
Maybe I should ask it a little bit differently. Do you have specific targets for change in train length that are part of the broader productivity plan? Are you planning to improve it 10%, 20%, or is that not one of the key drivers in your five-year plan?
No, it's not one of the ones that we put a specific metric on. We plan to improve it, but we don't have a target for that.
Okay. Then, I don't know if I can get a follow-on or a different topic, but is there any implication for long-term CapEx within the structural changes? If you take out 1,500 miles of track, does that help you get a lower CapEx number in the longer term?
It does. That's one of the benefits of reducing the network footprint from the 1,000 miles of rationalization we're looking at this year, and fully 1,500 miles by 2020. That does bring your CapEx down with respect to those lines, and there is some expense benefit from that as well. We are also looking at trying to contain CapEx at a lower level overall than it has been at in the last several years. We pointed out again that we reduced CapEx last year. That was appropriate given the circumstances. This year's capital budget, starting out, is double digits lower than last year's. We'll continue to be flexible with CapEx as market conditions require.
Okay. Thank you for the time.
Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, thanks. Morning, everyone. I wanted to follow up on the headcount, because I guess you're talking about a 7% reduction in headcount from here. Now, it strikes me, though, that volumes were down 7% in the fourth quarter and your headcount was up two. Meanwhile, all the other rails had headcount reductions in that 7% range. It feels like 7% headcount reduction is kind of just a catch-up to what other rails have just done to respond to the weak volumes. If we're thinking about real productivity savings, why isn't there a lot more headcount potential here? Because that's where we can get the most confidence and visibility to real margin improvement, and it feels like there should be potential for a lot more, and I guess I'm just not sure why we can't see that.
All right. Well, first, we started at a lower level of headcount overall. We built headcount somewhat last year to get our service back up to where it needs to be. It's there. Now we can begin to modulate headcount down. 1,200 fewer employees through a combination of attrition and furloughs this year would represent a 4% reduction in our workforce overall, year-over-year. We've given you the cost savings we expect from the attrition and the furloughs and other actions on comp and benefits. That's a big piece of the overall $650 million in productivity annualized by 2020, fully $420 million.
Okay. Just on the cash flow, just for a minute, when do you think you can get back to kind of the historical 16%-17% of revenue on CapEx? I guess a follow-up to what Tom was just asking you then. Marta, any thoughts on why you're slowing the buybacks in 2016?
Well, let's talk about CapEx first, I'll let Marta cover buybacks second. We're targeting about 19% of revenue through the completion of PTC, which takes us through 2018. After that, we intend to bring CapEx down to around 17%. We think that's a level of reinvestment, given other assumptions, that generates an adequate return for shareholders, an excellent return for shareholders, in fact. Marta, why don't you talk about the buybacks strategy?
Okay. In the share repurchases we discussed, we're beginning at a run rate this quarter of $200 million, which would imply right now $800 million for the year. That's very much in line with what we've done over the last 10 years. We've averaged about $1 billion.
Some years a little bit higher, some years a little bit lower. We finished 2015 at $1.1 billion, we're comfortable with that level of guidance for now.
I do want to point out, Scott, our board is very focused on buybacks right now. That's a big part of our strategy. It has been in the past. As we went through, we have kicked out to shareholders fully $15 billion through buybacks and dividends in the past, we will continue to buy back our shares.
Okay, thank you, guys.
Our next question comes from the line of John Barnes with RBC Capital Markets. Please proceed with your question.
Hey, good morning, guys. Thanks for the time. I just want to go back to coal for a second because I think we're struggling a little bit with the numbers in terms of the growth outlook. If I assume that 2016 is going to be down something similar to what the other rails are talking about, let's say it's a mid-teens type of decline this year, regardless of whether or not your franchise is less at risk to more switching on natural gas or something like that, you're still implying something like mid-single digit compound annual growth from 2017 through 2020. I think that when you look at the change in the eastern utilities portfolio, whether it's the introduction of more nuclear or what have you, that just seems like a big number, a big target out there for growth. Certainly, that's a growth number, not stabilization.
Can you just talk a little bit more about how you start to see that upswing and where this kind of CAGR of down 1 fits with something that looks like it's more up mid-single digit in the out years?
We're not looking for growth in coal in the out years. 2016 is another leg down in coal volumes, and after that, we see stabilization in the coal volumes. I'll let Alan return to the specific assumptions that underlie that. Let me just reemphasize, though. Ours is a flexible plan. We know this is a tough environment in which to talk about growth, and that's why we are so focused on cost reductions, on maintaining excellent service, and on safety. If we do those three things, we will have a successful 2016, and we will continue to drive on those three things as hard as we possibly can beyond 2016. We expect the results to offset any decline in volumes or revenue that we might experience contrary to our expectations.
Yeah. We know that much of the coal decline this year is the result of the warm weather. With coal dispatching behind natural gas, it is much more volatile with weather conditions. We're very clear that our guidance, once stockpiles normalize, is dependent upon normal weather patterns. We also know that the opportunity for coal to gas switching in our specific service region, and particularly in the Southeast, is muted going forward. To be clear, we are not looking for growth in our coal franchise. We expect it to decline. We're going to manage it very closely and continue to manage the resources that are applied against it.
What assumption have you made for coal shutdowns within the franchise in that forecasted amount?
Most of the additional natural gas plants that have been announced in the Southeast are not targeted at specific NS plants. Up in the PJM, there's more crossover, and there's more risk, and we've taken that into account. If there is a specific plant in the Southeast, that's been taken into account in our franchise, too. It comes in conjunction with looking at the announced natural gas plant additions in the next couple of years and talking to our customers about it. We do have some of it in there, more predominant in the Northeast.
My follow-up question. Thanks for the color. My follow-up is, you talked about 1,500 miles of track disposal. I know you guys sell real estate every year or so. You kind of know how to do it. My question on track disposal going forward is, it seems like a lot of this is going to be stuff that maybe doesn't have a lot of value left to a short line rail. There's not enough volume originating on that particular track. I'm curious, should we expect lower proceeds from track sales going forward just because there's less value on them? Are these going to be turned into really nice bike paths or something like that? Is there still some value to be had to a short line? Is there still enough volume originating on that 1,500 miles that there's some value there?
I think the way to view this, John, is not as a real estate transaction or a real estate strategy, but as a network optimization strategy. It's a mechanism by which we can bring down future capital spending associated with these lines, as we have said, and also to some extent reduce expenses. Alan, do you want to elaborate at all on the customer effects of some of this short line potential? Some of this may be dealt to short lines.
Some of it will be dealt to short lines so we can continue to handle the business. The ultimate goal is to ensure that with a short line handling, we do not increase the cost to the supply chain.
Okay. All right. Thanks for your time today.
Our next question comes from the line of Christian Wetherbee with Citi. Please proceed with your question.
Thanks. Good morning. Wanted to touch on sort of the broad volume outlook for 2016, understanding sort of where you guys are thinking about coal. When you think about the entire book of business, how should we think about that in 2016? Sounds like first quarter is going to be tougher, but how does it look after that?
Certainly, it remains a challenging macro environment. Alan will go through the specific assumptions for 2016. Again, let me say, this is why we are so focused on cost savings, on maintaining service, and on safety. Those will be the three pillars of our success in 2016. The growth will come. This is a long range plan, over the course of five years, we do expect to grow. We all know how powerful growth and pricing can be for the bottom line in the long run.
The largest headwinds that we have right now with respect to near term volume are coal inventory levels and retail inventory levels. Once those get worked through, we do see some growth because we're coming off a year in which we had minimal growth. We have a very strong intermodal franchise. Our proof service product is going to direct more of that business back to our lines in the domestic sector as we move into the second half of the year. We have a lot of strength in our international franchise, once retail inventory levels are normalized, that'll pick up. We have strength in our automotive franchise. We do have some franchises that have opportunities for growth. We had a record volume in chemicals last year, and we had record volume in intermodal too, despite the Triple Crown restructuring.
Note that Triple Crown will have a negative impact on volume comps, particularly for the first three quarters of the year. We do feel that as we progress through the year and as we take advantage of our service product and as inventory levels, whether in retail or in coal normalize, we're going to start to see significant improvement.
Okay. You're not predicating the outlook for 2016 on volume growth, it sounds like, though.
No, there is certainly opportunity there. We're watching it very closely because there's a lot of uncertainty around commodities and a lot of uncertainty on when, particularly the retail inventory levels getting reversed.
Sure. That's helpful. Appreciate that.
We're actively managing it with operations to make sure we're sizing our resources appropriately.
Okay. That's great. Just a quick follow-up, if I may, just on the fuel surcharge side. Marta, thanks for the incremental, the details that you've been giving us in terms of fuel surcharge. As you see the WTI program sort of bottom out here in January and then going forward, how should we think about the headwind to operating profit? You've sort of laid that out in the slide. Just kind of curious if there's a view that you can give us for 2016 when you think about that, sort of what's included in terms of either a headwind or sort of neutral impact from the fuel surcharge to profit in 2016. Thanks.
Okay. As Alan described, in the first quarter, the first quarter is the one that will have the toughest comp compared to 2015, because recall that the first quarter of 2015, in January, some of those WTI ones were kicking in. We had $163 million of fuel surcharge in the first quarter of 2015. Year-over-year, the biggest decline that we will see, we expect, if the forward curve stays like it is now, will be in the first quarter. Nevertheless, for all of the year, for all of the quarters, we expect to have much less net operating profit effect because our fuel expenses will be going down more commensurately with our fuel revenue if we stay in this oil price environment.
Okay. That's helpful. Thanks for the time, guys. Appreciate it.
Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.
Good morning, and thanks for taking my question. Jim, I know you said at the outset that you don't really want to talk about CP, but I'm getting plenty of emails here from investors that would like to discuss it. I guess in that context, I just want to respectfully ask, we've heard from these plans from Norfolk over the years that you guys always target peer margins, but we now have Canadian National, Canadian Pacific, Union Pacific, all in the low 60s, even cleaned up for the currency benefits up north. We're still struggling with the coal guidance. I think there was a question earlier about how do you get to a negative 1 CAGR when you're guiding 15 down this year. Clearly, Q4 was pretty challenging here, even after you take out the restructuring charges.
I don't think that we would argue that any of those big railroads that are running at a low 60s OR right now are in some sort of unsustainable or less safe operating condition than they were when they were running back in the 80s or even 90s OR. With your plan to drive about $600 million-$650 million of productivity improvements in the next 5 years, and CP's plan, which I would argue is backed up by a management team that has demonstrated the ability to do this in a very quick fashion, I think CP's plan is close to $1.2 billion over the same time frame. What is it about your business that you feel CP does not understand that makes shareholders better off with $650 million of improvement versus a low 60s OR and a $1.2 billion improvement plan?
We've outlined a plan today to get to a sub 65 operating ratio by 2020. As I said, we won't stop there. There's more we can do. We are going to continue to drive our operating ratio as low as we possibly can go with it. It's a good plan. It's a balanced plan. It contains a major component of cost cutting. We understand the need for that. That's absolutely critical. It's a flexible plan. If we don't see the growth, we will find additional ways to reduce expenses. It's a specific plan. It's the right plan for our markets, our franchise, and our customers.
Well, as a follow-up are you saying that $1.2 billion of improvement is just nowhere near attainable in the timeframe that they've laid out? Can Norfolk ever get to a 60 operating ratio, or is that just off the table for your network?
As I said, 65 is the starting point for us. That's what we've said we're going to try to achieve by 2020. We may be able to go faster. We'll see. After we reach 65, we're going to continue to drive it lower.
Thank you.
Our next question comes from the line of Matt Troy with Nomura. Please proceed with your question.
Thanks. I was just wondering if you could help us with the economics of the Pocahontas Division now that it's being consolidated. Just curious if you could size the magnitude of the royalties. Will your disclosure change with respect to how it's presented, and how much of a headwind that might be and the timing of the headwind as it runs off?
I think, Matt, we're talking about two different things here. The division consolidation that Mike went through reflects a strategy to reduce G&A, streamline operations, and streamline the organization. The coal royalties you referenced appear in our other income as part of rental and other income. Marta, maybe you could give us a run rate on that.
Yes. As you've mentioned, those have been decreasing, of course, with the decline in coal prices. Matt, that will continue to be reported in other income, and depending on coal prices, that will perhaps continue to decline. That's reflected in our charts, in our book that we put out, and they were down $4 million in the fourth quarter and $14 million for the full year.
The divisional reorganization in and of itself has no effect on.
I am glad you asked that question because with both of them having our corporation that handles the coal royalties being called Pocahontas and the division being called Pocahontas, we don't want any confusion there.
Understood. Thank you. Just as my follow-up, you mentioned share repurchases as a big part of your plan, and you gave us a targeted payout ratio of 33% and the return of $15 billion to shareholders. Just curious, maybe Marta, what are the guardrails in terms of balance sheet leverage or capital structure with respect to credit rating or leverage ratios you're comfortable pushing up against in order to drive share repurchases over time? Just want to refresh on where you think Norfolk is comfortable with respect to some of those credit metrics. Thank you.
Okay. Well, as you know, the share repurchase is just one part of our total capital allocation policy. It is a very important part. As Jim mentioned, our board is very focused on it. What we are doing is we are making sure that we stay within our credit rating band, we want to make sure we leverage as much as we can of that, and that's what we have done, buying back a little over $1 billion a year on average over the last 10 years. Right now, our expectation is that we will stay within that band and push as much of our free cash flow into share repurchases combined with the appropriate amount of leverage.
I'm just trying to get specifically, as we think about modeling, you are willing to lever up more than where you are today. Is there an upper band that you think is best?
As our balance sheet grows and as our profits grow with this five-year plan that Jim has described, we expect to grow our share repurchase program with it.
All right. Thank you.
Our next question comes from the line of Rob Salmon with Deutsche Bank. Please proceed with your question.
Hey, good morning. Thanks for taking the question. I guess, Jim, as a clarification for your 2016 OR guidance, you guys highlighted a bunch of track mile sales as well as the Roanoke office. I would imagine it's also going to be sold. Could you clarify to the extent that gains are incorporated in that sub 70 OR guidance that you're targeting for the full year? Obviously, it's a tough volume backdrop, and there'll be some mixed headwinds as well as we look out to this year.
Speaking specifically to real estate sales, gain on real estate sales, including any gain we record on sale of the Roanoke office building, would not be included in operating income but would be below the operating income line in other income. That would have no impact on the operating ratio. The proceeds from any line sales, I think would be rather minimal in conjunction with the restructuring or rationalization of the 1,000 miles we referred to. There could be some proceeds from that, but again, the main focus of that is reduction in capital spending and to some extent, expenses going forward.
Understood. I appreciate that clarification there. I guess getting back to Tom's earlier question with regard to sidings, I'm going to ask it a little bit differently. Could you give us a sense of what the siding capacity is today across your different franchises and what the train length currently stands at?
Okay, Mike?
Yeah, sure. Most of our sidings from the railroad are 8,000 feet long. As we build new sidings, and we've built a lot of new sidings over the years, and we built some up in the 10,000, 11,000, 12,000-foot range. We have got a lot of siding capacity out there. Relative to the size of the trains we're running now, our intermodal trains are running around 6,000 feet on average, a lot of capacity there, and the rest of the overall network is in the 5,000-6,000 feet. We have got plenty of capacity on our sidings out there.
Thanks so much.
Our next question comes from the line of Bascome Majors with Susquehanna. Please proceed with your question.
Yeah. Thank you for the time this morning. When framing your targeted expense reductions, I wanted to confirm that we should use 2015's GAAP results as a baseline and better understand how we should incorporate what are natural volume-driven OpEx fluctuations and general expense inflation to those numbers going forward. Since volume-insensitive costs should be down in 2016, is your $130 million productivity target for the year, is that fully incremental to the cost savings that you'd naturally see from lower volumes? Maybe longer term, as volumes return to growth per the plan, how should we compare that rising volume-driven expense and the broader cost inflation you'll see to your longer-term target for $650 million in savings over five years?
Okay. First, comparisons are to GAAP results in 2015. The cost savings that we have outlined are in relation to GAAP reported earnings in 2015. Now, Marta, why don't you take us through the dynamics of the productivity and other elements of the question?
Yes, they are compared to GAAP. The $130 in savings does not include the benefit of the restructuring costs. If you're looking year-over-year and you're looking at total expenses, you would expect a decline of $130 plus the $93 million of the restructuring costs that we had. Otherwise, it's all in there, the pluses and the minuses. If we have volume growth, you're exactly right. We would have incremental expenses associated with that volume growth, and that would not be in the $130.
Okay, understood. You maybe from a high level, just looking at the guidance to get below a 70 OR this year, if I plugged a 70 OR into consensus revenues, looks like something around 10% year-over-year EPS growth on your 2015 GAAP base of about $5.10 Is that the bogey that we should be looking at, or is there something underlying, maybe consensus revenue's too high or something else that we should be thinking about before using that as kind of our sense of your internal targets here?
Look, we said sub-65, excuse me, sub-70 OR in 2016 is our goal, that's what we're working toward through whatever combination of growth or lack thereof and expense savings. If we're heading into a recession, obviously the degree of difficulty gets that much higher. We are committed to this goal, and we're pushing hard to achieve it.
I would point out, too, that, Alan can elaborate on this, I would point out, too, that while we're expecting volume declines in coal, that's not the case for all of our commodity groups.
We'll pivot if we need to as well. If we need to pivot harder on costs, we will certainly do that. We're not going to sacrifice our service, but everything else is on the table. We'll cut whatever we need to cut short of hurting service.
Well, I guess just to follow up on that, if volumes do come in kind of as you expected, is something approaching the double digits on your GAAP earnings base out of the question for this year? Or is that within the range of possibilities in your view?
You can do the math on the EPS effect of driving the operating ratio below 70. Yeah.
All right. Thank you for the time.
Our next question comes from line of Jason Seidl with Cowen. Please proceed with your question.
Thank you, operator. Good morning, everyone. First question has to do with your CapEx going forward. Obviously, with shutting down some of your lines that you've had with coal and looking at the shutdown, I think what'd you say, you have 1,500 miles of track rearranging some of your locomotive needs and car types. Where is the new mix going to be? Is the mix going to change in terms of what you're investing in as we look at Norfolk Southern in 2020 versus 2015?
Well, by 2020, we will be done with PTC, so you'll see that roll out. You'll see more focus on core investments in our core network. That'll certainly be part of the equation all the way out to 2020. We will continue to invest in locomotives and equipment, other structures and other critical aspects of infrastructure. Other than the absence of PTC, no major change in the mix of our investments other than perhaps greater concentration on core lines.
Okay. That's a good clarification. Marta, just to get some clarification for 2017, kind of in relation to everyone trying to pinpoint an EPS number for you. You talked about your tax rate dropping down. It sounded like there were several items that hit it, but it sounded like some of these items might be continuing into 2016 here. What should we look at in terms of your tax rate for the year?
Yes, you are correct about that. The Tax Extenders Act also extended the credits already for this year. We would expect, in prior years, we've guided to an effective tax rate about 37.5, but for 2016, we think it'll be more like 37 even.
37 even. Okay. Thank you so much for the time, as always.
Our next question comes from the line of Ken Hoexter with Bank of America Merrill Lynch. Please proceed with your question.
Great. Good morning, Jim, Marta, Mike, and Alan. If we look back at the plan on page eight, you see a lot of revenue growth and I just want to understand in this slower growth market, you're expecting pricing to scale up to 2.5% from zero the last few years, your volume growth to accelerate. I don't know, it says 2015 to 2020, so I don't know if you're counting 2015 and 2016 within that CAGR, which would be a pretty big upside for 2017 through 2020. More importantly, how much of the 65% is built on revenue top line versus the costs that you've laid out?
In the plan, revenue growth is an important driver of operating ratio improvement and bottom-line improvement as well. Right now is a difficult environment in which to pitch growth. We understand that. That's why we're so focused on cost savings right now. Cost savings, keeping our service at the current level, and running a safe railroad are our top priorities in 2016, and we will do what we need to do to achieve the results. That's the other thing to appreciate about the plan. It's a flexible plan, a dynamic plan. If we need to pivot to a different strategy, we certainly can and will.
Okay. Is there a limit of how much in that 65 is tied to the top line versus your cost? I'm just trying to understand, at least for the base case that you've set, so as things change, we can understand what shifts need to be taken on, maybe more aggressive cost cutting. Is the plan based half on top line, half on costs, or as it is right now?
There are elements of both in the plan. It's a balanced plan. We think it's the right plan for our markets, our customers, and our franchise. It does assume some volume growth and pricing as well. Now, Alan feels confident about the pricing potential here. The volume growth is obviously a bit more of a wild card. We think we have the opportunity to grow volume over this five-year period. Pricing coupled with even modest growth is an important driver of bottom-line performance for us and everybody else in the industry. If we have to pivot to a different strategy and take the expenses down even more aggressively, we will.
Thanks. If I could do my follow-up on Triple Crown, Alan, maybe just a little bit on volumes. Why did the Triple Crown, when you shut it down, volumes not turn back to intermodal? Did it lose to truck or are they still in transition? Then, I guess ultimately, why was it eliminated? I presume because it wasn't additive to margin. Just want to understand that shift in the business, why you weren't able to recapture it in kind of different ways, whether it's through third party or what have you.
Ken, that's a good question. We worked with our channel partners to get as much of it back as possible. Almost by definition, the Triple Crown franchise was set up not to compete with our conventional intermodal franchise. There's not a lot of overlap. It's not yet fully defined how much will move back into our intermodal network. Frankly, Ken, we're seeing some move into our merchandise network too, which, once again, underscores the benefit of our improved service product that our merchandise network can compete for Triple Crown business.
Remember-
It's still in transition is what you're saying. Because it seems like a lot of, obviously, that opportunity, was it lost again to truck, or is it still moving around?
Ken, most of it will ultimately be lost to truck because our conventional network does not run in a lot of the lanes that Triple Crown ran in.
The important takeaway here, though, is as we have said, despite the volume decline, we expect the restructuring to be accretive to earnings modestly.
Okay. Helpful. Thank you very much for the time. Appreciate it.
Our next question comes from the line of Justin Long with Stephens. Please proceed with your question.
Thanks, and good morning. I wanted to just follow up on the 2016 volume question to be clear on that front. Is your guidance for a sub 70 OR assuming that volumes are down this year? If so, could you talk about the magnitude of the volume decline you're expecting?
The volumes are currently in play right now, and it's a tough start to the year, no doubt about it. If we're heading into a recession, this is going to be a tough slog for everybody. We will pivot to additional cost cutting if we have to. The sub 70 operating ratio is our goal. We're going to do whatever we possibly can short of going into a recession. That makes life difficult for all of us, for sure. Sub 70 is our goal. We're working hard to achieve it through a combination of expense reductions and whatever volume and pricing increases we can manage.
Okay, got it. Maybe to just follow up on the OR target for 2016. You highlighted in 2015, the OR was 71.7 when you exclude the impact from Roanoke and Triple Crown. Is there any way to frame up how much of the improvement off of that base you expect in 2016 just from the strategic changes you've made if you total up the impact from Roanoke, Triple Crown, and some of the other changes in the coal network?
Again, remember, we're comparing to GAAP results, including the restructuring charges in 2015. That gives you a head start on lower expenses right there in 2016, but that doesn't factor into the $130 million in productivity savings we're looking for.
Okay, one last quick one on that. Marta, sorry if I missed this, D&A, obviously, has taken a step up. What's your expectation for D&A this year?
Pardon me. What did you say? Depreciation?
Depreciation and amortization. Yeah. That was up in part because of the Triple Crown restructuring.
Yes. Depreciation, when you exclude the restructuring charge, was up $10 million in the fourth quarter, we would expect a similar amount in each quarter, to increase at each quarter in 2016.
Okay. Very helpful. Thanks for the time.
Thank you.
Our next question comes from line of Cherilyn Radbourne with TD Securities. Please proceed with your question.
Thanks very much, and good morning. Your service metrics improved quite significantly in Q4, it looked like a lot of that was pretty back-end loaded. From a cost perspective, even though your T&E overtime was down and your recrews were down, it would seem like you wouldn't have realized that full benefit in Q4. Was just wondering if you could help us think about that particular issue.
That's true. We did not see the full benefit of the service improvements in terms of expense reductions in Q4. Mike, talk a little bit about the trend and what we expect in the first quarter.
Yeah. If you look at the service metrics through the quarter, they did improve each month through the quarter, it was near the end of the quarter that we got back to our historic highs, which is what we're currently operating at. That's why we feel like the productivity savings we've got going forward are going to be very achievable because we did get to that level now.
Do you happen to have what T&E overtime and recrews would have looked like year-over-year in December as an example?
Hang on just a second.
What's the question?
What did it look like in December to give us a run rate for first quarter?
Just for T&E. Well, I gave the whole $13 million was for the entire quarter, Mike, the reduction in overtime. What we're saying is that occurred disproportionately-
Right
in December.
Right. Correct. We don't have that broken out just by December.
Okay. That's fine. It was back-end loaded.
Correct. Yeah. It was back-end loaded as the improvements happened sequentially each month through the quarter.
Great. That's all my questions. Thank you.
Our next question comes to the line of John Larkin with Stifel. Please proceed with your question.
Hey, good morning, everybody. Thanks for taking my question. Just wanted to dive a little more deeply into the rationalization of the coal network, which I guess will net 1,000 fewer track miles this year and 1,500 in total through 2020. Are there any regulatory hurdles that have to be negotiated through here, especially this year, as you're talking about taking so many miles out of the system, particularly if there's an abandonment that is required given that maybe some of these lines aren't going to be attractive to short line or regional railroads?
First, the 1,000 miles we are targeting in 2016 and the 1,500 by 2020 are not limited to the coal network. That would be across the entire expanse of our network. Now, a lot of that will be in the coal fields, for sure. Second, in general, these line rationalizations would not require regulatory approval because they would not be full-scale abandonments.
Okay. Thank you. I think you called out the continuing program to convert DC locomotives over to AC locomotives. Could you give us a sense for how many locomotives are involved in that program and what the savings per locomotive would be relative to purchasing new AC locomotives?
It's an important program, very important part of our long-term capital strategy for locomotives. Mike?
Yeah. If you look at the run rate, you have to look at it pretty far out because we've got about 1,200 of these Dash 9 locomotives that are starting to hit the age where you got to do something with them. We'll be doing these 1,200 locomotives over the next 10 plus years. The cost to rebuild about half the cost of a new locomotive, and we get a great reliable locomotive with increased tractive effort. We're pretty excited. The early indications are really positive on the test results.
Order of magnitude on the savings per locomotive may be in the neighborhood of $1 million, $1.5 million, somewhere in that range?
Capital versus buying new?
Yes.
Yeah, that's probably about right. Yep.
Thank you very much.
Our next question comes from the line of Jeff Kauffman with Buckingham Research. Please proceed with your question. Mr. Kauffman, your line is live.
Thank you very much. Sorry, I had you on mute. Most of my questions at this point have been answered, but let me come back to Marta with a detail question. When you're talking $2.1 billion of CapEx, that's a gross CapEx number, right? Not a net CapEx number?
That's correct. That's all of our capital for 2016. The components are in that pie that was in one of my slides.
Okay. I saw the slide. I just want to make sure I was counting it right. That's it. All my other questions have been answered. Good luck. Thank you.
Okay, thank you.
Our next question comes from the line of David Vernon with Bernstein Research. Please proceed with your question.
Hey, good morning. Alan, just a question for you on the fuel surcharge programs. It says here on the slide deck that you're shifting from WTI to diesel. I guess the first question is, are you expecting to get 100% of the fuel revenue that you lost through these new fuel programs, or will we also be seeing some of that recovery in the lost fuel revenue in core price?
We're going to see much of the recovery in core price because new fuel surcharge programs are paying pretty low also. As we compete with modal competition, their fuel surcharge programs are low too. We are focused primarily on price
We do not want to give up price to move to an on-highway diesel fuel surcharge program, but we are making progress in that arena.
As far as the progress you're making, is this a number of years to get that lost fuel revenue back as core price? Is this like a three-year, five-year, one-year? How long do you think this is going to take to reclaim some of that lost value that you had from the design of the surcharge program?
David, it's a multi-year program for us because our contracts average a term in excess of three-plus years. So that's one hurdle to getting it done immediately. The other hurdle is the volatility in the commodity prices. Once again, our commitment to focusing on price and not giving up pricing just to move to another fuel surcharge program that may also be out of the money.
Okay. Then, Marta, maybe just as a quick follow-up. The $200 million a quarter so that you're going to do through buybacks, are you planning to add more leverage this year, or is this all going to come organically from operations?
We'll add leverage in keeping with the size of our balance sheet. If you look over our past few years of our balance sheet, you can see that we're borrowing up to about 2.5x EBITDA. We're going to keep our balance sheet strong, keep within our credit ratings band. It'll be a mix of using the cash that we have on hand, the profits from operations, and leverage.
Okay, we should expect some added leverage this year then?
Yes.
Okay.
Thank you.
Our next question comes from the line of Tyler Brown with Raymond James. Please proceed with your question.
Hey, good morning. Hey, Marta, just real quick on the CapEx pinwheel in the deck, can you guys split out the $2.1 billion between growth and maintenance CapEx?
Yes, we can. It's basically in line with what, as Jim said, with not a huge change from our past strategy. If you pull out PTC, which you could see.
Right
In that wedge there is about $246. The remainder is about two-thirds, one-third core and growth.
Okay, perfect. I'm curious, why does that 17% of sales feel like the right spin number by 2020? You've got PTC falling off. You're going to have 1,500 miles of mainline that'll be rationalized. Service creates latent capacity. All the heavy lifting on intermodal has long been done by that point, and your loco plans really focus more on rebuilds. Why wouldn't that number potentially be a lot lower than 17? I guess I just want to be comfortable that you and the board are really focused on maximizing free cash flow and not necessarily OR EPS.
Of course. Of course, we're very focused on free cash flow, free cash flow equals cash from operations minus capital spending. From that standpoint, lower capital spending is better. We do certainly have a lot of replacement needs going forward, it's a very asset-intensive business we're in here, and we expect to continue to invest appropriately, prudently, but responsibly to keep that investment in great shape for our customers.
Real quickly to that point, though, you're spending, call it $600 million for growth this year. Is that about how much capital you need to spend to simply grow the business 2%-3%?
Well, I think by 2020, the growth capital starts to moderate, probably before then. In fact, as you know, we have built out a best-in-class intermodal terminal network. We're in the final stages of completing that terminal network. That takes some of the pressure off the growth part of CapEx. It's conceivable we could bring CapEx down further. That certainly would be healthy from the standpoint of free cash flow, we also want to make sure that we are investing responsibly for a safe and efficient operation.
Yes, I think you should consider that 17% to be just a general guideline.
not to exceed sort of thing, not a.
Okay, perfect. Thank you, guys.
Our next question comes from the line of Cleo Zagrean with Macquarie. Please proceed with your question.
Good morning. Thank you for your time. My first question is about the flexibility of your five-year cost reduction plan. Where is the highest flexibility you see? Please help us understand where is the highest opportunity for cutting costs, like you said, without affecting services, maybe by highlighting where you think your network offers more opportunity versus peers. In case demand is lower, what kind of pivoting do you have in mind? Thank you.
We went through the categories of cost savings we're targeting in the $650 million. Labor is the biggest contributor, then reduced fuel consumption, the car fleet, and locomotive maintenance. Additional cost savings would come from all of the above. We would be seeking to pull each of those cost levers even harder if we have to, we would be seeking additional cost savings as well through adjustment of our network in a kind of long-term down volume scenario.
Appreciate that. My follow-up relates to intermodal. This quarter, we saw pricing down about 2% ex-fuel. Can you help us understand what drove that? Was it new business? Was it renewals with existing customers, some mix impact? If you could share with us your outlook for price and volume growth this year for domestic and international, I would really appreciate that. Thank you.
Alan?
Hey, Cleo, the reason that we saw the decline in pricing or RPU ex-fuel for intermodal in the fourth quarter was the Triple Crown restructuring. If you strip that out, RPU ex-fuel for intermodal was actually up
4%, reflective of the pricing action that we've taken throughout the year. Our customers are committed in the intermodal network to long-term growth, they understand that we need to be able to invest in the network to accommodate the growth. We're taking a long-term view of this. We're accelerating pricing across all markets as we push to a disciplined market-based pricing approach. Intermodal will be taxed in the first half of the year due to the Triple Crown restructuring. As we bring back more domestic business with our improved service product and continue to benefit from shifts to East Coast ports, we expect volumes in our intermodal franchise to improve throughout the year. Thank you very much.
Thank you. Our final question will come from the line of Benjamin Hartford with Baird. Please proceed with your question.
Thanks for fitting me in here. Take a look at that five-year outlook for intermodal, the 5% annualized growth. I'm assuming that domestic intermodal, you're expecting to exceed international. One, I want to confirm that, and then two, if that's the case, kind of implied upper single-digit annualized domestic intermodal volume growth going forward. I mean, is it safe to assume that your intermediate-term outlook for domestic intermodal really hasn't materially changed, despite the fact that crude now is close to $30 as opposed to $100 about a year ago? Any perspective on that would be helpful. Thank you.
Compared to the compound annual growth rate for our intermodal franchise in the last five years, we actually do see a slowing of growth. Alan, give us a little color on that. Yeah, Ben, frankly, it's consistent with the rest of our five-year plan. It's conservative. It is less than what we've had in the past, but it's a number at which we can continue to push price and continue to encourage additional business on our lines. As trucking regulations are implemented in the last half of 2017, that will be a spark for domestic intermodal growth. We've talked frequently about the strength of our international franchise and the continued shift mix from West Coast to East Coast ports and our strategic alignment with shipping partners who are adding capacity to the East Coast.
Okay, in that 5% outlook, do you have assumed domestic intermodal volume growth exceeding international?
It approximates, so we feel like there's a level of conservatism in our plan.
Okay, great. Thank you.
Thank you. We have reached the end of the question and answer session. Mr. Squires, I would now like to turn the floor back over to you for concluding comments.
Thank you all for your questions today, we look forward to speaking with you next quarter.
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.