Greetings, welcome to the Norfolk Southern third quarter 2015 earnings call. At this time, all participants are in 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 from 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 for Norfolk Southern. Thank you, Ms. Cook. You may now begin.
Thank you, Rob, 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 Investors 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 Investors section.
Now, it is my pleasure to introduce Norfolk Southern Chairman, President, and CEO, Jim Squires.
Thank you, Katie. Good morning, everyone, welcome to Norfolk Southern's third quarter 2015 earnings conference call. With me today are our Chief Marketing Officer, Alan Shaw, our Chief Operating Officer, Mark Manion, and our Chief Financial Officer, Marta Stewart. Earnings for the quarter were $1.49 per share, which was 17% lower than last year's record of $1.79 per share and included $0.08 per share of expenses related to restructuring initiatives. The results also reflect softness in the commodities markets, most significantly in coal, where our revenues were down 23% in the quarter. Alan, Mark, and Marta will cover the various moving parts of the quarterly results momentarily, before delving into that, let me highlight the progress we made on some longer-term initiatives during the third quarter. First, we began restructuring our Triple Crown Services subsidiary.
With the restructuring, Triple Crown will focus on transporting automobile parts, while NS will work with other supply chain partners to bring non-auto parts business into our conventional intermodal network. Second, our headquarters consolidation initiative is mostly complete, with employees formerly in Roanoke, Virginia, now working in Atlanta or Norfolk. This initiative allowed us to combine some functions while reducing management headcount and G&A expenses from having three back-office locations. It will give us a more cohesive and focused approach. For example, in sales and marketing, where all managers not in the field are now co-located. Third, we completed the acquisition of the Delaware and Hudson Railway Companies line between Sunbury, Pennsylvania, and Schenectady, New York, from Canadian Pacific on September 18th.
This relatively small scale but highly complementary transaction gives us full operational control of an important network segment and greatly enhances our ability to serve markets in the Northeast. Implementation has gone very smoothly. These three long-term initiatives are in addition to our ongoing and continual efforts to improve service, asset utilization, and returns. In that regard, I'm pleased to report that service improved in the third quarter, and we are in good shape moving into the fall season this year with the onset of winter weather just a few months away. As you will hear from Mark, key resources like crews and locomotives are reasonably well-balanced with demand right now. While at the same time, we are looking hard at underutilized assets in some parts of our network.
Now, without further ado, I'll turn the program over to Alan, Mark, and Marta, and we'll return with some closing comments before taking your questions. Alan?
Thank you, Jim, and good morning to everyone. We appreciate you taking the time to join us today. There are four significant factors influencing our 2015 revenue. First, fuel surcharges are the primary driver of the revenue decline we have been discussing since the first quarter. The third quarter marks our largest expected quarterly drop in fuel surcharge revenue with a $255 million decrease. Second, low commodity prices and the strength of the U.S. dollar adversely impacted volumes of coal, steel, frac sand, crude oil, and export traffic. We estimate that almost 50% of our revenue base is tied to commodity pricing or foreign exchange rates. Additionally, inventory builds have softened freight shipments since the second quarter. Despite these challenges, international intermodal, automotive, and natural gas products all had large gains in the quarter.
Third, increased truck capacity, low diesel prices, and service levels reduced the pace of highway conversions in 2015. We expect truck capacity to tighten, which, coupled with continued improvement in rail service and Norfolk Southern's network reach, will allow us to secure additional demand moving to rail. Fourth, we've employed solid pricing as demonstrated by gains in our RPU ex-fuel overall and for all three primary business groups. We've achieved these positive results despite negative mix associated with decline of several commodities previously referenced and increased international intermodal. Continued focus on pricing has allowed us to improve total RPU ex-fuel each quarter this year, despite continued negative mix. During contract negotiations, we focus on both price and the fuel surcharge program for the best overall long-term result for Norfolk Southern, recognizing that the average duration of our contracts is in excess of three years.
We have emphasized market-based price increases and will continue with this focus, reflective of the long-term benefit of rail transportation. The strength of our diverse network, including our intermodal and automotive system, transfer terminals, and alignment with our short line partners and the customers they reach, gives us the opportunity to continue to provide right opportunities for growth. Our service continues to improve, and as it does, as aggregate demand strengthens, thereby negatively impacting trucking availability, we anticipate a return to strong domestic intermodal conversion in tandem with pricing strategies that are sustainable. As our business mix changes, we continue our focus on the bottom line by evaluating our network for opportunity to increase earnings per share. A good example of these strategic structuring efforts is our recently completed acquisition of the D&H South Line, streamlining operations in the Northeast and offering a more service competitive product.
Similarly, we recently announced the restructuring of our Triple Crown subsidiary, which will reduce revenue beginning in the fourth quarter, is expected to be accretive to our bottom line next year and allows a more efficient use of capital. Turning to the third quarter results on slide three, our revenue declined $310 million, primarily due to a combined $342 million decrease in coal and fuel surcharge revenue. Focusing on our coal franchise, revenue declined by 23% due to a decrease in fuel surcharge revenue, followed by lower export and utility coal volumes. Utility reductions were driven by materially lower natural gas prices that impacted the dispatch position of coal plants on our network. This, combined with stockpiles above target levels, led to a 10% decline in our utility market to 22 million tons, above our previous guidance of 20 million tons per quarter.
Export coal tonnage of three and a half million tons was challenged by weak macroeconomic conditions, low benchmark prices, and a strong US dollar. While risk in this market exceeds that of utility, we continue to guide to three million tons per quarter through 2016. Our domestic intermodal volume declined 5% due to network service challenges, lower fuel prices, and increased truck capacity. Domestic intermodal pricing remains strong, despite short-term truck capacity increases and softer truck spot pricing, we maintain a long-term projection of continued pricing gains and conversions to rail due to the value of the intermodal product as service improves. Driver availability, hours of service, and electronic logging devices have positively influenced pricing, leading shippers to lock in capacity for next year.
Our international intermodal volume grew by 9% due to growth at both East and West Coast ports, as well as freight shifting from the West to East Coast ports, taking advantage of our network reach and alignment with shipping partners. Closing with our merchandise markets, the strong dollar and low commodity price environment negatively impacted steel, frac sand, crude oil, and export grain. Conversely, strong consumer spending assisted with gains in automotive, ethanol, construction materials, and plastics. Lastly, volumes of natural gas liquids improved due to increased fractionator activity on our network, and domestic grain shipments grew due to regional crop opportunities. Moving into the fourth quarter, we anticipate volume declines in our commodity and export markets.
Sequentially, most of these markets will remain flat compared to the third quarter, although steel has the potential for further decline and export coal will likely be closer to our guidance of 3 million tons. These continued declines in commodity prices and the Triple Crown restructuring will lower fourth quarter volumes compared to last year, with the year-over-year rate of decline expected to be similar to that of the third quarter. Next year, we will clear the negative comps in the utility franchise, which was influenced by significantly higher natural gas prices and stockpile replenishments in 2014. We continue with our guidance of 20 million tons of utility coal per quarter.
As stated earlier, the Triple Crown restructuring will allow Triple Crown to focus on its auto parts business, with NS working with our shippers and channel partners to convert as much of the other business as possible to the conventional intermodal network, although the footprint of Triple Crown differs from our conventional network. As Triple Crown provides a door-to-door retail service restructure that's expected to negatively impact intermodal revenue per unit, although be modestly accretive to earnings next year. Reduced fuel surcharge revenue will continue to be a headwind in the fourth quarter, although we will lap this comp after the first quarter of next year. Long term, we will continue to focus on market-based pricing gains while better aligning our fuel programs with expenses.
Despite the headwinds mentioned, our customers understand the value of rail transportation, and as service continues to improve, we have the opportunity for market-based price increases and to grow our franchise. We expect growth opportunities in our consumer-based markets that include intermodal and automotive, as well as housing and construction-related commodities, ethanol, and basic chemicals. We also expect the impact of inventory builds, which will have a dampening effect in the fourth quarter, will lessen by the first quarter of 2016. Norfolk Southern sits at both ends of the economic spectrum, production and consumption. This diversity has helped us during economic downturns and is a continuing strength of our franchise. Today, we are seeing growth, particularly in automotive and the international side of intermodal. The strong dollar is a challenge, as is macroeconomic weakness overseas, which contributes to lower aggregate demand.
Regardless, we are well-positioned in multiple strategic markets for growth. As we move forward through the fourth quarter and into 2016, we will continue to partner with our customers to pursue strategic solutions that capitalize on market opportunities that create efficiencies and improve network productivity while generating growth beneficial to the bottom line. Thank you for your attention, and I will now turn the presentation over to Mark.
Thank you, Alan, and good morning, everyone. This morning, I'll update everyone on our operation, which continues to trend positively. Specifically, we've seen year-over-year as well as sequential improvements in our service composite, speed, and terminal dwell. While we still have work to do, we are encouraged by these results. First, let's take a look at our safety. Our reportable injury ratio was 1.05 for the first nine months of 2015 as compared to 1.19 for the same period last year. The train incidents for the first three quarters of this year were 143 versus 154 over the same period last year. Grade crossing accidents through September 2015 were 255, down from 286 over the same period in 2014. Turning to our service composite performance, we see services returning at a steady pace. We're optimistic we will continue to experience improvement as our resources are largely in place.
With regard to manpower, we have a sufficient crew base. In the third quarter, we added about 200 T&E employees. We've modulated our hiring based on volume, and we now expect our T&E count in the fourth quarter to be flat with the third quarter. With regard to locomotives, we have a sufficient number of locomotives to handle our business. Furthermore, our locomotive availability continues to improve due to improved velocity. Lastly, our operating plan in connection with our new yard expansion in Bellevue, Ohio is fully implemented and is benefiting us across the system. Turning to the next slide, we see train speed and terminal dwell are improving as well. Our speed for the quarter improved 3% year-over-year, and our dwell has improved 6%. These system improvements are important. It's also important to note we have seen solid improvement on our Chicago to Harrisburg line.
This line handles the highest volumes on our system with a heavy concentration of intermodal. Our third quarter premium intermodal speed for this route is nearly what it was in 2013, and recently, that speed has actually exceeded 2013 levels. In addition to the efficiencies we're seeing with our improving operation, we're continuing to make strategic reductions associated with our decrease in coal volumes. We have made manpower reductions at our Lambert's Point coal pier, as well as in the Central Appalachia and Northern Appalachian region, which encompass all of operations, not just transportation. Furthermore, we continue to make changes to some of our coal routes, with the most recent affected lines highlighted on this map. We've also reduced capital spending on branch lines where we've seen lower coal mine production.
These contractions to our employee counts and infrastructure have been a result of our continual efforts to match our level of investment to a changing marketplace. With that, I will now turn it over to you, Marta.
Thank you, Mark, and good morning, everyone. Slide two summarizes our operating results for the third quarter. As Alan has already discussed, the 10% decrease in revenues was largely related to lower fuel surcharge and to lower coal volume. Operating expenses in total declined by $134 million or 7%. Expenses benefited from significantly lower fuel prices but were unfavorably impacted by restructuring costs. The net result was an 18% reduction in income from railway operations and a 69.7 operating ratio for the quarter. The next slide shows the major components of the $134 million or 7% decrease in expenses. Favorability in the compensation and benefits category also contributed to the decline.
Before we get into the detail of the operating expenses, let's take a look at the effect of the restructuring costs on slide four. The first column shows the Triple Crown related charges. As Alan described, our Triple Crown Services subsidiary will, beginning in mid-November, be refocused exclusively on its auto parts business. Therefore, the bulk of the RoadRailer equipment used by Triple Crown will be surplus at that time. The $26 million shown as accelerated depreciation is the third quarter charge for Triple Crown equipment. Turning to the Roanoke closure costs, they totaled $10 million in the quarter and consisted primarily of moving and office space expenses, which are reflected in the materials and other and in the purchased services line items. These costs added $37 million to the quarter and impacted the bottom line by $23 million or $0.08 per share.
Going forward, we expect these two items to total $45 million in the fourth quarter, with Triple Crown restructuring costs of $36 million and Roanoke office closure costs of approximately $9 million. Let's take a look at the major expense line items. As shown on slide five, fuel expense decreased by $166 million or 43%, the majority of which was driven by lower fuel prices. Slide six details the $26 million or 4% decrease in compensation costs. Bonus and stock-based compensation expenses were lower by $51 million, resulting from the decline in financial results. We expect fourth quarter incentive compensation will be about $20 million lower than last year. Pay rate and payroll tax increases, as we discussed in the second quarter earnings call, began to moderate after July 1st. They were up $17 million and $9 million respectively.
We continue to run with a somewhat higher level of trainees, and that expense was up $6 million. Materials and other costs decreased $3 million or 1%. Material usage, primarily associated with locomotives and freight cars, declined by $10 million. We also had lower derailment expenses. These items were partially offset by the aforementioned restructuring costs. As shown on slide eight, depreciation expense increased by $39 million or 17%, due largely to the effect of accelerated depreciation of Triple Crown assets, and also as a result of our larger capital base. As Jim mentioned, we completed the acquisition of the D&H line during the quarter, and this increased our capital base by $215 million. Purchased services and rents were up $22 million or 5%, reflecting higher costs associated with equipment rents, engineering expenses, and the Roanoke closure.
As noted by Mark, velocity and terminal dwell have continued to improve. We expect these expenses decline sequentially in the fourth quarter. Other income reflected on slide 10 rose by $7 million or 22%, aided by $19 million in higher gains from sales of property, offset in part by decreased returns from corporate-owned life insurance and lower coal royalties. Slide 11 depicts our income tax accruals and effective rate. The 37.6% third quarter rate is in line with our full year guidance of 37.5%. Net income decreased by $107 million or 19%, and earnings per share was down $0.30 or 17%, inclusive of the $0.08 of restructuring costs. Thank you. I'll now turn the program back to Jim.
Thank you, Marta. As you've heard this morning, further softening in the commodities markets weighed on our third quarter results. It has tempered our fourth quarter outlook as well. We now expect fourth quarter volumes will decline versus last year at a rate similar to our third quarter results. This year obviously has been a challenging one. We didn't deliver the kind of improvements you and we expect. Looking to 2016, we are confident that with a reasonably stable economy and our own intense focus on service returns and growth, we are poised for better results. Thank you for your attention. We are now happy to take your questions.
Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 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. Due to the number of analysts joining us on the call today, we will be limiting everyone to one primary question and one follow-up question to accommodate as many participants as possible. Thank you. Our first question is from Thomas Kim with Goldman Sachs. Please go ahead with your question.
Good morning. Thanks for your time here. Obviously, this is an encouraging set of results, and we're certainly pleased to see the improvements on the cost side. I wanted to ask just a first-off question with regard to some of your cautious comments around the near-term demand outlook. How do we reconcile that with some of the increased training costs and your headcount expectations near-term?
Tom, let me answer that first. Obviously, we have some short-term headwinds in terms of the trend in commodities and business conditions generally, offset by continuing strength in some of our consumer markets. Our strategy is designed to carry us through economic cycles because it focuses on fundamentals. First, service, excellent service will allow us to increase prices and reduce cost. Second, return on capital because we're a very capital-intensive business, and every dollar that we spend must have revenue and profit generation potential. Third, growth. We do want to grow our top line and see opportunities to do so even in a so-so economy. We'll do that first through price increases, second through volume growth utilizing existing assets, and third, and only as necessary, growth through capacity additions. That, in a nutshell, is our strategy. We think that will carry us through changing business conditions.
Let's talk about the short-term resource picture. As I mentioned, we view key resources, crews, and locomotives as essentially in balance with demand as we see it today. With that said, we are going to be nimble with resources, and if business conditions change, so will our resource strategy. Marta, why don't you talk a little bit about the specifics around headcount trends and other efficiency-related spending?
All right, sure. Tom, we had earlier guided that we thought we would increase headcount about 1,000 for the full year. As Mark said, we're now up about 800 from the fourth quarter of last year to the third quarter of this year. As Mark said, we now do not think we're going to add that additional 200 for the end of the year. We think we're going to stay flat through this year and looking into 2016, as Jim just described, we think that's the right level for the company.
Okay. Just on that point, if I could ask maybe a bit of a longer-term question. As we've looked through your headcount and overall productivity, we've seen volumes effectively peak around 2006, and volumes even against last year's levels are still below that prior peak. Your overall headcount levels are still at the 2006 levels. I guess I'm wondering, is there something structurally that's changed in your book of business that requires more headcount per car load, or does this present perhaps an opportunity to improve productivity? You kind of alluded to the fact that as velocity increases, you potentially have room to be actually driving productivity further. If you could just maybe elaborate a little bit more about the longer-term outlook for us, because as we think about your OR, we certainly think and hope that there's opportunity to continue to drive that down.
One of the areas I've been looking at is just on the labor productivity side, it looks like you have room there to improve. I just wanted to get your perspective on how do I sort of think about the longer-term opportunity there, car load to employee headcount. Thank you.
Sure. Great line of questioning. We are absolutely focused on productivity. As the network velocity continues to increase, we will have opportunities to reduce headcount relative to the volume trend. Now, Mark, why don't you comment on that?
Yeah, I'd be glad to. We actually started modulating our hiring on the T&E side, particularly back last summer. We've been hiring more to attrition levels ever since midsummer and anticipate that will continue to go on, again, dependent on the business volumes. As our velocity continues to increase, there are just great things that happen with that. Aside from the customer service side, which is favorably impacted as well, those velocity increases really help us on the cost side. It helps us reduce our employment. It helps us reduce our overall asset base. We will have the advantage of picking up more locomotives as a result of that. Our expenses decrease as our asset turns increase. Another thing that we see is recrews go down, and in fact, they've been going down.
Even third quarter, recrews were down 6%. We'll continue to see that trend. Our overtime was down on the T&E side, not overall, but I think we'll continue to see a favorable trend on the overtime piece as well. We'll see that in the fourth quarter. We will continue to see that going into next quarter. Even things like our engineering department, as our fluidity improves, as our velocity improves, we can be more scheduled with our engineering department. They get more track time. They get out on the track when they need to be. They don't accumulate the overtime they otherwise would. In short, improved velocity just drives a lot of good things when it comes to cost reduction.
I appreciate that detail. Thanks a lot.
Our next question is from the line of Allison Landry with Credit Suisse. Please go ahead with your questions.
Good morning. Thanks for taking my question. First, I was wondering if you could talk about the decline in domestic intermodal, and particularly relative to your main competitor, which saw a 15% increase in the business. What I was wondering is if you could quantify or help to frame any potential share losses there, and whether you expect to fully recapture those volumes and over what period of time.
Sure, Alan, why don't you take Allison's question on that?
Allison, the story for our domestic intermodal franchise is one that I highlighted earlier. It's been fuel, it's been truck capacity, and it's been a service product that conducive to shifts to rail. That's going to get fixed. We're already seeing improvements in our velocity in our intermodal, and we're starting to see an uptick in our intermodal volumes. On the domestic side and certainly on the international side, we've seen great strength this year with more volume through the East Coast and our alliance with our shipping partners who are adding more capacity from the Far East to the East Coast, and we expect the same next year. We feel very good about our intermodal franchise going forward, both domestically and internationally.
My follow-up question on coal, thinking about the RPU on an ex-fuel basis being up slightly year-over-year. Could you talk about some of the dynamics there that pushed that to the positive side of the ledger? Was it mix? Was it the lapping of rate cuts on the export side or a shift to fixed/variable contracts?
Sure, Allison. Actually, we've experienced negative mix within our coal franchises. We had a 37% decline in export, which as you know, tends to be longer haul, which is effectively a proxy for RPU. Despite that, we've gotten increases, and it increases in our RPU. Although very slight, it is a positive, and we're going to hold on to that. It's a function of our long-term pricing strategy in the coal markets, and we feel very good next year because we're not going to have that negative comp in coal with respect to the utility franchise that we did this year.
Okay. Thank you.
Our next question is from the line of John Barnes with RBC Capital Markets. Please go ahead with your questions.
Hey, a follow-up question on the domestic intermodal side. In terms of the service that you're providing, and I think I'm hearing you say that you're not in a position yet where you're offering a truck-like product. Is that harming you more on the length of haul? Are you still very competitive on the longer stuff, but it's putting pressure on the shorter length of haul where at higher diesel fuel rates, you are becoming more competitive?
John, let me comment on our domestic intermodal strategy briefly, and then I'll let Alan address the specifics of your question. We certainly do want to grow our domestic intermodal business, and we have a service product that allows us to do that today. Can we be even better and attract even more freight from the highway? Absolutely. That's our goal. Now, with that said, our growth strategy in domestic intermodal is a combination of volume growth and pricing. Pricing is absolutely critical in that franchise as it is elsewhere. Our strategy is to grow that business as with our other businesses through price increases, through volume growth using existing assets to the maximum extent possible, and last, through increases in capacity, but only where necessary. Alan, what about the specifics of John's question?
John, to your question with respect to if there's a difference between length of haul and our ability to retain business or grow business due to fuel, we have not seen that.
Okay. All right. No worries. In terms of network realignment, I guess just from the standpoint of, and I'm thinking more on the coal export side. You own more of your assets there, whether it's the coal loading facilities and things like that. If we're now looking at a more permanently impaired export market, how aggressive can you be on realigning the cost around the export side of the business? Are there assets to shed, things along those lines that maybe better align those resources with the current volumes and then maybe even a little bit longer outlook, which again, looks to be maybe a bit more impaired? Thank you.
I'll get Mark to comment on some of the specific moves we've made in our coal franchise, following up on his commentary. Let me just say, we have fixed assets in our coal network as we do throughout our company, we are looking hard at which of those is underutilized, we will continue to do so. We have substantial fixed assets devoted to our coal franchise in the form of tracks and freight cars. One thing we can do and have done already is to begin working down the size of our coal car fleet. We can redeploy locomotives. That's a fungible asset. This is a notoriously volatile market. We don't believe that we've seen the best days of export coal. We think that the commodity cycle eventually will turn, those assets will be fully deployed again.
Mark, talk a little bit more about what we're doing in the coal fields.
Yeah, more current day. We've furloughed or are in the process of furloughing about 150 people, and that is across all the departments in operations, including transportation, mechanical engineering. We have, as I mentioned in the remarks, we've got lines that we have more recently either taken out of service or have pulled back on the investment for those lines. We continue to scrub the Central Appalachia as well as other areas in our coal franchise. Let's also keep in mind that we've got areas in our coal business where we've had some nice activity going on and continue to have promise for the Illinois Basin coal.
It's a bit of a mixed bag. We will continue to scrub that Central Appalachia in order to ensure that we're reducing our costs commensurate with the level of activity out there.
Thanks for your time.
Our next question is from the line of Jason Seidl of Cowen and Company. Please go ahead with your question.
Thank you. I wanted to focus a little bit on intermodal. Clearly, you've admitted you needed to get the service levels back up, and it seems like that's happening. That should be a good thing for freight as we head into 2016. However, longer term, how do you think about investments in that network profitability of that division as it takes over a larger percentage of the business whole?
Well, it's a good business. It's a growth opportunity, and it has been the volume growth engine of the company for years, and that's likely to continue given the export trends in trucking. With that said, we're going to be very judicious with our investments and make sure that they are revenue and profit maximizing, which is one of the foundations of our strategy. That applies to the domestic intermodal business as it does to all other businesses we operate. We should talk a little bit about international intermodal. That's a real bright spot right now. Alan, why don't you expand on that a little bit?
As we discussed, it's grown in the upper mid-single digits for the year. We anticipate a continued growth along that level in the near-term future as more volume matriculates over to the East Coast from the West Coast. Folks with whom we've aligned are adding capacity into the East Coast, and it allows us to build a lot of revenue density in our trains, it makes for a very efficient movement. We're excited about that and the growth opportunities and the returns that that provides.
Is there any way to quantify how much of that freight that moves over to the East Coast is sticky, and how much either went back or will go back after this year?
Yeah, some of it has definitely gone back. There is absolutely no doubt about that. Still East Coast volumes are up. As the Panama Canal widens, we're going to see even more larger ships hitting the East Coast, which are going to need to make multiple ports of call to discharge their cargoes. That's going to have a benefit for the ports that we serve all up and down the East Coast.
Are we going to see more on-dock rail at some of the ports, do you think, as that business comes in?
At least one of the ports has announced that, an infrastructure plan for that.
Okay. Gentlemen, thank you for your time.
Our next question is from the line of Thomas Wadewitz with UBS. Please proceed with your questions.
Yeah, good morning. I wanted to see if, Mark, I think in the past, you have talked about productivity targets, and I know with big change in volumes that some operating leverage effect. What do you think the kind of productivity number is that you might achieve this year, and how would you frame that opportunity for next year in terms of how you would de-define productivity? I think in the past you said something around $100 million. I wonder if you could offer some thoughts on that topic.
I'll take that one, Tom. We absolutely have productivity opportunities as we've been through this morning. As the network picks up speed, we will start to throw off a lot of productivity. We're also working on a number of business process initiatives and capital utilization initiatives that should lead to productivity benefits. All of that should add up to a sizable offset to volumetric and inflationary pressure on our expenses, particularly next year when operations are really humming.
Okay. Let's see. Then in terms of coal, how do we think about the I think you commented, Alan, that coal stockpiles are above target. I don't know if you could comment on maybe how far above target and whether that's a source of risk to your 20 million tons per quarter view that it's possible a couple of quarters you run below that to get the stockpiles down, and then you get back to that 20 million a quarter. Some thoughts on coal related to stockpiles.
That's a good question, Tom. We've actually seen stockpiles decrease in this quarter, even though we exceeded our guidance by about 10%. While stockpiles do have an impact, so far it has not negatively impacted our ability to hit our targets. Right now, Tom, we're estimating that stockpiles are about 15 days above target, and I would say about five days in the south and about 25 days in the north.
Okay, great. Thanks for the time.
Our next question is from the line of Rob Salmon with Deutsche Bank. Please go ahead with your question.
Hey, thanks. Another one here on coal. It looks like the tons per car increased significantly in the third quarter up to about 112. Can you give us a sense of what's driving that? Has this been the result of changes in the network, or is this merely business mix? Because we haven't been at this level for a long time.
Yeah, we're always focused on tons per cars. We in the coal network, we are paid by tons. Anytime you can improve the revenue density in a coal train, it's very For us. One of the factors that impacted the improvement in tons per car immediately into the third quarter was a continued decline in export volume. Metallurgical volume to the ports typically has a lower tons per car than utility volume.
Got it. I guess we should be thinking about something around these levels looking forward, given some of the challenges that are impacting the export book of business.
Yeah. To the extent that mix stays the same, yes. To the extent that we're continuing to work with our producers to get the optimum load level and the number of cars per train, we'll improve the profitability of the individual trains.
Thanks. That's really helpful. I guess turning it over back to intermodal as well as the pricing, we've been hearing a lot about truck capacity having loosened up, which has negatively impacted the overall spot market from a pricing perspective. Obviously, with Norfolk, we're seeing better service across the network with the velocity having ticked up here, as well as the service composite improved. How confident are you that we can see further improvement in pricing or just maintaining the level of pricing looking out to next year, given a tough volume environment outside of the coal franchise, as well as some weaker truck pricing that we're seeing in the marketplace?
Can you clarify, are you asking about pricing intermodal or overall?
Just overall pricing, just given what we're seeing in the trucking marketplace
Okay
with capacity having loosened up, somewhat offset by service improvement. How are you guys thinking about the ability to maintain current pricing or potentially improve it as we look forward?
We feel good about it, and we feel good about what we've accomplished so far, recognizing we have room to grow. Our RPU ex-fuel has grown each quarter of this year. Our customers are taking a long-term view of this, and they recognize the long-term value of rail transportation. Frankly, when service is back to where we want it to be, and we're making great strides to get there, then intermodal is a very easy sell, even with a tightening between the truck market and intermodal pricing. Lastly, I'll add that we're taking a long-term view of this. As Jim talked about, we're going to grow via price, and we're going to grow via utilizing existing capacity. Any additional investment that's required is going to have to generate an acceptable level of return.
Service-led price increases are a key component of our strategy, that applies to our domestic intermodal segment as well as all other segments of our business.
Rob, as you noted, spot pricing has gone down in the trucking industry, but contract pricing is still up year-over-year. Now it's moderated, but it's still up because shippers are concerned about long-term truck capacity. That certainly plays into the thesis for the value of rail transportation.
Thanks. Appreciate the thoughts.
Our next question is from the line of Matthew Troy with Nomura Securities. Please proceed with your questions.
Yeah, thanks, good morning, everybody. I just wanted to ask about coal, specifically related to your 20 million tons per quarter run rate going forward guidance. Would imply something kind of flattish as what you saw in 2015, a little bit more optimistic than the other railroads. Just wondering if you could help us maybe from a bottoms-up perspective, how you get there, how much of that might be under contract. Because I'm contrasting it with some pretty dire commentary from CONSOL Energy and Peabody Energy and other coal companies yesterday and earlier in the week about the outlook for domestic coal. I'm just wondering, be it mix shift, be it certain contracts you've secured, how you're confident that the coal volumes at 20 million per quarter will be flattish in 2016. Some help there would be great.
Okay. If you think about the current natural gas environment, most of the conversions from coal to gas have already occurred. Natural gas I know right now is close to $2 per million BTU, but the futures curve for next year is about $2.65 on average, which is pretty similar to where we were in 2012. We can model our volumes at the plants and units that we serve versus 2012. We also know that most of the near-term environmental headwinds associated with MATS, we've already been impacted by that. That's not going to be a headwind going forward. Now, longer term, the Clean Power Plan will potentially have an impact, and we're working with our customers to try to completely understand that and run scenarios within our own planning horizon.
Through 2016, based on our conversations with our customers and modeling how their plants performed in 2012, we feel good about our volumes of 20 million tons per quarter.
Understood. I guess my follow-up would be just if you could provide Triple Crown has had an interesting evolution under the Norfolk umbrella. If you could just refresh us in terms of the rationale for the restructuring, the focus on auto parts and your commentary, was interesting on how it would be mildly accretive next year. Could you just help us get from where the thought process was on Triple Crown, say, a year or two ago, to why this restructuring makes sense, and tactically, what's going to drive that accretion or efficiency or productivity relative to those assets? Thanks.
The strategy involves focusing Triple Crown on what Triple Crown does best, and that's transport auto parts and rechanneling with other supply chain partners, non-auto parts business into the conventional intermodal network, where those customers and that volume can enjoy maximum efficiencies.
Matt, you recall, Triple Crown was originally an auto parts network.
Right. This is just after a little bit of scope creep, it's just doubling down on the core competency of the business.
Right. It's going to improve our capital utilization by rechanneling as much of the other business, the freight all kinds, into our existing intermodal network where we already have the capacity.
Understood. Thank you for the time.
Our next question is from the line of Chris Wetherbee with Citigroup. Please go ahead with your questions.
Hey, thanks. Good morning. I think in the past you have recently talked about potentially volume increases in 2016. I guess I just wanted to get a sense in light of sort of what your view is on the fourth quarter and some of the challenges sort of shorter term in the business. How should we think about that? Is your thinking changing at all? Obviously, you've given the view on coal. I just want to get a sense, sort of the rest of the business, how you think about it for 2016 as the setup is right now.
Yeah, absolutely. We still feel very good about 2016. Our volumes year to date are down 1.2%. In an environment where we've had 20% declines in our utility coal franchise, 35% declines in our export coal franchise, and we haven't been able to attract highway conversions to our intermodal network. We're going to clear all of that next year. There is some underlying growth in international intermodal. We've talked about the automotive franchise is doing very well for us. Consumer goods are doing well. Once we clear some of these very visible comps or headwinds in the next year, then you're going to see, we're all going to see the benefits of the underlying growth in some of these other markets.
Okay. That's helpful. As a follow-up, just sort of switching to the pricing side, you mentioned earlier the focus on fuel surcharge adjustments and having to work through the book of business as it comes up for renewal. If you could just give us an update on sort of how that process has been playing out, receptivity of customers, which I'm guessing is never great to a rate increase and potentially a surcharge in there, but I want to get a sense sort of, what are the puts and takes, and do you have to give it all on pricing in order to get the fuel surcharge and how you sort of prioritize those?
Chris, you bring up a great point. We prioritize price first, we always will. We're not going to give up on price just to shift to another fuel surcharge program. Over time, we're going to be working with our customers to kind of align our fuel surcharge program more closely with expenses and also importantly, take the volatility out of it. It's a lot more difficult to do in this environment where the WTI-based fuel surcharge, which is on about 50% of our business, is out of the money.
Okay. The progress to that, it's sort of a multi-year effort is my guess.
Correct. It would certainly be benefited as oil prices increase.
Fair enough. Thanks for the time. Appreciate it.
Yeah.
Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your questions.
Hey, thanks. Morning, guys.
What's up?
Just first thing real quick, Marta or Alan, did you guys give a composite mix number in the quarter?
Scott, are you referring to the trend in mix in overall RPU?
Yes.
Okay. What is the change attributable to mix in total RPU?
It's a slight negative overall.
Okay.
Just very slight. That's because the export coal went down a little bit, slight negative. It's almost flat.
Okay. Thank you. In terms of coal, again, there was a pretty nice sequential increase in coal yields. Can you help us explain that, Alan? I'm not sure if there's kind of any liquidated damages in there or if that's mix. Then just how to think about that going forward on a sequential basis, the coal yields.
Certainly we've had negative mix associated with export. That has been an impact. We've had more utility south volume, which tends to be a longer haul for us, that has propped up the utility yield.
With your comments about stockpiles in the south being closer to target than the north, would you expect that mix to southern utilities to continue?
We feel good about our southern utility franchise going forward. The north is sitting frankly right on the Marcellus natural gas play, spot natural gas prices are
You can go to the Henry Hub published numbers. The opportunity exists for a greater percentage of new south and new north going forward than we've had in the past.
Okay. I want to go back to the headcount question from earlier. We've seen all the other rails implement some pretty meaningful headcount reductions, and I know your headcount was up sequentially, and I certainly understand your service metrics didn't improve as quickly as some of the others. Now that the service is improving, I guess I'm just not sure why you don't have an opportunity to take out a good amount of headcount like we've seen all the other rails do as their service has caught up.
Well, as Mark mentioned, we have a small opportunity, maybe the size you're talking about a big opportunity. We had a small opportunity, and we took it incrementally in the fourth quarter, we think we're going to be flat. Really, Scott, what we're looking at in 2016 in terms of productivity is not so much, because as we've said, we've guided towards level headcount next year. It's not so much the headcount, but it's the cost of those individuals. He pointed to the fact that we have costs now such as recruits and overtime, things like that, lack of track time because of the system velocity. It's the price per hour, if you will, that we think is where we're going to get the most productivity next year.
As we've said a couple of times, we believe absent a significant decline in volume, which we do not foresee now, that we think that the headcount level where we're at now in the third quarter is a good run rate for 2016.
Marta, you think that you could see savings on a per employee basis even with higher incentive comp next year?
Yeah. Higher incentive comp I'm looking at separately. This year's incentive comp is down. Assuming financial results are better next year, that will be up. Absent the things that are sort of standalone, like incentive comp and pension and post-retirement benefits and that sort of thing, the actual cash cost of the employees per person, we think will go down next year.
Okay. All right. Thank you.
Our next question is from the line of Ravi Shanker with Morgan Stanley. Please proceed with your questions.
Hey there. Thanks for the time. I hate to beat a dead horse, just back to the resource topic. Specifically for the fourth quarter, you guys are expecting total volumes to be down about 3% in line with the third quarter, which would imply sequentially about down 4%, yet you're not expecting to reduce the headcount. Can you just speak a little bit more specifically to the fourth quarter itself and why the car loads are going to come down but the headcount you don't expect to?
Well, we're going to be nimble with our resource strategy, and I said that earlier. If we see volumes deteriorate beyond where we think they're headed, we certainly will begin addressing the labor side of the resource equation. We're also focused on maintaining and improving service, that requires a certain level of employment. Moreover, we think that we came into this a little bit leaner than others, therefore, we have a little bit less to shed.
Okay.
I would also add that there's always a sequential fourth quarter decline in volume associated with holidays. While that doesn't impact the year-over-year comps, you are comparing it sequential, that does have an impact.
Okay. That's helpful. Jim, back to the service levels. I think a few quarters ago you were talking about expecting them to kind of get back to "normal" by the end of the year, and they certainly have shown improvement recently here, but it looks a little bit still a ways away from kind of the 2012, 2013 levels in terms of the metrics we see on the train speed and dwell. Do you still expect the service to get to the normalized levels by the end of this year? Maybe it might take a little bit longer into next year at this point?
You're right. We haven't made the kind of progress we said we would make on service as measured by network velocity and dwell, the metrics you see, or internally. We have made substantial progress, and we are in a lot better condition now than we were a year ago. Using our internal metrics, our composite metric is more than 10 percentage points above where it was last year at this time and trending well versus a downward trend last year. We feel very good about where we are in terms of our service, and our intermodal premium trends are running extremely well. The network is in overall much better shape. We still have a ways to go, and we will continue to push on that composite metric and get velocity up, too. That's our strategy.
It's taking a little bit longer for us to get there than we had thought, but we're well on our way.
Okay. That makes sense. Just lastly, a housekeeping question here for Marta. I think you had mentioned earlier in the call you expected purchased services and rent expense to be down sequentially in the fourth quarter. I was wondering maybe if you could maybe give us a little bit more quantification of how much you expect that bucket to be down sequentially.
We don't give guidance on specific dollar amounts, but what I will say is two things mentioned there is we had some service related costs in purchased services because we didn't quite get the velocity we had hoped for the quarter. We have that in purchased services and in equipment rents. The two probably of about $5 or $6 million, in addition to the service related costs we had in compensation and benefits. The other item is after the November 15th or 18th Triple Crown changeover, the Triple Crown dray costs are in that line item. They will, as the business transitions over to intermodal, the dray part cost will be in purchased services.
That's helpful. Thank you for the time.
Our next question is coming from the line of Ken Hoexter with Bank of America. Please go ahead with your questions.
Good morning. I know it's been a long call. Jim, congrats on the chairmanship, and Mark, good luck in your upcoming retirement. Just maybe some clarification on a couple of coal comments. Alan, you talked about clearing the deck. I just wanted to clarify to your answer before. Do you have any more MATS or CSAPR closings that are mandated in 2016? Is the 3 million run rate what you're looking for on the export side? I know you kept mentioning the 20 million on the domestic. Are you looking at the 3 million to hold through 2016 on the export side?
Ken, we've got about one or two plants, smaller plants, that will be impacted by MATS. It's not going to have that much of a material impact on what we're doing in our coal franchise next year. On the export side, yes, we are continuing to guide to 3 million tons a quarter, although I'll tell you that has more risk associated with it than the utility guidance. As I know you are, we're watching the worldwide indices. The spot market for Queensland coking coal is now down in the low 80s for metric ton.
Okay. Even with the prices, which doesn't really make sense to ship, your thoughts are that it kind of holds at these levels? Are there contracts that lock that in? I just want to get some idea of what level of confidence you have in that, or is that just an aggressive or conservative view?
To which are you speaking?
To the 3-million-ton outlook on the export side.
Yeah, I think that has downside risk to it.
Okay. Lastly, Jim, just stepping back, there have been a lot of questions on employee and headcount and efficiency. Your last sentence there, you kind of noted that you came into this a bit leaner than others in the downturn. Maybe just get your thoughts internally on the operating ratio at 69.7. Finally moving below 70, but now the industry has moved far ahead. Your peers are now over 500 basis points better in the third quarter. You now have three carriers at or below 60. Do you step back and kind of think about maybe something needs to be overhauled or completely changed in the way you've been operating to adjust that operating ratio, just as the peers are moving, it looks like farther away on that metric. Just what do you think needs to be done?
Well, I think we're going to make a lot of progress on the operating ratio, we have the ability to lower the operating ratio significantly, we're confident that we can do that. Do I think we're going to post a 53 operating ratio next year? Probably not. Hats off to those who are at that point already. With that said, we have a lot of progress that we can make on our operating ratio. We are keenly aware of where we stand in the peer comparisons, we are determined to improve our performance, both in terms of a lower operating ratio and higher earnings.
Okay, you don't step back as now in the Chairman CEO role and say, "Wow, we need to either gut programs or overhaul something." I see the step on Triple Crown, there's nothing that you see as needs to be overhauled to really make fundamental changes to get that lower.
Look, nothing's off the table, we are having far-ranging strategic discussions inside the company right now. We could certainly entertain different approaches to sizing our asset base relative to our revenue and income generation potential. That's a strategy that takes a while to deploy and deserves careful consideration because any strategy that starts hiving off significant portions of the asset base entails the risk of revenue loss. We need to be very thoughtful about that. Certainly, we are open internally and talking about different ways to run this company and are determined, as I said, to reduce the operating ratio and grow our profits.
Is there a certain level of OR as the industry approaches that you fear more regulatory insight or overhang?
Well, look, the industry's view, I think it's the right view, is we need to generate substantial profits and returns in order to justify reinvestment. We're a very capital-intensive business. We have major reinvestment needs. The only way that's going to happen is if we generate adequate returns. That's our focus. I think it's a compelling argument in the regulatory arena. Don't cap our returns, otherwise you will see reinvestment decline. I don't think anybody wants that.
Jim, I appreciate the time and insight. Thank you.
Our next question comes from the line of Justin Long with Stephens. Please proceed with your questions.
Thanks, good morning. I wanted to start maybe following up on that last question. I wanted to ask about CapEx. It sounds like there are several areas where you're improving capital efficiency. With that in mind, how do you expect your CapEx to trend next year? Is there an opportunity on an absolute dollar basis for CapEx to be down in 2016?
Absolutely. Now, bear in mind that CapEx in 2015 includes the D&H acquisition at around $200 million. Barring a similar transaction next year, that would come off CapEx. We do believe we have room to bring CapEx down beyond even that component. Yes, look for somewhat lower capital spending next year from us.
Any initial kind of order of magnitude that you're thinking about or is it still too early?
I'll say this, it is early, and we haven't completed our capital budget for 2016 yet. In my view, the kinds of capital spending that we've been putting up relative to revenue or cash flow is not something we want to continue to do, and we do see a need to bring CapEx down relative to sales and relative to cash flow. That's our plan starting next year.
Okay, great. Maybe as my second one, I wanted to ask another one on pricing. As we look into 2016, do you think the magnitude of core price increases will look similar to what you've experienced this year? Or with uncertainty in the industrial economy, do you see downside risk to the current pricing environment?
Price increases are a key component of our strategy. We absolutely intend to increase our pricing commensurate with the value of the product that we are offering in the marketplace. There will be no letup in terms of our emphasis on price increases as a driver of revenue and profit growth.
Okay, I'll leave it at that. Thanks for the time.
Our next question is from the line of Brandon Oglenski with Barclays. Please proceed with your questions.
Well, good morning, everyone. I know it's been a very long call, so I'm just going to keep it to one. Jim, it's kind of along the lines of what Ken was just discussing with you here. I know you're talking about OR improvement, but it just feels like maybe your franchise is a little bit more levered to higher commodity prices. Previously, you booked some profits in your fuel revenue, which have obviously gone away. You've historically made a lot of money in the coal markets. Coal's gone from 30% of your revenue now down to 17%. I know you think that things are going to be stable, but natural gas prices are even lower this year. How do we just put all this together?
If natural gas stays here, if we don't get a rebound in fuel prices, how do you aggressively attack the OR with some of those headwinds? Speaking to the CapEx side or even the asset side or restructuring, why not get more aggressive on restructuring the coal network? Again, it is down significantly from where it was even three or four years ago.
Well, you're right. We're a commodities hauler. You heard Alan say 50% of our loads are commodities-based, it definitely is more challenging in this sort of commodities environment. That doesn't mean we don't have any opportunities. We're going to continue to push on revenue growth, as Alan went through. Fortunately, we have a pretty diversified franchise, levered to commodities as it is. We still have other opportunities to grow. We're going to push on those. We're going to be very judicious with our spending. We're going to watch our capital very carefully and focus on, again, service improvements, return on capital, and good growth.
Okay. Thank you.
Thank you. The next question comes from the line of Brian Ossenbeck with J.P. Morgan. Please go ahead with your question.
Hey, good morning, and thanks for making some time here at the end. I know it's been a pretty long call. My question is basically just on the coal network rationalization. If you can just give a little bit more context of how has it been going on for 18 months or so, 300 miles have been taken out of service or restricted. Can you just give us a sense of how much of the network has been analyzed at this point? You mentioned the labor savings, obviously taking some assets, but you're still not abandoning them. I'm assuming you're going to have to have some maintenance expense with that. If you can try to quantify that for us, that would be helpful. Also how you approach that in general.
Is this a proactive type of analysis where you get out ahead of volume cuts, or you just kind of take it as the mines start to slow down?
It is a proactive approach. I would characterize what we have done as a good start. There may be other opportunities as well. We are very actively analyzing all opportunities to rationalize our asset base, particularly in the coal network. There may be other rationalization opportunities ahead. By the same token, we do want to retain the ability to handle coal's volume, which we think we will garner in the future. We're not throwing in the towel on our coal business. We are going to continue to be a coal hauler now and in future, and we want to make sure we have the assets on hand to do that.
Okay, just a quick follow-up. Is there any sense you can give us in terms of how much of the network has been looked at at this point in time, and any savings, rule of thumb per mile taken out that you're able to realize?
We focused up to this point on the Central Appalachia network in particular, as Mark went through. The savings will be meaningful, and we'll see those both in terms of expense savings and capital avoidance.
Okay. Thanks for your time.
Our next question comes from the line of Ben Hartford with Robert W. Baird. Please go ahead with your question.
Yeah, good morning. Real quick on the Triple Crown transition. Can you give an update on the transition of the non-auto business? I know that we're coming up toward the November 15th service cut first, second, what was the logic in keeping the auto parts business intact?
Well, I'll take the last part of that because that goes to the strategic rationale for the transaction. I'll let Alan talk about what's happening in terms of the rechanneling. Triple Crown started out as an auto parts hauler, that is where they really excel. The technology that we will continue to deploy in that service works really well in the lanes where they'll continue to haul the auto parts. That's their forte, we made the decision to keep them going in that area while looking to re-channel the other freight. Alan?
Yes, we are working with our channel partners, I'll reiterate what I said before, because I don't want expectations to get too high, is that almost on purpose, the Triple Crown network did not overlay the conventional network, it doesn't necessarily operate in the same lanes. It's still accretive to earnings, it still represents an improvement in capital utilization.
Appreciate the time.
Our next question is from the line of Jeff Kauffman with Buckingham Research. Please proceed with your questions. Mr. Kauffman, your line is open for questions.
Oh, sorry about that. Hey, guys. Well, congratulations in a tough environment. Most of my question's been answered, but let me come back to Marta on capital spend and free cash. I think it was you, Jim, that said that you could see CapEx lower next year. You want to get back to a more normalized spend. Including D&H, what are we looking at in terms of CapEx this year, and how do you think about CapEx, say, over a two, three-year period, longer term? Where do you think it should be?
I'd like to respond to your free cash flow point first. I'll let Marta talk about the trend in capital spending. Our free cash flow has been somewhat subdued this year, and we're going to turn that around next year as well, and the formula for that obviously involves higher net income, bonus depreciation, if that occurs. It's the absence of the D&H transaction affecting capital expenditures. It's a somewhat lower non-D&H related CapEx. I think all of that gives you much more robust free cash flow, we believe, next year.
Okay. Marta?
Yes. Jeff, with regard to our capital program, at the beginning of the year, we announced a $2.4 billion capital program.
When the volumes didn't come in exactly with where we had been forecasting, we lowered it by about 5% or $130 million. Of course, this year, we have the $215 million that Jim described. Going forward, you should think about levels more like the original $2.4 minus the $130. As Jim said, we think the absolute number in 2016 will be lower than that normalized level this year.
All right. Just to follow up on that, you've increased the share buyback this year. With the stock down at these levels, is there a better use of free cash after capital spending than shares right now?
We certainly have deployed both borrowing capacity, cash on hand, and free cash flow for share buybacks this year, and we see good value in our shares. We'll continue to use excess free cash flow over and above our dividend and available borrowing capacity for that purpose in the future.
All right. Well, congratulations, guys. Thank you.
Our next question is from the line of David Vernon with Bernstein Research. Please go ahead with your questions.
Hey, good morning, guys, and thanks for making time here. Just kind of thinking broad brush here with the headwinds that might be with the Triple Crown business migrating off, and obviously the export coal decline next year. Would you expect volume kind of overall to be positive or negative coming into 2016 off of 2015?
Hey, David. We saw the potential for growth next year. I think it's going to be more targeted towards the second half of the year.
More flattish, maybe up a little.
Yeah
in aggregate. I guess, Marta, as a question for you, in terms of that lower rate of volume growth next year, do you think that sort of lack of volume driven productivity may offset some of your ability to recover the efficiency-led costs or the inefficiency-added costs of the last couple of quarters and some of the things around Triple Crown?
Well, we'll definitely be pushing on efficiency next year, and Triple Crown is going to be one of the reasons how. As Alan said, those moves that move on the intermodal network should be more efficient than the shorter road rail trains we were running some of this year.
Yeah, it just seems like the operating income decline relative to the 3% decline in RTMs is pretty significant from a volume leverage standpoint. Which would seem to indicate that if you've got a flatter volume year next year, it may be tougher to get some of that leverage to fall through or some of those efficiency savings to fall through. Am I thinking about that right, or do you think there's going to be a strong prospect for organic earnings growth in a flat volume year?
Well, one thing to remember for next year is this year thus far, we've had all three quarters so far this year, we've had service-related expenses and some weather-related expenses in the first quarter, but they cumulatively total about $82 million. Year-over-year, we don't expect those to recur in 2016. That will begin our productivity improvements, and we expect to increase on that.
Okay. Thanks.
Our next question comes from the line of Cleo Zagrins with Macquarie. Please go ahead with your questions.
Good morning, and thank you for your time. My first question relates to coal royalties. We've seen them contribute about $0.04 this quarter. When are they up for renewal? Please remind us whether they relate mostly to domestic utility coal or other areas as well. Thank you.
I think it varies by contract with respect to the duration, much of our coal royalties is associated with metallurgical coal.
I'm sorry?
Much of our coal royalties is associated with metallurgical coal.
Metallurgical, okay. All right, My second question comes back to fuel surcharges versus core price. You've commented on this call and recent other calls that your customers have been unwilling to give up fuel savings without a value exchange in terms of core price. On your end, you said you are unwilling to do that. Is it best for us to model core price increases offset by some negative mix, and then leave surcharges unchanged into 2017 as forward curves suggest? Thank you.
Model. Can you say that point about, did you mention 2017?
Yes, in the sense that on the current forward curves, your surcharge programs are out of the money for some years out. If right now that change is not occurring and you're saying you're needing fuel prices to go higher for that to happen, should we assume that there is no change on the fuel surcharge and just model core price increases?
Okay. I get your point. It will be easier to accomplish this as or if WTI prices go up, but it also gives us the opportunity to push price.
Okay. Your feedback from customers so far, can you tell us a little bit about that?
Of which?
About your customers.
Can you help me understand?
Yeah. It's about how discussions are going in terms of getting core price. In my understanding that conversation is still tough as you're trying to get core, but they don't want to give up the fuel. How is that all netting out?
That's a good point. Yeah. Negotiations with customers with respect to price are always tough. They do recognize the long-term value of rail transportation. There's a pause right now in demand in some commodity markets. Jim talked about how 50% of our revenues are tied to commodity or foreign exchange. That's a short-term pause. Inventory drawdowns, we believe, will be complete by the end of this year. Shippers are trying to line up capacity for 2016 and 2017, which is why you see in the trucking market spot prices declining, but contract prices still moving up, although moderating.
Okay. Is it true that at this time of year, you're already starting to discuss the book for intermodal for next year? How is that going given your improvement in service in terms of setting up prices for next year? Thank you very much for your time.
In terms of filling up what, Cleo?
The book.
The book.
In terms of getting contracts for the book.
Our intermodal contracts aren't necessarily at the end of the year. We always have a mix of contracts, whether it's commodity or customer base that are up throughout the year. Yeah, certainly we are discussing contracts for the remainder of this year and next year, and we're pushing price and the long-term value of rail transportation.
Thank you. Appreciate your time.
Cleo, if I could mention one more thing on the fuel surcharge revenue you asked about for modeling for next year. Don't forget that in the first quarter of this year, we still had a somewhat elevated level because the month of January benefited from the lag when oil prices were higher. Each quarter of this year, you've seen declining absolute numbers of fuel surcharge revenue. We expect that to continue and have declining fuel surcharge revenue in the fourth quarter. I just wanted to put that out there for when you're modeling 2016.
Thank you, Marta.
Thank you. This concludes the question and answer session. I will now turn the call back over to Mr. Jim Squires for closing comments.
Well, thank you, everyone. We appreciate all your excellent questions. We will talk to you again next quarter.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.