Greetings, and welcome to the Kansas City Southern First Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. This presentation includes statements concerning potential future events involving the company, which could materially differ from events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the company’s Form 10-K of the year ended December 31, 2015, filed with the SEC. The company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments. All reconciliations to GAAP can be found on the KCS Web site, www.kcsouthern.com. It is now my pleasure to introduce your host, David Starling, Chief Executive Officer for Kansas City Southern. Thank you. Mr. Starling, you may begin.

Thank you. Good morning and welcome to Kansas City Southern's first quarter 2016 earnings call. Joining me today are KCS President, Pat Ottensmeyer; Chief Operating Officer, Jeff Songer; Chief Marketing Officer, Brian Hancock; Chief Financial Officer, Mike Upchurch. And joining us by phone President and Executive Representative of KCSM, Jose Zozaya. A quick look at our overview of first quarter. KCS revenues declined by 7% from a year ago. Of course a weak peso and lower U.S. fuel prices had significant impact on the top line. When you exclude those factors, our revenues were down 1% from first quarter 2015. In addition to these factors, we were hit with serious flooding on parts of our network in Texas and Louisiana beginning in mid-March, which had a noticeable negative impact on the revenues for the quarter. Despite all of these challenges, as well as the 5% reduction in carloads, KCS posted an adjusted operating ratio for the quarter of 66.6, a 2.3 point improvement over the prior year. A few comments on the flood and impacts of three critical corridors of our railroads being out of service for over three weeks. We were very pleased with our ability to keep a lot of the trains moving during those three weeks and get our system up and running as quickly as it did. It’s a testament to Jeff Songer and his operating team and to the exceptional coordination between operations, marketing and sales personnel keeping our customers impacted on their cargo movement. It also speaks to a high degree of cooperation between KCS and other railroads, particularly the Union Pacific and BNSF who were battling their own flood-related problems as well. We detoured trains on our own respective networks to minimize the effect to our customers. We were also assisted by Canadian National. We may be fierce competitors on most days but when hit with financial disasters, railroads work together to keep the freight moving to the greatest extent possible. It was a great effort. My final thought is that to be able to improve your operating ratio by over 2 points while losing an important part of your rail system for nearly a month and without the benefits for incremental volume growth is a real noteworthy achievement and should give you all confidence in KCS organization and particularly our operating team going forward. With that, I’ll turn the call over to Pat Ottensmeyer.

Thanks, Dave. Good morning, everyone. I will begin my comments on Slide 7. Dave gave you a summary of our first quarter results. Jeff, Brian and Mike will get into a lot more detail on the following slides. What I would like to do in the next few slides is provide more of an assessment or evaluation of our performance during the quarter and talk briefly about our longer term outlook. Sticking with the general theme from our fourth quarter earnings presentation, we will focus our comments this morning more on those factors that we can manage to drive performance in an uncertain and volatile economic environment; things like service, cost control, asset utilization and capital structure. Overall, we feel that our performance in the first quarter was very good in spite of continued headwinds from energy markets, specifically coal and crude oil, fuel prices and foreign exchange, as Dave mentioned, all of which had a negative impact on volumes and/or revenues during the quarter. In addition, KCS revenues and volumes were negatively impacted by heavy rain, flooding and service interruptions that essentially shutdown parts of our Southern region and our cross-border route in March. Jeff will have to say about that in a few minutes. Returning to the first quarter assessment, until about March 9, we were all feeling pretty good about the pace of business this year although I would say the phrase we were using to describe our first quarter at that point was worse than last year but better than expected. Then the rain started and we experienced severe and in some regions record-breaking flooding in Louisiana and Texas. As you will see on the following slide, our year-to-date volumes had actually crossed over into positive territory on March 9 where they were up 1% versus…

Thank you, Pat, and good morning. Beginning with Slide 11, strong operating performance in the quarter allowed for improvements in key operating metrics. Velocity for the quarter was 28 miles per hour, a 3.2% improvement over prior year and a 3.5% improvement over Q4 2015. Overall dwell for the quarter of 21.1 hours was a 7.8% improvement over prior year. Despite significant impacts during the flood in March, we were able to achieve substantial improvements in both the operating metrics and cost control, as we will discuss. The organizational changes discussed last quarter are fully in place and we are seeing the results. Moving to Slide 12, efforts in resource management and cost control are showing results. In Mexico, our workforce is stable and operating metrics have largely returned to expected levels. Furthermore, improved cycle times have led to reduced car hire expense. In U.S., we continue our focus on resource management. Currently, 12% of the U.S. T&E workforce is in furlough status and 12% of our locomotives are in storage. Highlighting other cost initiatives, we have started to fuel optimization technology program and have accelerated capital funding to allow us to install this technology in approximately 20% of our road fleet by the end of 2016. We continue to improve Mexico workload allowing for crew efficiencies. Ongoing projects such as reducing crew change points in areas such as Leal, which will improve run times between Monterrey and the border and modifying operations in the Escobedo area will ease congestion and prove fluidity in this area. In the U.S., crew management efforts such as eliminating the Jackson, Mississippi crew change and another ongoing initiatives have allowed us to reduce our year-over-year number of re-crews by 37% across the network. Additionally, we continue to improve our mechanical maintenance agreement. You will…

Thanks, Jeff, and good morning. To begin, and as noted earlier, the March flood in Texas and the Southeastern U.S. primarily impacted our intermodal, industrial and consumer and chemical and petroleum business segment. In spite of this disruption, our year-over-year revenue was down 1% excluding currency and fuel while our carloads for the quarter were down 5%. In Q1, we also continued to turn to solid performance with our core pricing results coming in at 3.8%. The commercial team also expressed our appreciation for the extraordinary efforts of our operating and customer service organization for providing real-time options for our customers and closely working with our other rail partners during these extraordinary weather events. I’ll now provide a little more detail by line of business using Slide 15 as a reference. Our chemicals and petroleum business continues to show steady growth with a 3% volume increase and 2% revenue increase driven by strength in the petroleum and plastics business partially offset by the impact of the flood. Industrial and consumer while also negatively impacted by flooding still showed a 1% increase in volume but had a 3% decline in revenue primarily due to the impact of currency and fuel. Softness in both our metals and paper segment had a significant impact in Q1 but we’re seeing some improvements as our customers are finding new markets for their products. Additionally, we saw strength in our other carload segment. During Q1, our ag and mineral business saw increases of 4% in both volume and revenue driven by strength in grain particularly in the cross-border business. Our energy line of business continued to be negatively impacted by volatility in coal and crude. Overall carloads were down 16% and revenue down 37% versus first quarter of 2015 with coal making up about 52% of…

Thanks, Brian, and good morning. I’m going to begin my comments on Slide 18. First quarter volumes declined 5% and revenue declined by 7%. Revenue was negatively impacted by both foreign exchange and U.S. fuel prices. Excluding those impacts, revenue was down less than 1% in the quarter. The significant peso depreciation had a $20 million negative impact on revenues during the quarter. Declining U.S. fuel prices contributed an additional $17 million decline in revenue. These declines were partially offset by positive pricing impacts. Moving to adjusted operating ratio, we saw a decline by 230 basis points to 66.6%. Despite the revenue decline, adjusted operating income was flat reflecting foreign exchange benefits, lower fuel costs and good expense controls during the quarter particularly in our operating group. Reported EPS was $0.99 per share and adjusting for FX benefit or impacts adjusted EPS was $1.03 flat to 2015. And we have provided more P&L details in the Appendix including foreign exchange, income taxes, interest expense and share count. Moving to Slide 19, to provide some insight into future revenue trends, which we expect will continue to be pressured as a result of year-over-year peso depreciation and lower fuel prices, Slide 19 shows first quarter actual and 2Q through 4Q forecast for peso depreciation and U.S. fuel price. With respect to the peso, projections for the year would indicate an average exchange rate of approximately 17.5, which would represent a 15%, 7% and 5%, respectively, decline in the peso for the remaining quarters of the year. As shown in the Appendix on Slide 29, approximately 16% of our first quarter revenues were denominated in pesos and therefore subject to revaluation resulting in a 3 percentage point revenue decline. Also depicted on Slide 29, I would remind everyone that peso denominated expenses largely…

Thanks, Mike. Just a couple of brief remarks on our very interesting quarter. We were very pleased with our overall performance and I would like to echo Pat’s conviction that KCS is well positioned with a very talented and dedicated team to respond to all of the business growth opportunities we have in the coming years. With that, I’m going to open it up to questions. We have a lot of people on the list this morning, so we would like to respect everyone’s time and have it down to one question please.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.

Good morning and thank you. So you guys gave some good color on how much the flooding impacted carloads during the first quarter, and Mike I think you provided what the washout expense was. But I was wondering if you could quantify how much weather impacted the top line and expenses in aggregate, and how much volume you think will be pushed into the second quarter?

Allison, good question. We did disclose the 3.9 million of incremental expense during the quarter. We also had some property damage, which is capitalized which was about $8 million. But understand that it’s extremely difficult for us to forecast what was lost revenue and deferred revenue and we’re still working through all of those details and at this point in time aren’t really in a position to disclose that. It certainly had a big impact on our quarter but we’re not prepared at this point to give a specific number on revenue loss.

Okay. So we should think about it in terms of the 3.9 million you called out as the expense and then the 8 million which was capitalized?

Correct.

Okay. All right, thank you.

Our next question comes from the line of Tom Wadewitz with UBS. Please proceed with your question.

Good morning. Wanted to ask you a little bit about the volume side? I know you don’t want to give specific forecast but in terms of your best read on the economy, which I know is quite difficult in your market, it sounded like you’re more optimistic going into March before you got hit with the flooding. I think Pat you said something about – I don’t know if it’s April to-date up 3%. What do you think is the way we ought to look at volumes here, your kind of best look going forward? Is it that 3% that’s kind of reasonable or I think we’re having difficulty parsing out the flooding impact broader for the industry and the current weak volumes versus what might be a little more optimistic run rate? Any thoughts on that would be appreciated.

Okay, I’ll try to cover that but I would not extrapolate the 3% for 15 days in April. Again, there are a lot of factors; the flood which I’ll echo Mike’s comments. We really aren’t going to quantify what we think the flood impact on the revenue and volume was. But again we also had Easter holiday occurring in first quarter of this year, it was second quarter last year. So there were other factors that contributed to the decline at the end of March. And we’re going to be steadfast in our position of staying away from volume and revenue guidance just because there are a lot of unknowns out there. The timing and magnitude and potential difficulties that might occur when the auto plants ramp up, some of these other factors that we just are going to stick to our position of saying, volume and revenues are going to be whatever they are and the impact to the economy and foreign exchange, other factors are going to weigh in there and we’re going to focus on things that we can control and will manage to respond to those changing circumstances as they occur. So realize that it’s probably not a really satisfying answer to yours and others questions but that’s really what we’re going to stick with.

That’s fine. I understand that and I appreciate the discipline not talking about markets where it’s tough to tell, but in aggregate do you feel a little better about volumes or would you say – about your overall markets or would you say it feels like it’s pretty weak out there and there’s not much visibility?

Again, I’ll stick with what I said in my comments that we felt that things were proceeding worse than last year but better than expected. So I think that’s kind of a phase that we still feel when we sort out the impact of the flood and other factors at the end of March. We do feel – I feel that things are a little bit better than we expected. But certainly for the foreseeable future there are going to worse than last year because of some of the factors that we talked about such as the auto plant shutdowns. So yes, I think we feel pretty positive about things given that our overall outlook at the beginning of the year was that 2016 was going to be down in volumes and revenues.

Okay, that’s great. I appreciate it and nice job getting the railroad back up and running in the tough condition.

Thank you.

Thanks, Tom.

Our next question comes from the line of John Barnes with RBC Capital Markets. Please proceed with your question.

Hi. Thanks. On the projects around the refined product imports into Mexico, what I understand you got the curveball thrown at you in terms of accelerating that timeline to April 1 and it certainly sounded like most of the participants in that business were not prepared for an April 1 kickoff. But do you anticipate seeing any of that volume materialize in the second half of 2016 given now that it’s legal to move those volumes in? And then do you have feel on magnitude this year where you might start 2017 from a run rate perspective?

Hi, John. Thanks. This is Brian. I’ll take that one. What I would tell you is there are a number of companies that are often working on these projects as we discussed in the comments, both the WTC/Watco facility as well as the Rangeland facility. There are a number of other companies that are looking at that. We really don’t see a lot of that occurring in 2016. If it does ramp it, it will be very slow and sporadic. We do feel comfortable that people have identified that market, identified the opportunity and we’ll continue to work with each one of those but there are so many different projects and the investment is significant as you might imagine that people are kind of holding that closer to the vest. And so we’ll work with them as we get the opportunity. As they develop their business case and find the right answer within that mix for Energy Reform legislation, but it’s going to take a while to bring that up. So 2016 will be very sparse and sporadic. And then as the 2017 market where everybody was kind of focused, we believe there will be a potential impact and we’ll make sure that we quantify that when we have the ability to do it.

All right. And is there any necessary investment by KSU to exploit these opportunities or is what’s being done fully funded by the participant, the couple of the projects you highlighted?

John, this is Dave Starling. This project is a little unique and that the landowner is the same partner that we had on the intermodal facility at San Luis Potosi. So generally one of our issues in Mexico is getting all of the land together because you got a lot of the [indiscernible] that you have to buy a lot of individual parcels and then put them altogether. In this particular case, the [indiscernible] family owns his property. They’ve already done drawings. We’ve already met with Watco, so we’ve already got track layouts. And you’ve got Watco involved who operates these kind of terminals in the U.S., so the land is secured. Watco is there with the expertise to run it and it’s right on our mainline right across from our intermodal facility. So we’re there to build the lead in. So it’s all going to be about permitting and getting a customer. So this one – when the opportunity is there, it should move faster than if we were just going out to some greenfield site with an idea of what we would like to do. And I think he in Mexico who builds this terminal first should be a big winner because the demand is there and right now you just don’t have the receiving facilities in Mexico to make that happen. So again, we don’t want to throw any dates out there because we don’t have them yet, but a lot of obstacles that you would generally have building something like this in Mexico are going to be easier for us to --

That’s good to hear. That keeps reminding us about the amount of money you’re spending on Sasol before any revenue shows up, so this certainly feels like a better kind of investment near term. Thanks for your time today. I appreciate it.

I’ll just add one thing here in addition to what Dave and Brian said. If you go back to Jeff’s comments and his slides, he talked about San Luis Potosi and capital investment in that area. So we are looking at and kind of assessing the overall need for capacity in the San Luis area driven by the WTC/Watco project, the Ford plant, the BMW plant and General Motors expansion. All of those things are taking place in an area of about 5 miles. So we’ll probably have more detail on that as we evolve and develop our plans, but we do think that there is going to be capital required to support the growth in that region.

Which is a good thing.

Yes.

Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

Thanks. Good morning, everyone. A question on orders. There was a news article I think last month that cited potential delays in a Kia plant opening because the government wanted to renegotiate some of the incentives. Do you have any more color on that? And is that an issue that could potentially snowball into some of the other projects as well? And also what are your current views on the auto cycle as we see it? I think some investors are concerned about potential peaking in the cycle there given the last couple of star data points haven’t been great. What are you hearing from the auto EMs on that front?

This is Brian, Ravi. Thanks for the questions. Really we are working daily with Kia. We know that production will begin in May, so we’re literally 30 or 45 days out from beginning production. So we believe we will start to see the business in June as we plan. I read the article that you speak of but there’s been no notice on our side or from Kia and we’re continuing to work daily with them to bring that business to pass and it starts in a month. So we really don’t see a delay in that production. From an order perspective, I’m going to let the automotive company speak for themselves on that. But we continue to see strong volumes from the company that we support in Mexico and in the U.S. and that automotive volume continues to be a key part of the process moving forward. So we feel very comfortable that we’re very close to our automotive customers that each one of them has given us good projection and they feel comfortable in those projections. And the Kia plant is set to open next month and we’re ready to open with them.

And then just a couple of additional comments. As far as the Kia dispute with the government rippling into other plants, no. We think this is an isolated case and they’ll work it out. As Brian said, the plant is being built and almost finished. So they’re going to ship autos. And as far as the industry outlook, again you guys have resources and insights into just the general level of auto sales. We’re just going to try to be as nimble as we can. We should be a little bit different than the market in general because of the plant shutdowns and ramp up we’re going to be experiencing this year. But the auto industry has always been cyclical and so we’re just going to be as nimble as we can and respond accordingly if it does turn down.

Great. Just one quick follow up on the weather. Is the weather event over, because I read a news article this morning that said – spoke of record flooding in Houston. So, is it done and completely back to normal or is that an ongoing situation?

Yes, this is a new and a separate event here in Houston from yesterday. We are completely restored from the prior event in early March. Right now we’re still above water everywhere. This event was centralized really around Houston. We’re watching our Rosenberg sub, cautiously optimistic that we won’t have a problem. Certainly, we don’t anticipate anything much at all, certainly not to the extent of the last impact. So it’s something we’re watching but right now no impact.

You got to remember, last time that weather front in Louisiana just sat there for three days. So this one moves through, there may be another weather front behind it but you’re kind of getting a break. That’s a great question. That’s the same one I had when I got here this morning.

All right. Thanks for the color guys.

Our next question comes from the line of Chris Wetherbee with Citi. Please proceed with your question.

Hi. Thanks. Good morning. Wanted to ask a question about the competitive dynamic in Mexico both from a truck perspective but also from a rail perspective. We’ve heard some anecdotes about service from competitors of yours in Mexico maybe not being quite as what it was a year or two ago. Just want to get a sense kind of how you’re seeing that play out. Have there been incremental wins? And then on the truck side how the peso dynamic, obviously a weakening U.S. dollar recently probably helps you but how that’s played out?

Chris, thanks. This is Brian again. I’ll take that one. Certainly, we have seen additional competition from truck in certain markets primarily in the intermodal market. There is a lot of capacity out there, much the same as there is in the U.S. and it continues to have an impact on us. But we feel very comfortable. We work with our customers. We’re providing a great value for them. We see this primarily in some of the shorter haul activities but in reality we believe that we have our share and we’re continuing to grow that share and that’s our desire and most of our plans are focused around that. When you think about our competitors, I’ll let them speak for themselves but we feel like we have a great competitive product and we’re going to continue to do the best we can to provide great service to our customers and we think we’re winning in those markets where we feel very comfortable that we’re doing those things. Regarding the – it is absolutely competitive between rail and truck. It is absolutely between rail and rail and we believe that we have great value and we’re winning in certain spaces within our markets.

That’s helpful. I appreciate it. And then just a quick follow up sort of big picture taking a step back when you think about Mexico in the second half of '16 and then '17, as we’ve seen some of these projects come on line and maybe some of the Energy Reform getting pulled forward. Does it seem like the opportunity in the next 18 months or so is maybe better than what you thought it might have been six months ago or nine months ago? Just trying to get a rough sense on maybe how you think about the timing dynamics and whether or not that’s a little bit upside to what you originally thought?

The only thing that’s really changed, Chris, in terms of our view from say 90 days ago or six months ago, the timing of the Energy Reform but as Brian mentioned I’m not sure that’s a real significant change because no one’s prepared to move as quickly. The acceleration of the date came with almost no notice, so people weren’t prepared to move and actually take advantage of that accelerated timeframe. We always thought that it would be here in a 2017, 2018 timeframe. But as we said that the long-term outlook continues to be very bright, new announcements. We know there’s likely to be more even in the automotive space. We know that there are other people looking for plants, so we still feel very good about the longer term outlook. It’s just getting through 2016 is going to be a challenge.

Great. That’s very helpful. Thanks for the time, guys. I appreciate it.

Our next question comes from the line of Scott Group with Wolfe Research. Please proceed with your question.

Hi. Thanks. Good morning, guys.

Hi, Scott. Good morning.

Brian, I think you mentioned that you had some strength in export grain. Can you just put some numbers around that and give us your view on how you think export grain plays out the next few quarters just because I always think about export grain as one of the things that has a positive mix for you guys? And then just secondly, can you clarify maybe Mike if there’s any opportunity given the changes with the refined products in Mexico, for you guys to be bringing U.S. fuel into Mexico and getting cheaper fuel costs for yourself?

Scott, I’ll start with the grain because I would say there’s strength in grain overall. We continue to have great relationships in our ag and mineral division and we continue to see strength from that. But I would tell you it’s just been one of those quarters where volume has stayed fairly steady. We feel very comfortable that the service continues to improve for those customers and they have more confidence. I would also say we have significantly more cars than we had last year and that has a big impact. We’re able to get at other markets where we potentially weren’t able to do within the last 18 months. And so the additional cars coupled with a good, strong, steady grain market going down to some of the facilities down in Mexico has been the driver of that. So that drives kind of the 4% volume, 4% revenue gain that you saw. It’s primarily cars and setting volume.

And I think the one thing that’s better this year, we have more cars, we’ve improved cycle times so we’re turning the assets quicker. And grain was probably one of the highlight areas during the quarter where we were able to keep our cross border grain trains moving in spite of the fact that our own network was out of service, because of the support and cooperation we got from our connecting carriers.

Scott, this is Mike. On your question around benefiting from refined products moving into Mexico for our own fuel. As you probably remember, we do try to take advantage of cross border operations by essentially fueling up in Laredo full on southbound moves and on northbound moves trying to wait until we get across the border. So I think we’ve done a pretty effective job of taking advantage of that. As the markets are opening up, we have filed for permits to bring our own fuel down into Mexico. We do expect to get approval for that fairly quickly. But also would just caution that while there might be the appearance of significantly cheaper fuel in the U.S., there are taxes being assessed by the government that effectively eliminate a lot of that arbitrage. So we’ll take advantage of it where it makes sense and we’ll try to maximize that benefit but I don’t think it’s going to be anything significant or material at this point.

Can you just say net of the taxes or including the taxes what that cost savings might be per gallon right now?

No, I cannot do that at this point.

Okay. All right, thank you guys.

Thanks.

Our next question comes from the line of Jason Seidl with Cowen and Company. Please proceed with your question.

Hi. Thanks, guys. Good morning. And I’d like to say it’s very heartening to see the railroads work together. It’s been many years since I’ve seen that as well, maybe since UP had their washouts in the LA Basin. Wanted to talk a little bit about headcount. Obviously, we’ve seen your volumes pick up here early in 2Q. And if that trend continues, could we see you guys start calling back the furlough? I’m just trying to figure out how to model this going forward.

This is Jeff. Yes, certainly we are in a good position in the U.S. with the crew, so the furlough based – as we exercised last year, you saw that volatility we were able to furlough and quickly restore crews. So we maintain that ability in the U.S. On the Mexico side, as I’ve said, I’m comfortable with where we’re at. Your year-over-year comps, because if you recall we hired and 250 was the number last year in Mexico, your year-over-year comps look a little inflated. But we’re in the right position and you’re seeing that in the performance metrics and as you recall the length of time it takes to hire in Mexico, we certainly want to be in a position to accommodate any of these new opportunities that Brian described.

So we should look for headcount in the U.S. to potentially go up if some of these opportunities arise?

Yes. We’ll scale the headcount with volume as appropriate.

Okay. Gentlemen, thank you for your time as always.

Our next question comes from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.

Hi. Good morning. Great job in cutting costs and working around the floods but a question for Mike and I guess following on Jason’s question there or perhaps on the operations. You scaled your furloughed employees 12% in locomotives and volumes were down 5%. Is that because you’re structurally operating better and you don’t need the workforce in locomotives, or is this just economic related? I want to understand if maybe on the flipside of bringing it back you can permanently cut out additional resources? And I guess Mike on that same thing you mentioned some conversion opportunities. You’re now at industry average. Is there even more room to go on the equipment side?

Ken, this is Jeff. I think you hit it with the volume versus kind of the furlough and locomotive storage numbers. That variance, a lot of that do attribute to more fluid operations, the management structure, kind of the renewed focus if you will on managing the resources. So yes, I would say definitely over and above this volume decline we saw, we are achieving those benefits and reductions and those should hold for the most part. And when we refer to volume up-ticking a bit, again I think we’re at a good number right now and as volume continues to grow or modify from where it’s been today, I think you’d see continued movement. But all-in-all, I think some of those resources have been based on the productivity improvements you’ve seen.

And Ken --

Sorry, Mike.

Go ahead.

I was going to understand. So, Jeff, are they going to – again, I just want to understand. Do they permanently – do you keep reducing that structurally or do just save them in case the volumes start growing and you want to use all of that?

We’ll manage both. So we’ve been able to cut out I think I reference a recrew number. That’s certainly efficiencies that we’ve cut out because of the improvements in the car activity. Managing to volume is a delicate thing to whereas as the volume drops or rises. We’re able to manage that furlough crew relatively rapidly to meet that volume demand. But I would say we’re really managing both. You’ve seen some good reductions that you’d hold and you’re seeing those numbers in the velocity, the cycle times. That just requires fewer resources and I look for those to hold and I look to continue to expand upon those opportunities.

Ken, this is Mike. On your question with respect to leased assets, as you know back in 2011 we were at 18% ownership of our equipment. We’re now at 65%. We own 88% of our locomotives. The remaining locomotives on lease were done in 2007 and are just not economic for us to pursue at this point. On the freight cars, we own 63% of that and there are some incremental opportunities that I’d also acknowledge. We’re probably in the eighth inning on that effort. And when we started this program we said we thought we had 200 to 250 basis point improvement, opportunity to reduce our equipment costs and right now we’re right in the middle of that at about 225 basis points. So some opportunity left, but nothing material.

Jeff, Mike, thanks a lot for the time.

Our next question comes from the line of Brian Ossenbeck with JPMorgan Chase. Please proceed with your question.

Hi. Good morning. Thanks for taking my call.

Good morning. You’re welcome.

Just had one question for Brian. Now that the volume structure has changed in Mexico for the refined by rail products, when do you think the pricing would move that is associated with that? Last I remember that was still fixed until I think the end of 2017 or perhaps the beginning of '18?

Brian, thanks for the question. What is going to happen is you’ll start to see pricing in the LPG space in 2017 and then the refined products is the first of 2018. And we don’t see any signs or anything that that’s going to move forward and so we’re going under the assumption that you’ll have pre-pricing at those times.

Okay. And do you think that impairs the pace of investment at all? Will there be any arbitrage opportunities that appear in certain pockets of the market that might force the government’s hand to loosen that restriction as well?

I’m not going to speculate as to what the government will do. My assumption is I don’t believe it will impair the investment. People are already very, very focused on the market. They realized the opportunity. Mexico is a growing and vibrant economy and we feel very comfortable that there’s going to be plenty of investments and we’ll be able to service that market as it continues to grow. So, no, we don’t see that.

Okay. Thanks for your time, guys.

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

Thanks. Good morning.

Good morning, Justin.

So after a solid margin performance in the first quarter with year-over-year improvement in the OR and a tough volume environment, I wanted to ask if you think the long-term target for a low 60s OR is something you can achieve without volume growth? Obviously in that scenario it would take a lot longer. But I just wanted to understand if you think some of the operational or productivity improvements you’re implementing could get you to that target?

This is Jeff. I’m certainly proud of what we’ve done this quarter and I think you’re seeing some of these benefits and reduction of expenses. I think a lot of this will hold and I think you’ve got again a new team in place focused on the right things. And we look to continue the focus and continue the opportunity. Do I think there’s additional opportunity? Yes. Am I prepared to quantify that? No.

We also feel very optimistic and certainly committed to getting to the low 60s, but as we said in the past the timing in the absence of volume growth is going to be tougher. But I’ll just echo and amplify some things that Jeff said that the level of creativity and the things we’re doing to improve our operational performance is very promising.

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

Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.

Good morning, everyone, and congrats on a pretty darned good quarter, especially given March.

Thank you.

I think some of the Wall Street analysts get too negative sometimes, especially the one speaking right now.

They can improve that, you know.

Well, let’s work on that. I’m going to ask a critical question, which I guess I always do, but your ROIC has come in a little bit lower as is for every railroad. But you guys kind of rank lowest amongst your big peers. Now I know you’re making a lot of investments for the future. So can we talk about – and I want to come back to the earlier question about the potential for capital investments in some of these customer projects that you highlighted earlier. But how do you guys pursue these CapEx projects given that a lot of other railroads would rather see their customers invest in some of these terminals? Do you view the contracting process differently? What do you do to protect returns in the out years such that you can get the ROIC closer to your peer levels?

I’ll take a first stab at that and then Mike might provide some color. If we go back and I don’t know if this is what you’re specifically referring to, but the Sasol project, keep in mind we’re investing something like 150 million, 160 million over two years; they’re investing 8 billion. And this model of the support [ph] yards and that type of capital investment on the railroads part is pretty common. We have done in other cases and the other rails have done it as well. Things like the refined product projects that we’ve talked about, we would be very interested in supporting those investments where we can with our own support yards. We see that as really an opportunity to help ourselves in the long run by investing in projects or co-investing that are going to drive line-haul revenue growth for years to come. What we generally have done in the past and prefer to do is we’re making substantial capital investments like those. We would have revenue and commercial agreements in place that would assure us of some level of return on those investments looking at our time horizons and return thresholds. So we haven’t done a lot of those type of projects on spec in the past, so we’re looking for some degree of comfort and commitment that we’re going to be able to get a return. I think we’ll continue to look at those. And I think like Sanchez, things like the San Luis Potosi, complex projects that we talked about, those aren’t necessarily tied to a single commercial or business opportunity but in those cases we would look at operational improvements and just growth in general to support the returns.

Brandon, this is Mike. Just one additional comment on Sasol. We’re also building a new yard there which will not only support Sasol but there are a number of other chemical customers very close to that facility that I’m sure Brian will be very eager to try to win their business. But in general on the return on invested capital, we target high teens to make sure we’re continuing to make incremental progress. Obviously in a down volume environment that’s been a bit more challenging and the longer term nature of our assets tend to get you to eight, nine, 10 years on discounted cash flow break even. So I think all of that said, if you look over the last 10 years we’ve roughly doubled our return on invested capital and this entire team on the call here is incented on return on invested capital at 75% of our performance-based stock award. So we’re pretty laser focused on making sure we continue to improve that. And just over the last 18 months obviously have been a very difficult volume environment to get those incremental revenues and margin.

I completely understand. It’s been difficult for the industry in the past year, year and a half, so appreciate the feedback on that.

Our next question comes from the line of Bascome Majors with Susquehanna International Group. Please proceed with your question.

Thanks for the time this morning. One for Dave. You recently commissioned a big survey of both buy-side and sell-side analysts about your corporate strategy and your communication with investors. I’m assuming you’ve gotten the results by now. Can you share with us a little bit? What surprised you and what did you learn that might change the way you manage the company going forward?

Actually we just got it yesterday, so we haven’t digested all of the data yet. But I think a common theme that we heard, that we’ve been hearing for a couple of years is don’t overcommit. Tell us what you can do and tell us what you know. And then be laser focused on getting that done. And I think by us doing what we’re doing today with guidance and sticking with this and while some people are saying we might be sandbagging a bit, I think it’s like Joe Friday, just tell it like it is. And that’s what we’re trying to do and trying to give you all the facts that we have without embellishing those facts. So that’s probably number one. The service problems we have in 2015 in Mexico, there were certainly some displeasure with that not only externally but also internally. So we think that we have addressed that head on and we’ve got the organization in place that that would not happen again. In fact, you’ll see us turn that survey out probably pretty quickly to see the reaction again. But I think it was healthy. I think it was good for us. But one thing that we really heard from the shareholders were they have a lot of faith in our growth potential. They want us to invest in our network. That was overwhelmingly the right decision versus share repurchase and stock buyback. They wanted us to reinvest in our own company, which was very encouraging. So a lot of good stuff came out of it. But a few big takeaways for us was don’t have another service interruption like you did in Mexico and make sure that you’re being cautious on the guidance that you’re giving and don’t wear rose-colored glasses. Tell it like it is.

I appreciate the color there. Thank you.

Our final question comes from the line of Jeff Kauffman with Buckingham Research. Please proceed with your question.

Hi, guys. Thanks for squeezing me in and congratulations in a tough quarter.

Thank you.

Most of my questions have been answered. So let me just ask this quick one. You talked a little bit about what you were doing with headcount, but you noted that 12% of your locomotives were in storage. What’s the normal number and how much could you grow volume without having to make significant locomotive adds at this point?

So if you recall over the last, it’ll be two years now, not for six months, we added I think it was 10% to our locomotive fleet on the anticipation of the energy. So most of that is in store. Half the new locomotives what we’ve been able to do is obviously store the older, more maintenance-intensive units. So you’re seeing some benefit out of that. With the improved cycle times, with the improved performance, improved velocity, certainly there is room to continue to grow volume without matching that on one-for-one with locomotives or crews. So as we continue to manage the resources with the volume, I think there’s opportunities to continue to outpace the resources that we might have to put back with the additional volume, but that’s something we’re certainly working hard and every day on.

In a perfect world, what percentage of your locomotive fleet is in storage?

I think in a perfect – well, that’d be a tough question. I’d say zero. I want them all working. I want them all pulling freight. But a company our size if we’ve got 50 or 75 older locomotives in storage as a surge fleet and if we got an opportunity we would be able to get those in service fairly quickly. But our high horsepower fuel conservative locomotives, we want them all operating and we really scrutinized the process when we order locomotives. We don’t have a standard order every year. We justify every locomotive we order, but you do have replenishment. I mean they’ll run for 30 years but you do have to replace them at some point. If you look at the numbers that we have stored compared to other railroads, we are extremely conservative.

Okay. Guys, congratulations and thank you.

Thank you very much.

There are no further questions at this time. Mr. Starling, I would like to turn the floor back over to you for closing comments.

Okay. Thank you for joining us on the call and we look forward to the second quarter call in July. Thank you.