Greetings, and welcome to the Norfolk Southern Corporation First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen only mode and a question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Katie Cook.
Thank you, Ms. Cook. You may begin.
Thank you, Chris, and good afternoon. 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. As noted in our disclosures found on Slide 2 of our presentation, please be advised that during this call, we may make certain forward looking statements.
These 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's Chairman, President and CEO, Jim Squires.
Good afternoon, everyone, and welcome to Norfolk Southern's Q1 2016 earnings call. With me today are NS's Chief Marketing Officer, Alan Shaw our Chief Operating Officer, Mike Wheeler and our Chief Financial Officer, Marta Stewart. We'll share the details of our strong Q1 financial results with you momentarily, but let me begin by saying how proud I am of the men and women of Norfolk Southern who are so successfully executing our strategic plan. Their flexibility and initiative are driving shareholder value even in the midst of a challenging and ever changing marketplace. Turning to our results on Slide 4, our team delivered a record setting 1st quarter operating ratio of 70.1%, 630 basis points lower than last year's Q1.
This performance was in the face of weak commodities, a strong dollar and coal volumes down 23%. Norfolk Southern's earnings for the Q1 were $1.29 per share, 29% higher than last year's dollar per share. Marta will go over the details shortly. We were able to generate these results thanks in large part to improved network performance. Mike will follow with an update on operations, but let me highlight here that our team increased the composite service measure by 23%, increased train speeds by 15% and reduced terminal dwell by 14%.
These strong improvements helped us control costs while enhancing the value of our product. Better service is of course a prerequisite to growth and a foundation of our strategy. It is what allowed us to grow in the Q1 in markets like automotive and intermodal even within a challenging macro environment. Furthermore, this focus on improved service helped to counterbalance weakness in commodities like coal and crude oil. Alan will share all the details of our top line results in a moment.
With respect to our strategic plan and as noted on Slide 5, our focus on strengthening Norfolk Southern is yielding results. We are now on track to achieve productivity savings of about $200,000,000 for the full year, up from our previous target of $130,000,000 dollars and we still expect to achieve a full year operating ratio below 70. Last quarter, we showcased a number of initiatives to right size our asset base. As this year progresses, we continue to explore and implement additional initiatives, including as we announced yesterday, our reduced train operations at Knoxville Yards. By 2020, we expect to achieve annual productivity savings of over $650,000,000 through cost reductions in labor, materials, fuel and purchase services.
Our plan is dynamic and our longer term expectations include growth in both pricing and volumes. As previously noted, we are targeting 2.5% compound annual growth in pricing and a similar rate of growth in volumes over the 5 year plan period. Our goal, as we have said, is a sub-sixty five operating ratio by 2020 accompanied by double digit compound annual growth in EPS. Based on our strong first quarter results, we are clearly moving in the right direction. Our plan also provides for significant return of capital to shareholders.
Over the past 10 years Norfolk Southern distributed nearly $15,000,000,000 through share repurchases and dividends. This year we plan to distribute $800,000,000 through share repurchases while continuing a steadfast commitment to maintaining our dividend. We have the right team in place. They have demonstrated their ability to perform. Delivering superior shareholder value is their abiding objective and mine.
I have every confidence as shown by our strong start to 2016 that this team will go above and beyond to produce results. I'll now turn the program over to Alan, Mike and Marta who will provide more details on our 2016 results and outlook and then return with some closing comments before taking your questions. Alan?
Thank you, Jim and good afternoon to our audience. We appreciate you're joining us today. On Slide 7, you can see that our Q1 revenue declined 6% year over year to $2,400,000,000 A majority of the decrease was attributable to lower on highway diesel and WTI prices, which reduced fuel surcharge revenues compared to last year. The remaining decrease in revenue was due to a 23% decline in coal volume, driven by unseasonably warm weather and to the Triple Crown restructuring. Coal now represents less than 15% of our revenue, down from 29% in 2010.
Excluding the impact of Triple Crown, our volumes were relatively flat despite the declining commodity markets due to our diverse portfolio and improved service product. Revenue per unit less fuel increased year over year for the Q3 in a row as a result of our pricing focus, which more than offset the negative mix impact from increased intermodal volumes and declines in higher rated commodities. As you can see on Slide 8, merchandise revenue increased 2% in the Q1 of 2016 with a 3% increase in volume. Volume grew in all business groups except chemicals, which was impacted by decreased crude oil shipments. Automotive volume was up 18% in the quarter, exceeding North American vehicle production growth of 5% with relatively easy comparisons from last year.
We do not anticipate year over year growth to continue at this level. Comparisons will become more difficult as the year progresses. For the year, we anticipate growth to be better aligned with North American vehicle production, which is now projected at an annual growth rate of 1.4%. Coil, steel and plastics benefited from automotive production, while housing and construction activity drove growth in aggregates, cement and lumber. Turning to Intermodal on Slide 9.
Overall volume was flat, notwithstanding the impact of the Triple Crown Restructure. Excluding our Triple Crown subsidiary, intermodal volume increased 6% with a 15% increase in international business, resulting from our network reach and service. Domestic growth, excluding Triple Crown, was impacted by the inventory overhang that we discussed last quarter, though volumes improved sequentially each month as a result of service gains. Lower volumes of higher rated Triple Crown Freight and lower fuel surcharge revenue decreased intermodal RPU by 12%. However, excluding the impact of Triple Crown and fuel surcharges, intermodal RPU increased 1% as pricing initiatives offset the negative mix associated with increased international volume and truck capacity.
Moving to the coal market on Slide 10. Utility coal met our previous guidance of 15,000,000 tons for the quarter, a decrease from last year due to warm weather and low natural gas prices. Exports slightly exceeded our guidance of 2,500,000 to 3,000,000 tons for the quarter, although challenges continue to be continue in an oversupply global market. We maintain our previous export guidance through 2016. Excluding fuel, revenue per unit increased 3%.
RPU was positively impacted by $10,000,000 in liquidated damages in the Q1 as rate increases were offset by unfavorable changes in the mix of business. As referenced on Slide 11, warm weather in our service territory continued through March, resulting in stockpiles well above average levels. We expect this impact to extend into at least the 4th quarter and anticipate utility volumes continuing at the 1st quarter pace until stockpiles return to target levels assuming normal weather patterns. Concluding with our outlook on Slide 12, coal volumes in 20 16 will be impacted as utilities work down the stockpile buildup resulting from the warm winter. Low oil and gas prices have significantly reduced rig counts and drilling activity, which will negatively impact our volume of crude by rail as well as natural gas drilling inputs including frac sand and pipe.
The triple ground restructure will dampen intermodal volume for the rest of the year. Longer term, our improved service product combined with increased regulation in the trucking industry provides stronger growth opportunities for domestic intermodal. Additionally, international intermodal volume benefits from our alignment with shipping partners adding capacity to the East Coast. Our pricing outlook is favorable, reflecting the value of our service product. Our lower on highway diesel and WTI prices and associated fuel surcharges continue to affect top line growth, that impact has greatly subsided.
We focus on growth by providing a service product the market values while negotiating market competitive prices. This quarter, our improved service levels especially benefited intermodal and automotive and allowed Norfolk Southern to aggressively manage through the changing economic environment. While executing against our strategic plan, we are enhancing shareholder return by successfully operating a network that efficiently and fluidly handles a diverse portfolio of business and strategically inserting NS as a valued component of our customer supply chains, which will generate greater opportunities for growth even as individual markets fluctuate. Next, Michael described operational improvements that have reduced our costs and enhanced the value of our products.
Thank you, Alan. I am pleased to announce we are continuing to operate at high service levels, while also making significant strides in our cost reduction initiatives. Thanks to the commitment and focus of our employees on executing these key drivers of our strategic plan. The following results are a validation of NS employees' hard work. Let me begin with one of our core principles on Slide 14, which is safety.
While our injury ratio saw a slight uptick in the Q1 as compared to the same period last year, we have actually seen a 5% improvement in our injury count. However, this was more than offset by a reduction in hours worked. We also achieved a reduction in the number of serious injuries resulting in an improvement in our serious injury ratio. Turning to service on slide 15. You can see we are maintaining the high service levels we delivered in the 4th quarter.
We have achieved this while aggressively and successfully pursuing cost reduction initiatives, which is something we committed to on our last call. We remain confident we can continue to keep service at a high level while we focus on identifying and implementing further cost reduction initiatives. As you can see on Slide 16, our speed has continued to improve which has aided our asset utilization. We are continuing to operate at our historic highs on this key metric. Well increased from the 4th quarter due in part to seasonal impact, but we were significantly below Q1 2015.
We are encouraged that our overall velocity as measured at the car level is near our previous record levels. Taking a look at our resources on slide 17, we continued rightsizing our workforce in the Q1 to match the business levels. These reductions occurred in all the operating departments. We had 1300 T and E employees furloughed at the end of the quarter along with 4 50 non T and E employees. We are in the process of recalling approximately 500 T and E employees to prepare for seasonal volume increases and to cover attrition.
Although for the full year, we are ahead of our plan for headcount reductions, which Marta will update you on later. On the locomotive side, aided by our high velocity and the execution of our strategic plan to run a more efficient and profitable railroad, we continue to rationalize our locomotive fleet. In addition to currently storing high adhesion road locomotives, we have rightsized our yard and local fleet. A total of 150 units have been removed from this fleet, representing a 12% reduction. We accomplished this without negatively impacting customer service levels.
In addition, we plan to add 50 new locomotives in the 2nd quarter, which will allow us to remove less efficient road locomotives from the fleet. Now on Slide 18, the cost reduction initiatives just discussed coupled with our efforts to keep the railroad operating at a high level have resulted in significant productivity savings. Through the 1st 3 months of the year, we have been able to realize significant improvements in key areas. Our 2.8% reduction in crew starts has outpaced our drop in volume driven in part by our improvement in train length. That percentage is even higher when considering the sharp production in recrues, which along with the drop in overtime is indicative of a very fluid railroad.
All of these together are driving improved productivity as seen in the gross ton miles for T and E employee. So certainly some positive results. As Jim stated, this is indicative we are ahead of our $130,000,000 productivity savings and now expect $200,000,000 in productivity savings for the full year. Some of this was front end loaded due to the benefit of not having last year's weather and service costs in the Q1. On Slide 19, I would like to update you on the status of our previously announced additional cost reduction initiatives.
We have ceased road operations on the West Virginia secondary as well as completed the consolidation of the Pocahontas and Virginia divisions. We also continue to make progress with the idling of the Ashtabula coal terminal which should be completed in the Q2. As seen on slide 20, we have also consolidated our operational alignment from 3 regions to 2. In addition to reducing regional supervision across all departments within operations, This initiative further streamlines our network and improves communication and coordination across the railroad. Lastly, on Slide 21, we have also made significant progress with our yard rationalizations.
We have been executing on this rationalization of our operation for several years, starting with the idling of Buckeye Yard in Columbus in 2,009 continuing with Roanoke in 2013 and now Knoxville, Tennessee. As recently announced, we are idling terminal operations at our hump yard in Knoxville effective May 1. 1 130 positions will be impacted by this reduction in operations. The annual savings on this initiative is approximately 13,000,000 dollars Our ability to realize these savings is due in large part to our expansion at our Bellevue hump yard and the capacity that has given us. In addition, we have curtailed activities at many of our smaller yards.
In all, we have reduced the rationalized yard operations at 25 locations across our system. We see a lot of positive signs from our operation and we will continue to execute our tactical and strategic cost control initiatives and at the same time ensure we continue to provide a great service product to our customers. Thank you. And I will now turn it over to Marta who will update you on the financials.
Thank you, Mike and good afternoon everyone. Let's take a look at our Q1 financials, starting with operations. Slide 23 summarizes our operating results compared to last year's Q1 and as Jim already mentioned, reflects a record setting 70.1 operating ratio. As you know, the Q1 historically has the highest OR of the year and so this result is very supportive of our anticipated full year operating ratio below 70%. Revenues, as Alan described, were down 6% in the quarter.
However, this was offset by a larger decline of 13% or $264,000,000 in expenses. The net result was an increase of $117,000,000 or 19% in income from railway operation. Taking a look at Slide 24, the 13% decline in operating expenses reflects the aggressive efforts our team has taken to reduce expenses and control costs. Every cost category except for depreciation declined in the quarter. Let's take a closer look at each of the components.
Slide 25 depicts the significant drop in fuel costs. As you would expect, most of the decrease is price related. In addition, consumption per unit improved as gallons of fuel used declined by 4% on the 2% reduction in traffic volume. Turning to Slide 26. Compensation costs were down by $60,000,000 or 8%.
As Mike discussed, our efforts to minimize overtime and recruse combined with a lower overall headcount resulted in $45,000,000 of lower payroll. Commensurate with the reduced compensation base was a lower level of payroll taxes, which were down $13,000,000 Additionally, we lapped the $11,000,000 in costs related to last year signing bonus and had $10,000,000 in lower pension expense. These items were partially offset by health and welfare rate increases of $15,000,000 As shown on the lower left of the slide, our average headcount for the quarter declined by about 1900 positions, both for the year over year and the sequential comparison. As Mike described, some of this is seasonal and we now expect a full year headcount reduction of 1500 versus the 1200 from our previous forecast. Slide 27 details our materials and other category, showing a decrease of $52,000,000 or 21%.
Reductions totaling 42,000,000 were due to a decline in all areas of material usage in locomotives, freight cars and roadway. The largest drop was in locomotive materials as a result of the 7% decline in locomotives in service. In addition to the decreased number of locomotive, we greatly reduced locomotive overhauls and strategically utilized parts from the fleet of DC locomotives that are slated for AC conversion. Additionally, fewer freight cars and the mild winter weather also contributed to lower material usage. For the remainder of the year, we expect the decline in materials to moderate to about a $10,000,000 quarter over quarter favorable variance.
Moving on to Slide 28, purchase services and rents were down $44,000,000 or 10%, largely due to $34,000,000 in lower Triple Crown costs associated with its much smaller operation. Additionally, expenses related to engineering and transportation services declined by $10,000,000 and equipment rents were down $3,000,000 notwithstanding the strong automotive volume, velocity related benefit offset these volumetric effects. Turning to income taxes on Slide 29. The effective rate for the Q1 was 35.5 percent versus 37.4 percent in 2015. A combination of small items, including a state tax law change and corporate online insurance proceeds slightly lowered the rate.
For the remaining quarters of this year, we continue to expect a roughly 37% effective income tax rate. Slide 30 shows our bottom line results with net income of 387,000,000 dollars reflecting an increase of $77,000,000 or 25 percent and diluted earnings per share of 1.29 dollars up 29% compared with last year. We're making solid progress and remain committed to continued improvement. Wrapping up our financial overview on Slide 31. Cash from operations for the 1st 3 months was $879,000,000 Capital spending through the Q1 was approximately $400,000,000 Due to the reduction in traffic volume, we've revisited our capital plan and have modestly reduced our full year capital budget from $2,100,000,000 to $2,000,000,000 even.
Turning back to cash flows, the improved operating cash and level CapEx resulted in free cash flow of almost $500,000,000 With respect to shareholder returns, we repurchased $200,000,000 of stock and paid $176,000,000 in dividends during the quarter. And with that, I thank you for your attention and I'll turn the program back to Jim.
Thank you, Marta. Norfolk Southern has adapted to a challenging environment and delivered strong first quarter results. The NS team remains focused on executing our plan to reduce costs, drive profitability and enhance value for all NS shareholders. We're on the right track and showing tangible results. And with that, we will now open the line for Q and A.
Operator?
And our first question comes from the line of Justin Long from Stephens. Please proceed with your question, sir.
Thanks and congrats on the quarter. The first question I had was, I was wondering if you could provide any expectation for the sequential progression of the OR throughout the year. You mentioned in the prepared remarks that 1Q is usually the highest OR of the year. So I'm just curious if you think that typical seasonality will hold true in 2016.
So Justin, as you properly observe, the Q1 is traditionally the highest operating ratio quarter of the year. And so with our guidance for a sub-seventy percent operating ratio for the full year, we would expect to see declining operating ratios from here. And now with that said, we do certainly have some headwinds out there. The commodities landscape is anything but certain right now. And we're heading into some tough comps in the Q2, some of the highest volume weeks of the year last year.
And a variety of other areas as well, the revenue outlook is somewhat uncertain, but we are confident that we can deliver. We're pulling out all the stops on costs as you saw in the Q1. And we intend to deliver sub-seventy percent operating ratio for the full year.
Okay, great. And then maybe as my follow-up on pricing, I know you don't give details on core price, but I was wondering first if you could talk about how much of your 20 16 pricing is locked in as of today? And then maybe just on a relative basis for that pricing that is locked in, how that stacks up to the level of increases you saw in 2015?
Hey, Justin. We've got about 3 quarters of our business for 2016 locked up right now with pricing. And I would say at this point pricing is above the levels that we were seeing at this time last year.
Okay, great. I'll leave it at that. Thanks so much for the time.
And our next question comes from the line of Matt Troy from Nomura Asset Management. Please proceed with your question.
Yes. Hi. Thanks for taking my call. Just a quick one. I think a couple of quarters ago, people had asked about your decision to maintain the WTI based surcharges.
You've now said you're going to move in the last couple of quarters to on highway diesel. Just wondering if you could frame for us roughly what percentage of your fuel surcharge programs are currently on the on highway diesel framework? And what's the opportunity over what time frame to migrate that? Thanks.
We've gotten our WTI based revenue from a little bit over 50% to somewhere between 40% to 45% depending upon traffic mix.
Okay. And my follow-up would then be just a simple question on pension. You said it was lower by $10,000,000 in the quarter. Wondering if you could just dimensionalize for the year, is that a good run rate? Should we expect pension expense to be about $10,000,000 lower per quarter?
Or do you have an annual forecast there? Thanks.
Yes, Matt. You're correct. That pension trend set for the Q1 will continue for each of the quarters the rest of the year.
Great. Thanks, everybody.
And our next question comes from the line of Allison Landry from Credit Suisse Group. Please proceed with your question.
Thanks. So thinking about the improved free cash flow here in the Q1, is there upside potential to the $800,000,000 of share buybacks you alluded to? And then, in terms of CapEx, you did take it down about $100,000,000 but do you see further opportunities to take that down even lower?
Allison, I'll start. We are certainly working hard to adjust our CapEx as appropriate to keep it within limits that generate satisfactory returns. And that's why we have modulated our capital spending both this year and last downward in the face of declining revenue relative to our original expectations for the year. Marta, why don't you comment on the buybacks we've outlined today?
Okay. The buybacks are something that our Board reviews continually. Each time we meet with our Board, we look at that. We look at the free cash flow projection. And right now, we're comfortable with the guidance that we gave of $800,000,000 for the full year.
Great. Thank you.
You're welcome.
And our next question comes from the line of Ken Hoexter from Merrill Lynch. Please proceed with your question, sir.
Great. Jim and team, congrats on a great job. So stepping back from the active events around the M and A and you fought that back and a lot of weight on your shoulders to prove that you can achieve. So great job out of the gate now that you can just focus on actually running the business. But earlier, Michael, you talked about re crews down about 51%.
Just wondering operationally, is what are you changing in order to kind of achieve that? And what structurally when you take a step back? Obviously, you're shutting down a bunch of the different local networks that you've talked about in combining systems. But what operationally do you need to change? And is there more room to improve from those changes?
Yes, Ken. Well, obviously, like we talked about last year, getting the right resources in place, crews and locomotives, and those are in place. And with that, we've been executing our operating plan very well. And that's allowed us to reduce the re crews and do all the productivity things we've seen as well as all the high service levels we provided. So that's kind of the big driver of it.
We've got the resources. We've got the right operating plan and we're executing that operating plan. Now going forward, we've always said that we're going to continue to take a look at what opportunities are out there. You saw what we've announced yesterday. We continue to look and we will, but we're always going to make sure that we protect the service products that we have and keep that at a high levels and continue to reduce costs.
Is there, I guess, Jim, when you step back, is there a master plan of different buckets that when you look at this 65 OR target that you can tell us and walk us through it at some point, whether it's train lanes, what you need to do on sidings, reduction on employees or locomotives that you feel needs to be done to get there? Or is this kind of piecemeal each time you improve, you just keep coming out with, oh, we can close this now? Or is there something, Master, that you can kind of set targets on a little more specifically?
Sure. And we have outlined some targets along those lines, Ken, to go with the annual productivity savings totaling more than $650,000,000 by 2020. For example, we have said that we intend to bring employment down significantly with associated compensation and benefits expense savings by 2020. And that's a function of productivity labor productivity initiatives across the board. We also have targets for our locomotive fleet and for various other resources that will drive those productivity savings.
Is that something you're going to share with us kind of targets and goals so we can kind of watch you along the way or are they just more internal targets?
We'll certainly update you as we move along as we have today with regard to our labor targets. And Mike also got into the locomotive fleet size and efforts there to rationalize that asset.
Great, great job. Thank you for the time.
Now our next question comes from the line of Chris Wetherbee from Citigroup. Please proceed with your question.
Hey, thanks. Good afternoon. I wanted to ask about the productivity, the $200,000,000 upsized from $130,000,000 Can we get a sense of how much was in the Q1? It sounded like maybe some of it was a little bit pulled forward due to weather and some other favorable operating conditions. But just want to get a sense of sort of what was in 1Q and then maybe how think about the cadence for the rest of the year?
Yes, that's right, Chris. We entered the year with a running start and we had some built in favorability from the absence of weather and service related spending in the Q1 of last year and that boosted productivity in the Q1. We were also benefiting from other initiatives that we had kicked off last year that gave us a lot of momentum in energy entering 2016. And we're going to keep that going. We've revised upward, as we've said, the productivity target for the full year to $200,000,000
So just trying to understand sort of how much of that $200,000,000 might have been in 1Q and then what we can expect for the rest of the year?
$200,000,000 for the full year is our new goal, as I said. Again, that was a bit from the Q1. And Marta went through, for example, the run rate on mechanical spending relative to last year will lessen somewhat in subsequent quarters. So call it a fast start, we're going to stay at it and for the full year $200,000,000
Okay, that's helpful. And then just thinking about sort of the headcount as we go forward, obviously you updated the target there. That would suggest roughly flattish, maybe a little bit down, maybe a little bit, yes, sort of up a little bit over the course of the rest of the year. I just want to think, is that the right way to sort of think about how that cadence plays out up the seasonal uptick generally in volume over the next couple of quarters, but sounds like you can handle that with the existing resources you have.
So our guidance, Chris, was that for the full year, we think we're going to be down 1500. So I don't know if you're looking at it sequentially or year over year, but the way to think about it is if you look at our last year average that we have in our financial data book, we think we're going to end the year 1500 below that.
Okay. That's helpful. I appreciate it.
And now our next question comes from the line of Scott Group from Wolfe Research. Please proceed with your question.
Hey, thanks. Afternoon, guys. So outside of the $10,000,000 or so of liquidated damages, is there anything else that you would call unusual in this quarter? And I guess I'm trying to go back to that first question about the sequential margin trend because we typically see, I don't know, 400 basis points or 500 basis points of margin improvement from 1Q to 2Q. And I don't know if that's a realistic expectation kind of given the strength we saw in the Q1.
Well, Scott, let me reference you to something that Jim said about the weather related. If you'll recall last year, we had some weather and service related costs in each of the 1st three quarters, but they were definitely weighted towards the Q1. So that was $42,000,000 that we called out last year. So that's kind of the running start that he and Mike referred to. So that would tell you that we had more of a reduction in the Q1 than you would normally expect.
Does that make sense with the $42,000,000 of the $82,000,000 was incurred in the Q1 of last year?
Okay. So maybe, we've got $40 so 1,000,000 of lower than normal weather costs and then
a little bit of the liquidated damages to think about
for the Q1 this year. Okay.
And the third item would be the materials that we highlighted that we had a materials year over year reduction of $42,000,000 in this first quarter, but we're forecasting that will be just a $10,000,000 reduction in the second, 3rd and 4th quarters.
What's the change there?
That's the materials. We had some items in the Q1 that I called out in terms of locomotive overhauls that were greatly reduced and some specific things we did with freight cars and locomotives in terms of using parts that is a Q1 only item. So part of the materials reduction will continue, but a large part that we have in the Q1 will not.
Okay. And then just in terms of headcount, so you're already above the 1500 people you're talking about for the year. And I mean, we're not really seeing the seasonal volume uptick. Your service metrics are at kind of great levels right now. Then you just announced some additional closures yesterday or 2 days ago.
So I guess I'm a little confused why we're not raising the headcount target even more.
Well, we do need to bring the folks back to cover attrition and we need those folks to make sure we continue to maintain the service levels that we have. That's a key point. And we historically do see higher seasonal volumes in the second and third quarter than what we have in the Q1. And that's expected to cover that as well.
What are you assuming for volume growth volumes in the second quarter?
Well, we expect sequentially higher volumes in line with the usual seasonal pattern. Alan, why don't you break that down a little bit for Scott?
Scott, it'll be down year over year though because as Jim noted, some of our greatest volume comps were in the Q2 of last year. We're going to continue to have headwinds in our coal market, which I've outlined.
We will
not have the level of growth in our automotive franchise that we had in the Q1 due to the fact that we had some pretty easy comps in the Q1 of last year. And there are a couple of models that are built and plans served by NS, which are effectively being taken offline due to low demand. So we are going to have some headwinds with respect to volume in the second quarter. But ultimately, service is driving more intermodal volumes for us. And Triple Crown will be a headwind for us into the Q4 of this year.
Okay. Thank you, guys.
Welcome.
And our next question comes from the line of Jason Seidl from Cowen and Company. Please proceed with your question.
Thank you, operator. Hey, guys.
You know the old saying, you got to walk before you run and it looks like at least you guys are starting a job. Just a question to the sort of your physical plan going forward. I know as one of the callers alluded to before that you guys made some recent streamlining announcements. What in terms of maybe some track sales or maybe some track divestitures might be left here in 2016? And when should we expect more color on them?
We have previously announced a goal of short lining, idling or downgrading 1,000 miles of track this year. That remains our goal in terms of the track structure. Mike, other thoughts on infrastructure related rightsizing?
No, we continue to look at it. We've got a lot of modeling that goes on to try and find where we can do that. And we take the opportunities. We will do that. We have some of those things you're talking about kind of on the table going forward that will be announced later on in the year.
Okay. That's fair enough. Also how should we think about coal next year? I know it's very negative now and all the other railroads are talking about massively high stockpiles, warmest winter on record. How should we look at it next year if we get more normalized weather patterns?
Jason, if stockpiles return to target by the end of the year, then coal volumes will be kind of close to where we were at a run rate last year, where we again are utility markets. We were 17,000,000, 19,000,000 tons is what we were looking at. And exports could be highly dependent upon what happens with the overseas market.
Right, Rod. I understand that. So where are we now with stockpiles in your region?
Jason, they're about 100 days right now. And target, I would tell you, is probably about 60, dependent upon the geography. So there's a lot of inventory overhang that needs to get worked through this summer in order for us to get back target. So we're
going to need
a hot summer that does support that Kohl's franchise.
I'll keep my fingers crossed for you. Well, listen guys, I appreciate the time as always.
And our next question comes from the line of Brandon Oglenski from Barclays. Please proceed with your question.
Hey, good afternoon, everyone, and thanks for taking the question. And Jim, if guys keep delivering earnings up 29%, some of those critical stuff in the past 3 months probably goes away pretty quickly. I just want to ask you, Marta, because you grouped in materials and other and I think purchased services in some other line items. So can you go over the guidance for those 2 broad categories again as they're supposed to trend throughout the year?
Okay. Certainly. So in materials, we were down $42,000,000 in the Q1, but quarter over quarter for the remainder of the year, we think that's going to be down $10,000,000 okay? And then in purchase services
Sorry, Mark, I just want to clarify. So sequentially down $10,000,000 or meaning year on year on year?
Year over year. So Q2 of 2016 compared to Q2 of 2015 and so on, we think that will be down 10,000,000 dollars in material. And then with purchase services and rent, the predominant reason for the reduction there was the reduction in Triple Crown services. So that was $34,000,000 of that decline and that will continue at that level for the at approximately that level for the 2nd and third quarter. In the 4th quarter, it will be about half of that because recall that we downsized Triple Crown in the middle of Q4 of last year.
Okay, got it. That's helpful. Thank you for clarifying. I guess, let me just slip one more question, if you guys don't mind. So Jim, what can you leverage on the service side?
Now that it appears you have your cost structure a little bit better than where it was last year. Service does appear to be improving for Norfolk. When markets come back, what's the plan on the marketing side? Because we've talked a lot here about the cost side.
Sure, absolutely. And we are well positioned to grow as commodities rebound and other markets recover from inventory overhang. And that's the great benefit of having service at the current level. It sheds cost and it positions us for growth. So we are very confident that we can grow into this level of service and will just as soon as business picks up.
Okay. Thank you.
And our next question comes from the line of Rob Salmon from Deutsche Bank. Please proceed with your question.
Hey, good afternoon, guys. Marta, with the benefits from the Knoxville closing, it sounded like if I heard you correct, it's about $13,000,000 on an annualized basis. Are there any costs that we should be thinking about in terms of that will be incurred in Q2 in anticipation of the savings that we should be modeling in?
No, no. You're good with that $13,000,000 that Mike talked about. Again, if it's going to be effective May 1 and the $13,000,000 dollars is annualized, so roughly half of that will realize this year with midyear implementation.
All right. That's helpful. And then with regard to the train length, I saw they increased about 2.5% on a year over year basis. Is that predominantly driven by the growth that we saw in terms of traffic in your merchandise network? Or was this kind of more broad based and that's kind of not a fair apples to apples comparison?
No, you're exactly right. The our intermodal and the unit train stayed at very high levels, but the growth was in the merchandise section. In fact that section grew 6%.
Okay. That's helpful. And how should we think about the cadence looking out from here? Are there incremental initiatives that should allow further growth? Or is the growth going to come from volume eventually picking up?
I would say both. We'll be able to handle the volume growth onto the train network. The other thing is we continue to have initiatives looking at where we can build big trains, particularly between terminal and terminal, including more use of the distributed power technology and we're doing more and more of that and big trains terminal to terminal where it makes sense.
Okay. And are there any goals that you're willing to share in terms of targets for the back half of the year at this point?
No, not at this time.
Okay. Thanks for the time.
And our next question comes from the line of David Vernon from Bernstein. Please proceed with your question.
Just a question for you on some of the intermodal pricing and the outlook for intermodal rates both in the sort of near term. It looks like the RPU ex Triple Crown and fuel surcharge grew at about 1%. And I'm just wondering, kind of what your expectation is in the context of that pricing above inflation, what we should be expecting in that core intermodal rate?
Well, David, recognize that, that 1% growth had a negative mix component from flat domestic and a 15% increase in international, which tends to be a shorter haul and have a lower RPU, 40 foot box versus 50 3 foot box. So let's strip that mix, and we had pricing and intermodal that exceeded rail inflation and pricing and intermodal that drives sufficient shareholder returns to allow it to compete for capital.
So you're not seeing any pressure there from any temporary looseness in the truck market on the intermodal rates?
To be sure, truck capacity is limiting probably the level of increase that we could get, but it's not causing rate decreases.
Okay. And then maybe just as a quick follow-up, obviously, Jim, this is a pretty amazing sort of inflection point in sequential productivity. And I guess as you think about kind of the outlook, obviously, you're going to be delivering more, but should we be thinking this Q1 is the like you said, a running start and is going to be kind of the peak for the rate of change in productivity going forward or are you also holding some things back for later in the year?
Yes. No, I think that's
a fair assumption. We front loaded some of the productivity gains. As I said, we had a very fast start to the year with a lot of momentum and energy based on the plans that we made, the things that we did last year to position ourselves for it. So yes, we have the pedal to the metal and that's where it's going to stay.
All right. Well, a 70 OR in the Q1 is truly impressive and great results guys. Thanks.
And our next question comes from the line of Tom Wadewitz from UBS. Please proceed with your question.
Yes, good afternoon. And I'd echo the other commentary, very strong results, obviously. Let's see, can you comment a little on the kind of look on markets where I know you said that the 2nd quarter comps are more difficult volume wise. But as you look at things, I guess, macro variables changing and so forth, where might you be most optimistic that you could see some improvement in markets? Would it be in steel with some of the actions that might take place that might help the domestic producers?
Would it be where might you actually see a little more optimism looking beyond maybe the tough comps here in the near term?
Tom, we've talked about the coil steel benefiting from the automotive market. And as you alluded to, the recent tariff activity has improved steel pricing and steel capacity utilization. So there are some aspects of the steel market that are performing well within our metals and construction, of course, is frac sand. And we're going to have a pretty significant decline there due to the decline drilling activity as is pipe. I would tell you that once the retail and wholesale inventory levels normalize, we see a lot of opportunity in that consumer base market because of our improved service product.
And even with pressure on corporate profits now, shippers are looking to shift to intermodal because it still is a lower priced option than truck.
So what's a reasonable time frame to see the volumes look a little bit better? You think they can grow later in the year? Or is that just hard to tell?
It's going to be wholly dependent upon what happens with commodity pricing, the pressures in crude oil, frac sand and coal and then what happens with the retail and wholesale inventory levels.
Okay. And then just a short follow-up. On the comp and benefits, can you give me any sense of how to model that year over year looking forward, Marta? Does that change because incentive comp is more of a headwind or different? Or do you think it's kind of down per worker year over year the next several quarters?
Yes. I think you've keyed on the one thing that's going to be different in the second through 4th quarters. In my prepared remarks, I talked about 3 things and they're going to continue. Just to summarize those, that's headcount. It's going to continue, but at a moderated levels we've already discussed.
The inflation that we had guided to at 3.5% and you saw the $15,000,000 in health and welfare, that's going to continue. The pension, as someone else asked a few minutes ago, that's going to continue. But the one thing that is going to be different in the second, 3rd and 4th quarters is the year over year headwind from incentive comp. Because as you'll recall, last year in the Q1, we had been accruing at a beginning of year bonus accrual level. But as the year went along and we didn't meet expectations, we had reversals of those accruals.
And so each of the quarters last year had year over year incentive comp reductions. And so depending on how our performance is the remainder of the year, you will see headwinds from that item.
Okay, great. Thank you for the time.
You're welcome.
Our next question comes from the line of Tyler Brown from Raymond James.
Jim, I just wanted to ask you a little bit about the opening of the Bellevue hump yard and the Englewood flyover from last year. So first, are you guys seeing the returns on those projects that you expected? And then 2, I'm just curious if those projects have been instrumental in the ability to close Roanoke and Knoxville, hump yards and even if they've been a key driver on productivity?
No doubt about it. The Bellevue capacity and throughput has facilitated asset rationalization elsewhere on the network, including at the terminal level and elsewhere as well. And certainly, the flyover has helped with our meets in and out of Chicago. So yes to both.
Okay, great. And then I am curious, have you at this point, has rationalizations impacted schedules or transit times at all on the intermodal side, maybe positively or negatively?
No, no. We are continuing to run at the high levels that we've had in the past. So they've all it's all been good.
Okay, great. Great quarter. Thanks guys.
Our next comes from the line of Ben Hartford from Robert W. Baird. Please proceed with your question.
Yes, thanks. Marta, could I circle back on the incentive comp discussion? Did you provide what the headwind was in the Q1, if there was any in terms of IC?
It was approximately flat in the Q1. If you look at the full year of last year, it was a year over year $150,000,000 but it was all in the second, 3rd and 4th quarters.
Okay. So will there be catch up in the in 2Q, 3Q, 4Q from the Q1 or was it just none for some reason even though it just might be the quarter strength?
It's more of a year over year thing, Ben. So the Q1 of last year, we had an incentive comp accrual. And then the Q1 of this year, we had a roughly similar amount. As you move into the remainder of the year, the issue will be the year over year comparison.
Got it. Alan, I guess maybe your view on international intermodal and then SOLUS in the container waiting discussion, what is your take in terms of potential pull forward of international intermodal ahead of the implementation mid year? And what type of effect do you expect if and when that is implemented?
Ben, we've heard the theory that, that could cause some volumes to be pulled forward. But as we've talked to our customers in the shipping lines, we haven't seen any activity to that regard.
Any concerns? I assume there are concerns, but any changes in behavior that you see from shippers preparing for that potential implementation?
Nothing meaningful.
Okay. Thank you.
There are no further questions at this time. I'd like to turn the conference back over to management for any closing remarks.
All right. Thank you very much for your participation in today's call.
Ladies and gentlemen, this does conclude today's teleconference. We thank you for your time and participation. You may disconnect your lines at this time and have a wonderful rest of your