Greetings. Welcome to the Union Pacific Second Quarter Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded and the slides for today's presentation are available on Union Pacific's website.
It is now my pleasure to introduce your host, Mr. Lance Fritz, President and CEO for Union Pacific. Thank you, Mr. Fritz. You may now begin.
Good morning, everybody, and welcome to Union Pacific's 2nd quarter earnings conference call. With me here today in Omaha are Eric Butler, Executive Vice President of Marketing and Sales Cameron Scott, our Executive Vice President of Operations and Rob Knight, our Chief Financial Officer. This morning, Union Pacific is reporting net income of $1,200,000,000 or $1.38 per share for the Q2 of 2015. This is a 3% decrease in earnings per share compared to the Q2 of 2014. Solid core pricing gains were not enough to overcome a significant decrease in demand.
Total volumes in the 2nd quarter were down 6%, led by a sharp decline in coal. Industrial Products and Agricultural Products also posted significant volume decreases. As you recall, 1st quarter volumes were down 2% and we began realigning our resources early in the year, storing locomotives and furloughing employees. These efforts continued throughout the Q2. We've made meaningful progress rightsizing our resources to current volumes, and I'm encouraged to report that we've made these improvements while posting strong safety performance.
But our work is now finished. We'll continue to become more agile with our network and our resources. We remain focused on providing safe and efficient service for our customers and strong financial performance for our shareholders. With that, I'll turn it over to Eric.
Thanks, Lance, and good morning. In the Q2, our volume was down 6% with gains in automotive and intermodal more than offset by declines in coal, industrial products and add products. We generated solid core pricing gains of 4%, it was not enough to offset the drop in fuel surcharge and the mix headwinds as average revenue per car declined 5% in the quarter. You'll see the impact of lower fuel surcharge revenue as we discuss each business group. Overall, the decline in volume and lower average revenue per car drove a 10% decrease in freight revenue.
Let's take a close look at each of the 6 business groups. Air Products revenue was down 7% on a 7% declined 6% as we returned to more normal seasonal shipping patterns compared to the strong demand last year. Export feed grain was impacted by the strong U. S. Dollar and abundant global grain supply driving our export shipments down 36%.
In wheat, our export shipments also declined, but were partially offset by moderately better domestic shipments. Grain products volume was down 3% for the quarter. Ethanol volume declined 6%, driven by extended plant maintenance downtime following a record year of production. Partially offsetting the ethanol decline was increased demand for soybean meal exports to China and an increase in biodiesel shipments. Food and refrigerator shipments were down 2%, driven primarily by fewer potato shipments and also due to lower frozen meat exports.
Automotive revenue was up 3% in the 2nd quarter and a 7% increase in volume, partially offset by a 3% reduction in average revenue per car. Finished vehicle shipments were up 8% this quarter driven by continued strength in consumer demand. The seasonally adjusted annual rate for North American automotive sales was 17,100,000 vehicles in the 2nd quarter, up 3.6% from the same quarter in 2014. This is the Q1 with the SAAR rate above 17,000,000 vehicles since the Q3 of 2,005. In auto parts, volume grew 5% this quarter, driven primarily by increased vehicle production.
Chemicals revenue was down 1% for the quarter on a 1% reduction in average revenue per car and flat volume. Plastic shipments were up 11% in the 2nd quarter, stable resin pricing led to strong buyer confidence in the market and we also saw strength in export volume. Petroleum and liquid petroleum gas volume was up 10% in the 2nd quarter, driven primarily by strength in several LPG markets. Our volume gains were offset by a 29% decline in crude oil shipments, which continued to be impacted by lower crude oil prices and unfavorable price spreads. Coal revenue declined 31% in the 2nd quarter on a 26% reduction in volume and a 7% decrease in average revenue per car.
Southern Powder River Basin tonnage was down 28% for the quarter as demand for coal continued to be impacted by mild weather and low natural gas prices. And in addition to soft demand, volumes were also impacted by heavy rains in June that flooded coal mines in the Powder River Basin and damaged our main line. Colorado, Utah tonnage was down 31% for the quarter, driven by both the soft domestic demand and reduced export shipments. I'll talk more about our outlook for coal in just a minute. Industrial Products revenue was down 14% on a 13% decline in volume and a 1% decrease in average revenue per car.
Construction products revenue was down 5% for the quarter. We experienced higher than normal rainfall in the southern part of our franchise during the quarter, which led to construction delays that impacted both cement and rock volume. We still think the construction market is fundamentally strong, particularly in Texas, and that our construction products business will rebound. Minerals volume was down 24% in the Q2. The reduction in drilling activity led to a 28% decline in shipments of frac sand.
Finally, metals volume was down 27% as lower crude oil prices reduced drilling related shipments by nearly 50%. Also the strong U. S. Dollar continued to drive increased imports, which reduces demand from domestic steel producers. Intermodal revenue was down 5% as a 2% volume increase was more than offset by 7% decrease in average revenue per unit.
Domestic shipments grew 3% in the 2nd quarter as we continue to see strong demand from highway conversions and for premium services. International intermodal was up 1% as our recovery from the West Coast port labor dispute was muted by the strong comparisons from 2014. You will recall that the Q2 2014 results included pre shipments ahead of the West Coast port labor contract expiration. Additionally, we experienced a slowdown later in the quarter due to relatively high retail inventory levels and softer than expected retail sales. I'll update you on our expectations for peak season in just a minute.
To wrap up, let's take a look at our outlook for the rest of the year. In Ag Products, overall crop conditions in our territory appear favorable at the moment. However, low commodity prices and abundant global supply creates uncertainty in our volume outlook for grain. In grain products, we expect demand for soybean meal to remain strong in the near term and ethanol production should return to seasonally normal levels. Automotive should continue to benefit from strength in sales and we expect growth in finished vehicles and auto parts shipments.
In coal, while the weather has been closer to seasonally normal temperatures recently, we expect lower natural gas prices, higher inventories and low export demand to continue to be headwinds in the second half of the year. Although we anticipate continued year over year declines in the back half of the year, we expect that volumes will sequentially improve from 2nd quarter levels. Most chemical markets should remain solid for the remainder of the year with strength expected in LPG and plastics. We continue to expect crude oil prices and unfavorable spreads will remain a significant headwind for crude by rail shipments for the rest of the year. Lower crude oil prices will also continue to impact some of our industrial products markets.
Rig counts are down roughly 50% from their peak in 2014, but seems to have stabilized in recent weeks. We expect our frac sand shipments to level off as well, though they will be significantly lower year over year given the strong comps. The reduction in new drilling activity along with the strong dollar will continue to be headwinds for our metals business. The housing market continues to strengthen year over year and we believe our lumber franchise is well positioned to grow with demand. In construction products, we anticipate to return to growth as weather conditions normalize.
Finally, in intermodal, the relatively high current retail inventory levels could moderate our growth in the second half of the year in both domestic However, many of the consumer confidence and spending indicators are still positive, so we are preparing for a normal peak shipping season, though it could be muted. As always, highway conversions will continue to present growth opportunities in domestic intermodal. Overall, while there is uncertainty in some of our markets, we continue to see opportunity in several others. We will continue our focus on solid core pricing gains and on business development across our diverse franchise. With that, I'll turn it over to Cameron.
Thanks, Eric, and good morning. Starting with our safety performance, our first half reportable injury rate improved 23% versus 2014 to a record low 0.82. Successfully finding and addressing risk in the workplace is clearly having a positive impact as we improve towards our goal of 0 incidents. In rail equipment incidents or derailments, our reportable rate increased 17% to 3.46%, driven by an increase in yard and industry reportables. To make improvement going forward, we will continue to focus on enhanced TE and Y training to eliminate human factor incidents.
We're also continue making investments that harden our infrastructure to reduce incidents. In public safety, our grade crossing incident rate improved 11% versus 2014 to 1.97%. We continue to drive improvement by reinforcing public awareness through channels including public safety campaigns and community partnerships. Moving to network performance, we continue to face a very dynamic environment. Significant volume swings and business mix shifts have led us to more frequently adjust our transportation plans.
Add to it the numerous flooding related outages we faced during the quarter and it was a challenging operating environment. During the quarter, we experienced 64 weather interruption days caused by more than 100 weather related track outages, including a significant interruption in the Powder River Basin during early June. We define interruption days as more than 50 hours of train delay associated with weather or incident events. The strength of our franchise and investments we have made in resources have enabled us to mitigate the impact of these events. We rerouted trains where possible, while our engineering crews worked around the clock to restore operations.
I'm very proud of the men and women of Union Pacific who faced these challenges head on, enabling us to generate year over year improvement in both velocity and terminal dwell. That said, we know there is more work to do and we are working diligently to improve service and reduce costs. Throughout the year, you have heard us discuss the importance of resource alignment as a key lever to reduce cost. While we strive to be as real time as possible, the reality is that there is a time lag in adjusting the resource space, especially during periods of volume swings and business mix shifts. As you can see in the charts on the right, we have made meaningful progress rightsizing our TE and Y workforce and active locomotive fleet throughout the first half.
Our total TE and Y workforce was down 4 training pipeline. We expect a further reduction in the Q3. By the end of June, we had around 1200 TEOI employees either furloughed or an alternative work status and had about 900 locomotives in storage. This is up from the end of the Q1 when we had around 500 TE and Y employees furloughed or an alternative work status and 475 locomotives in storage. While we still have some work left to do, we are now getting closer to having our resources aligned with demand.
But as always, we will continue to monitor and adjust our workforce levels and equipment fleet as volume dictates. Moving to network productivity. Even in the face of less than optimal operating conditions and lower volumes, we were able to generate some efficiencies during the quarter. We ran record train lengths in nearly all major categories, remaining agile and adapting our transportation plan to current demand. We were also able to generate efficiency gains within terminals as productivity initiatives led to record terminal productivity despite a decline in the number of cars switched.
Growth capacity investments, whether it be in the form of sidings, double track or terminal infrastructure, have enhanced our ability to generate productivity and have increased the fluid capabilities of our network. However, as was also the case in the prior quarter, the associated time lag in adjusting resources to lower volumes continued to lead to inefficiencies in other areas. This was particularly evident in efficiency metrics such as locomotive productivity, which is measured as gross ton miles per horsepower day. While lower coal and grain volumes did create a mix headwind, this fleet productivity metric was down 8% versus the Q2 of 2014. To wrap up, as we move into the back half of the year, we expect our safety strategy will continue yielding record results on our way to an incident free environment.
We will continue making operational improvements by leveraging the strengths of our franchise to improve operational performance. And while our resources are now more closely in line with demand, we will continue our focus on other productivity initiatives to reduce costs. Ultimately, safety and service will drive our ability to run an efficient network, all of which creates value for our customers and increases returns for our shareholders. With that,
I'll turn it over to Rob. Thanks. Good morning. Let's start with a recap of our 2nd quarter results. Operating revenue was just over $5,400,000,000 in the quarter, down 10% versus last year.
A significant decline in volume and lower fuel surcharge revenue along with a negative shift to business mix more than offset another quarter of solid core pricing. Operating expenses totaled just under $3,500,000,000 decreasing 9% when compared to last year. Drivers of this expense reduction were significantly lower fuel expense along with volume related reductions and cost saving initiatives. The net result was an 11% decrease in operating income to $1,900,000,000 Below the line, other income totaled $142,000,000 up from $22,000,000 in 2014. Included in this amount is the previously announced Fremont, California land sale, which contributed $113,000,000 to pre tax income or $0.08 per share to total earnings.
Interest expense of $153,000,000 was up 11% compared to the previous year, driven by increased debt issuance during the last 12 months. Income tax expense decreased 7% to $734,000,000 driven primarily by reduced pre tax earnings. Net income decreased 7% versus last year, while the outstanding share balance declined 3% as a result of our continued share repurchase activity. These results combined to produce a quarterly earnings of $1.38 per share, down 3% versus last year. Now turning to our top line, freight revenue of about $5,100,000,000 was down 10% versus last year.
In addition to a 6% volume decline, fuel surcharge revenue was down about $400,000,000 when compared to 2014. All in, we estimate the net impact of fuel price was a $0.06 headwind to earnings in the Q2 versus last year. This includes the net impact from both fuel surcharges and lower diesel fuel costs. Of course, this is a turnaround from the Q1 where we had the benefit of surcharge lag and more favorable spreads. Assuming fuel prices and associated spreads remain at current levels, we estimate that fuel will be a slight headwind to earnings for the remainder of the year.
Business mix as we guided on our Q1 earnings call was a negative contributor to freight revenue for the Q2. The primary drivers of this mix shift were significant declines in bulk grains, frac sand and steel shipments along with an increase in intermodal volumes. Looking ahead, business mix will likely continue to be a headwind to freight revenue for the remainder of the year. A 4% core price increase was a positive contributor to freight revenue in the quarter. Slide 21 provides more detail on our core pricing trends.
Core pricing continued at levels that are above inflation and reflects the value proposition that we offer in the marketplace. Of the 4% this quarter, just under a 0.5% can be attributed to the benefit of the legacy business we renewed earlier this year. And this includes both the 2015 and 2016 legacy contract renewals. Moving on to the expense side, Slide 22 provides a summary of our compensation and benefits expense, which increased 5% versus 2014. Lower volumes were more than offset by labor inflation, increased training expense and operating inefficiencies.
Looking at our total workforce levels, our employee count was up 4% when compared to 2014. About half of this increase was in our capital related workforce. Excluding our capital related employees, our force level grew by about 2.5%, but is down 500 sequentially from the Q1. And as Cam just discussed, we are continuing to adjust our TE and Y workforce levels to better align with current demand. While we have made progress, we continue to look for every opportunity to right size our workforce and focus on labor productivity.
By year end, we now expect our net overall workforce levels to come in somewhat lower than the 48,000 that we reported at the end of last year. Labor inflation was about 6% for the 2nd quarter, driven primarily by agreement wage inflation. And remember that the 1st two quarters of this year includes a 3% agreement wage increase effective the 1st of this year on top of the 3.5% wage increase from last July. For the full year, we still expect labor inflation to be about 5%, including slightly higher pension costs. Turning to the next slide, fuel expense totaled $541,000,000 down 41% when compared to 2014.
Lower diesel fuel prices along with a 10% decline in gross ton miles drove the decrease in fuel expense for the quarter. Compared to the Q2 of last year, our fuel consumption rate deteriorated 2%, largely driven by the decline in coal volumes, while our average fuel price declined 36% to $1.99 per gallon. Moving on to the other expense categories, purchase services and materials expense decreased 6% to $600,000,000 Reduced contract service expenses associated with our subsidiaries was partially offset by an increase in locomotive material expenses. Depreciation expense was $497,000,000 up 6% compared to 2014. We still expect depreciation to increase about 6% for the full year.
Slide 25 summarizes the remaining 2 expense categories. Equipment and other rents expense totaled $312,000,000 which is down 1% when compared to 2014. Lower locomotive lease and freight car rental expense were the primary drivers. Other expenses came in at $225,000,000 down 1% versus last year. Lower personal injury expense was somewhat offset by higher state and local taxes.
Year to date, other expenses up 7% consistent with our full year expectation of a 5% to 10% increase excluding any large unusual items. Turning now to our operating ratio performance. The quarterly operating ratio came in at 64.1 percent, an increase of 0.6 points when compared to the Q2 of 2014. The operating ratio benefited just under a point from the net impact of lower fuel prices in the quarter. Turning now to our cash flow.
Cash from operations for the first half increased to just under $3,800,000,000 This is up 17% compared to 2014, primarily driven by the timing of tax payments and changes in working capital. We also invested more than $2,100,000,000 this half in cash capital investments. Taking a look at the balance sheet, our adjusted debt balance grew to $16,600,000,000 atquarterend, up from $14,900,000,000 at year end. This takes our adjusted debt to capital ratio to 44.2%, up from 41.3% at year end 2014. We continue to target an adjusted debt to cap ratio in the lowtomid40 percent range and an adjusted debt to EBITDA ratio of 1.5 plus.
We have made meaningful progress towards our targets as we continue to execute our cash allocation strategies. Our profitability and cash generation enable us to continue to fund both our capital program and cash returns to shareholders. Since the 1st of the year, we have bought back about 15,000,000 shares totaling $1,600,000,000 Between the 1st and second quarter dividends along with our share repurchases, we returned $2,600,000,000 to our shareholders in the first half of twenty fifteen. And this represents roughly a 15% increase over 2014 demonstrating our commitment to increasing shareholder value. So that's a recap of our 2nd quarter results.
As we look towards the back half of the year, we will continue to focus on achieving solid core pricing gains. However, we expect volumes to be down somewhat year over year in the second half given the market dynamics that we are experiencing many of our business segments. Also, as we discussed earlier, business mix will continue to be a headwind on freight revenue. On the expense side, we noted on our Q1 earnings call that inefficiencies cost us as much as 2 points on the operating ratio. We've made good progress since then.
We estimate that these extra costs added just under a point in the 2nd quarter. And in the Q3, we expect to reduce these costs even further. While we continue to improve, it is not likely at this point that we will achieve record earnings on a full year basis given this year's challenges. Longer term, however, we expect to be on track to achieve our long term financial guidance. And as always, we remain committed to providing our customers with safe and efficient service and our shareholders with strong financial returns.
So with that, I'll turn it back over to Lance.
Thanks, Rob. With the challenges of the first half now behind us, our focus is on the remainder of the year and beyond. Clearly, there are still a lot of moving parts. We'll keep a close eye on crude oil and natural gas prices, the upcoming grain harvest, the strong dollar impact on balance of trade, as well as the continued demand for autos and the outlook for the consumer economy. All of this leads to a fluid demand picture across many of our business segments.
While the volume outlook is uncertain, we remain laser focused on operating safely and efficiently no matter what the market environment. We will continue to reduce costs and improve productivity as we further align resources with demand. While we've made some progress, there is more to be done. Longer term, we continue to be optimistic about the strengths of our diverse rail franchise. We remain committed to providing excellent service for our customers and strong returns to our shareholders in the years ahead.
So with that, let's open up the line for your questions.
Lance, if I can and Rob, if I can make one comment before we take the first question.
Sure.
We just understand here recently that some of you have had trouble accessing the slides on our website. They are back up and running now. So if you have any difficulty, we suggest you log out and log back in and they should be up and available for you. We apologize for that.
Thanks, Rob.
Thank you. We'll now be conducting question and answer you. And our first question today comes from the line of Chris Wetherbee with Citigroup. Please go ahead with your question.
Hey, thanks. Good morning, guys. Good morning. I wanted to touch on, Rob, what you just kind of wrapped up there with, when you think about sort of earnings progression as we go through the rest of the year, clearly, we sort of had the pinch point here in the Q2 with resources relative to volume. Volume gets better a little bit sequentially and resources are still adjusting.
Do you feel like getting back to year over year earnings growth is something that can be achieved by the Q4 of this year? I don't want to get too specific in terms of guidance, but just want to get a rough sense of sort of the puts and takes about trying to get back up to a positive trajectory and then thinking out into 2016?
Yes, Chris. I mean, we're focused on obviously improving earnings as best we can and you're exactly right. We're going to be laser focused on continuing to align the resources and be as efficient as we can on the cost. But I think what we're calling out in my comment to suggesting that there's it's not likely that we will beat last year's record earnings is the reality of what we're seeing in the business mix, particularly the coal volumes. I mean, we're not calling for any dramatic turnaround in our coal volumes.
As Eric pointed out, while we are seeing some sequential improvement as we speak right now, we are anticipating that that will be a challenge. The other thing I would just point out Chris in the way you're looking at it is recall last year actually was a is a very tough comp for the Q4 in particular. So we've got that sort of headwind if you will in terms of getting back above that level. So we're focused on taking advantage of every opportunity we can, but we just see some continued softness in some of our key markets and that's going to be the key driver.
That's great. That's helpful. And just a quick follow-up on the coal that you mentioned there. As you see that sequential improvement into the 3Q, any kind of sense
you can give us on how
to think about that specific commodity group in the back half or just maybe the 3rd quarter and maybe where sort of stockpiles are so we can get some rough sense there? Thank you.
Eric, can you take care of that for us?
It all depends, Chris, as we always say, depending on weather. Inventory levels are still higher than the higher the 5 year average. They have come down about 3 or 4 days. The burn is increasing, but they're still higher. The volumes will depend on weather.
It will depend a lot on natural gas pricing and current natural gas levels. It remains a difficult comparison for coal to remain coal is about a 30%, 32% market share today versus a 39.40% last year. The big change in that is natural gas pricing.
Okay. That's very helpful. Thanks for your time.
Our next question is coming from the line of Allison Landry with Credit Suisse. Please go ahead with your questions.
Thanks. Good morning. So I just wanted to talk a little bit about the mix headwind that you mentioned going forward. So based on some of your comments, if grain volumes do end up materializing, you do see a rebound in construction products and potentially some muted growth on the intermodal side. Is there a scenario where mix could be flattish?
I guess I'm just trying to understand maybe some of the puts and takes and the magnitude of the negative mix on the back half?
Rob, do you want to take that? Yes.
I mean, if what you just outlined Allison came through that those would certainly be positive contributors to the mix. And as you know, I don't give guidance on mix. It's rare that we do. This year is unique in that we are confident that the mix headwinds are in front of us. So we're giving that directional guidance.
And I would just remind everyone that because of the great diversity of our business mix, which is a very strong attribute of the Union Pacific franchise, we tend to have a lot of mix swings in our business from quarter to quarter. So the points that you're making would certainly contribute. Would they be enough to overcome some of the But every opportunity we have to narrow the gap, if you will, and improve on the mix, we'll certainly take advantage of it.
Yes. I'd like to add to that. This is Lance. So our commercial team has a robust business development pipeline and they're pursuing business opportunity that presents itself to us because of our wonderful diverse franchise. And so to Rob's point, it's hard to be precise in making a future call.
There are opportunities and puts and takes, but the guidance we've given you is what we think is our best guess.
Okay. And just a follow-up question. Could you give us
a sense of how much the inefficiencies cost you in the Q2?
Yes. Allison, just to rephrase that, we said it was up to about a 2 point call it $100,000,000 in the first quarter. It was closer to just under a point, let's say in the second quarter. So from a dollar standpoint call that a $50,000,000 improvement from 1st to 2nd quarter in those efficiencies. And again, we're focused on continuing aggressively to get that remove those efficiencies as quickly as we can.
Perfect. Thanks. Sorry, I missed that last part. Thank you.
Our next question comes from the line of Scott Group with Wolfe Research. Please go ahead with your questions.
Hey, thanks. Good morning, guys.
Good morning.
Just want to clarify one quick thing first. Rob, your comments about earnings growth, what are you assuming for the 2nd quarter? Is that based on $1.30 or 1.38
dollars In the second quarter, dollars 1.38 including I guess what you're getting at is the land sale. Got it all in.
Okay. So, question on coal. We understand some of the pressures, but seeing such so much more weakness in your volumes relative to BNSF. And is there any color you can provide on maybe is there a big market share loss or customer loss that we should be thinking about and when that began? And then are you starting to see any pressure from the utilities on a pricing standpoint?
So I'm going to let Eric answer that question.
Yes. So as we mentioned at last quarter Scott, we do think we came into this year at a different place than our Western competitor in terms of inventory levels of our key customer utilities and we do think that that has had an impact. We also think as we mentioned in our comments that some of the flooding and track outages that we experienced particularly in June had an impact that you probably won't see in the numbers of our Western competitor. One of the other impacts that we have seen is that there are probably a couple of specific customers that have had outages and have had challenges in their energy markets in terms of them competing that are probably disproportionately impacting us than our competitor. We think over time that kind of works its way out, but certainly in the Q2 it had an impact.
We always compete for business. We think we have a market value. We are continuing to focus on the strong price in terms of your second part of your question. And we feel good about the market value and the price of our services and that is reflected in our results in the Q2.
Okay. Thanks. And just the next question last question. I want to ask about share buybacks. It seems to me for the past several years you guys have had this really unique story with the legacy pricing and that's behind us now.
But it seems to me you still have a really unique opportunity in terms of having by far the least leverage of any of the rails. And given the weakness in the stock and maybe tougher to grow earnings, do you start to think about using that optionality more aggressively? And why not?
Yes, Scott. I mean, you know the guidance we've given in terms of the metrics that we're comfortable with. But to your point on the share buyback, if you look at first half this year compared to last year's first half, we're up about 10% in terms of our share buyback and we will continue to be opportunistic. And at the prices that we're seeing right now, we think those are nice entry points. So we will we are certainly as we always have buy more when it's down and less when it's up.
But your longer term question I think is answered in our comfort with our longer term metrics that we've given.
Yes. And Scott, this is Lance. I want to react to something that was in your question, which said tougher to grow earnings going forward. Again, I want to reemphasize what we've constantly focused on with our investors and that is we've got an industry best franchise. It's got plenty of opportunity for growth and business development and we've got plenty of opportunity to continue to improve the productivity and efficiency of operations.
So for the very long term, we feel very good about our long term guidance.
Okay. That's helpful. Thank you, guys.
Thank you. Our next question comes from the line of Ken Hoexter with Merrill Lynch. Please go ahead with your question.
Great. Good morning. Just a little bit on the follow-up on the coal just for a second, but I want to go back to last quarter. You thought coal was going to be down 5%. At that point, it was already running down in the mid teens.
So I just want to think back to the inefficiencies as you noted. Have you been maybe slower to cut costs in addition to the inefficiencies? And I guess Lance the question would be, what gets you to move quicker thinking about how to balance cutting costs and staying ahead of that, but then if you get that inflection on volumes at some point to still be prepared. So how do you think about how quickly you want to cut out some of those additional costs?
Sure. So Ken, putting this all in context, right, so this time last year, Q2 last year, we were behind in resources, experiencing substantial growth and as rapidly as we could, filling our pipeline with new employees. We came into this quarter or this year and in the Q1, as you note, declined 2%, which was not our expectation and then further declined in the Q2. So as soon as we recognize this year that we need to make adjustments, we've been doing so. The big thing that has us mismatched right now is really 2 parts and Rob hit both.
One is our capital program and the type of capital we're spending is demanding that we have more capital headcount. So there's a headcount imbalance there, grew year over year. And our training pipeline, where we were just filling it up in the Q2 last year and we're now emptying it out in the Q2 this year. As we move into the Q3, all of that is happening at a rapid pace and will continue to happen. And I expect by the end of the third quarter, much more balanced as regards training and as regards overall headcount and resources targeted on the transportation product.
Answering your question, could we do things faster? Hindsight is a luxury we typically don't have in planning the business. I certainly wish we had better clarity in what our markets would be doing, what the mix would look like. We certainly would be making adjustments more rapidly if we did. However, in the pragmatic world we're in right now, there is an opportunity for us to be better.
We're working very hard right now on trying to figure out ways to be more agile with our resources, to be quicker in recognizing market shifts and being quicker and being able to take those actions. So I think it's a fair question.
I appreciate that. It just clearly seems tough to see with some more volatility on the volume side. On the follow-up, I guess maybe throwing it to Eric on the I think the question before was talking about more on the coal side and the competition if you're seeing that impacting pricing. It seems like with your positive 4% pure pricing, you're not seeing too much. But I want to understand, are you seeing kind of across the other commodities as Burlington has improved their service levels?
Are you seeing increased competition on the volume side? And any kind of thoughts on pricing or what that may do outside of your legacy renewals?
Ken, as we always say, we have a tough competitor. They always have been a tough competitor, always will be. Not only is the Burlington a tough competitor, but we do compete with other railroads in other markets. We also compete with trucks. Trucks are also a tough competitor and lower fuel prices are helping them.
That being said, we feel good about our value proposition. We're continuing to focus on the strategies and initiatives to improve our value proposition. It's our goal to have the best service and value proposition in the industry. And if we do that, we think we'll be able to price appropriately for our value.
Thanks for the time and insight.
The next question is from the line of Brandon Oglenski with Barclays. Please go ahead with your question.
Well, good morning, everyone. Good morning. Rob, can I follow-up on this line of questions here? Just thinking about your OR or your margins in the back half of the year. I think if we look back the last couple of years, you've had quite a bit of sequential improvement in profitability.
And so we're talking about a lot of pluses and minuses here. Business mix should be negative, still lower volumes year on year, but sequentially improving, still getting price. And then you talked a lot about the fuel impact in the Q2 and how that could be incremental headwind. You have wage inflation, but headcount reduction. So as you balance all this out and with the best view right now, I mean, how do you feel about the operating ratio heading into the second half of the year?
Yes. There's a lot of moving parts as you point out fuel being a big one in terms of the impact that that has on the operating ratio itself. But our focus would be that that is an opportunity still for us to make year over year improvement. And the way things look at this point in time, fuel would probably help in that regard unless it dramatically changes and spikes up. But we are focused on for all the efficiencies that we plan on taking the continued focus on price, the diverse opportunities that still will present themselves, we are focused on still improving the operating ratio year over year.
Okay. That's helpful. And Eric, can you comment a little bit on grain markets, because there's a big discussion that if we have another big harvest or relatively large harvest, which I think the government is calling for right now, how much of
that could we actually store if folks decide they don't want
to sell into a low commodity price environment? Or is there just not that much stores? Are we going to end up having to move the volume anyways?
Yes. So that's a good question, Brendan. As you know, the outlook right now is that the yields look strong. It's still relatively early in the growing season, so anything could happen from a weather standpoint. But right now, the projections are while it may not be a record crop like the last 2 years, it still will be a pretty good pretty strong corn and bean crop.
As you suggest, storage of crops are relatively high because U. S. Grain has not been able to compete as effectively because there have been strong world grain crops and the strong U. S. Dollar.
So there is a speculation that says if it is a strong crop, there will have to have the current products or the crop move. And so that would be a positive for us in the second half of the year. And there's always uncertainty in our markets, but that is one of the scenarios that could be positive for the transportation system.
All right. Thank you.
The next question is coming from the line of David Vernon with Bernstein Research. Please proceed with your questions.
Hey, good morning guys. Rob, with the weather events that we have this year kind of being a lot worse than last year, is there any estimate for the cost that you guys maybe incurred this quarter that wouldn't be there if weather would have been a little more favorable or is that just too hard to call?
I think it's too hard to call, David, to be honest. It'd be rolled up in those inefficiencies that I called out.
Okay. And then from a mix perspective, the revenue ton miles were down sort of 14% relative to the carload decline of sort of mid single digit. Where in the business, Eric, do you see the biggest negative mix on the length of haul right now?
As Rob said, there's a lot of ins and outs in terms of mix and we actually have had ins and outs in terms of mix kind of across the business line. Coal certainly is a negative mix item as you might imagine. But we have grown our intermodal business which is a longer haul, so that would be positive. There's always lots of ins and outs.
But I mean, is the fall off in frac sand, for example, were those sort of longer length of haul than your average industrial product
shipment? Frac sand is probably right around the average length of haul for industrial products. Certainly, the fall off in that has had a revenue mix impact as Rob talked about.
All right. Thank you.
Our next question is from the line of Tom Wadewitz with UBS. Please go ahead with your questions.
Yes. Good morning. I wanted to ask you about volumes in second half and I know that it's kind of a directional question. I know it's hard to have tons of granularity on this stuff. But volumes were down 6% year over year in Q2.
I think the comparisons maybe just a touch easier in 3rd. So the way we should look at this is less worse year over year in Q3. Is that a pretty reasonable assumption? And then when you look at Q4, a little bit less worse or I don't know, how would you any kind of broad comments on just thinking about modeling volumes year over year Q3 and Q4?
So before I let Rob speak to it in perhaps more detail, the way we're thinking about volumes in the second half, and we said it, is we're expecting a normal seasonal pattern. So seasonally, we see a peak in the second half and the third quarter. But there's a lot of reason for us to think that it's a muted peak. So I think that says sequentially better, but there's headwinds against year over year. Rob?
Yes, Tom, I would just reiterate what we said earlier and that is we expect them to be down somewhat in the back half and it's hard to we're not giving guidance on quarterly guidance on the volume. But the thing I would just point out is that I'd like to think that the sequential improvement that we're starting to see that Eric pointed out in coal will help in that 3rd quarter year over year look. And then the Q4 is a little bit more of a challenge for us. So we're not calling it, but we're certainly focused and hopeful that things from a year over year perspective don't look like a 6% down kind of number, but we aren't giving precise guidance on that.
Okay. No, that's good. I appreciate the comments. And then the follow-up question. On the expenses, obviously, there's a lag on some of these items.
So I suppose training expense and maybe in some of your like materials expenses, some others. How would I look sequentially at some of these categories where you have seen improvement? If I look at purchase services, you're down quite a bit sequentially. Is that down more in Q3 versus 2nd? And I guess another category rents was kind of flat sequentially.
Are some of those categories down more in absolute terms in Q3 versus 2nd? Thank you.
Yes. Tom, I would just this probably won't shock you. I'm not going to you're stump me in terms of trying to get into the individual expense categories. But I would just say that kind of all of the categories are stones that we are uncovering and looking for opportunities in every single category. Labor, of course, shows up across the board and that I would say at a large as a large position is what we're really focused on that might show up of course in multiple expense categories.
And as I pointed out, remember we took the $100,000,000 of inefficiency or misalignment in the Q1 down to, let's call it, $50,000,000 ish in the 2nd quarter and we're focused on going after that 50,000,000 dollars and then some. I mean our focus is to not just stop there, but continue to achieve as efficient of operations as we possibly can matching against demand. So long answer to your short question, but I would say it's across the board that we're going to expect ourselves to make improvements.
Okay, great. Thank you.
Our next question is from the line of Bascome Majors with Susquehanna. Please go ahead with your question.
Yes. Thanks for taking my question here. So I mean clearly there were a lot of volatility and low visibility in the second half I'm sorry, the Q2 relative where you thought you were entering the quarter from a demand perspective. I'm just curious, now versus 2 or 3 months ago, what's your sense from your customers? Are they seeing more stability and low visibility?
Or is there any conviction that things have stabilized on top of the comments you made on coal earlier?
So let me start with that and then we'll get it to the expert and Eric. When you look at our top line, the story that we talked about in Q1 really is the same in Q2, just more acute, and that is there are areas of the economy that feel pretty stable and pretty good, and it's reflected in the consumer side of the economy and specifically in things like our automotive shipments in the domestic intermodal product, a couple of other things like that. This acute impact in the energy side of our business, specifically coal and shale energy related product, is largely driving that top line problem. Eric?
Yes. I mean that's right. I'm not sure there's much to add, but the economy feels pretty good. Most of the macroeconomic indicators are going in the right direction. You know them as well as I do and we're seeing that in our business.
The issue we have is a significant shortfall in coal driven by natural gas, mild weather and some episodic issues with some large customers of ours and frankly the fall off in our share related business. But aside from that the economic indicators and the economy, customers are feeling pretty good. The trends are already up in the correct direction.
Thank you for that. If I can just get one more in on the margin front. You mentioned that the headwinds from operational inefficiencies were about a point less in 2Q versus 1Q. But if I net out the impact of fuel surcharges, you'd have to go back quite a ways to see the net year over year margin decline as steep as you saw this quarter. So just as we try to directionally understand the drivers here, can you kind of rank order mix demand related and simply a function of what the marketplace and have addressed the resource resizing already to some extent?
And how significant is the net fuel headwind for the year that you alluded to in your prepared remarks earlier?
So Rob, you want to take
some of that? Yes. Let me just let me try to answer that just simply by saying, I mean, they're all contributors and they're all challenges that we deal with in our daily lives. But I would say if you look at the Q2, the biggest hit if you would is would start with volume driven by coal. And then 2nd on the list I would say is the mix impact which obviously is impacted by that coal pull off as well, but the mix impact of changing within our business mix, the sand, etcetera, the grains, etcetera.
And those would be the big drivers.
What's part disappointing and part encouraging and Cameron walked us through this, we had real we had areas of real productivity improvement that our team drove, both the commercial and the operating team from the standpoint of train size improvement to near record levels on almost every product, continued improvement and switching efficiency. And it was overwhelmed by this mismatch, this imbalance in resources. And we're aggressively going after that and we'll get that right.
All right. Thanks for that color. I really appreciate it.
Our next question is from the line of Brian Ossenbeck with JPMorgan. Please with your question.
Hey, good morning. Thanks for taking my call.
So clearly
a lot going on in the volume aspect, but I want to talk more about the regulatory front where there's also a lot going on. We got 2 transportation spending bills in Congress. If you look into the Senate version, which may or may not make it, there's actually a whole lot of stuff in there about rail, PTC, hazardous materials, recording devices, etcetera. So with that and the recent challenge on the standards, Can you just give us kind of a high level view on our expectation? It's always there.
It's always something to look at and be cognizant of. But anything that you're especially focused on the remainder of 2015 and into next year?
Brian, you broke up just a little bit when you were asking the detail of your question. Let me tell you what I think I heard and you tell me if that's right. You're asking broadly there's a lot going on in the regulatory environment and what do we see coming out of that in the next rest of the year and next year?
Yes, that's good. Thanks.
Okay. So our first primary focus in Washington is an extension on positive train control or PTC. We've been crystal clear with our regulators and elected officials that we need that, that Union Pacific is not going to make the deadline. There really no railroad that will make that deadline and the industry needs an extension. I believe everybody understands that.
It looks like there's an opportunity to have that happen as maybe part of a highway bill or some other vehicle. The hard part of that is we've got to start making plans in case PTC extension does not occur and we'll have to then start communicating to our affected customers and commuter agencies what those plans are and what the timing is. And that probably starts up in sometime in September. So there is a bit of a clock ticking on that. The second thing we are focused on intently is HAZMAT regulation, as you pointed out.
We are in that dialogue. We think the regulation, as published by the DOT, has a couple of flaws. More broadly, we are very supportive of a new tank car standard. We've been asking for it both as a company, as an industry for years, and we are working diligently to get that standard right to make it more safe than it currently is. And then the last thing we're working pretty hard on is different issues in front of the STB, which is our primary commercial regulator.
And we're active in that dialogue and trying to navigate that for the best of our company.
Okay. Thanks, Lance. That was a good overview. And hopefully, I've found a better spot for self signal for the quick follow-up. I was just wondering with all the stuff going on with coal as you look into next year, anything there's another regulatory question.
And with the Metz ruling being kicked down to the Circuit Court of by the Supreme Court a couple of weeks ago, do you think that more I guess ever had really any impact in your service area? And 2, if it did, do you see any potential benefit from that rule being kind of thrown back for reconsideration?
Thanks. So I'm going to let Eric answer the specific question on coal emissions regulation. I'll just start with a broad statement and that is we believe coal needs to continue to be a robust part of electricity generation in the United States. It's low cost, it's abundant and it can be clean in terms of its emissions. And that's very important for the U.
S. Economy and for the U. S. Manufacturers to be competitive on a global scale. Eric?
Yes. In terms of the specific question, we don't think that the while we applaud the ruling, we don't think it's going to have a significant impact. Either entities were already planning for it and or they might still plan for it just because they don't know what might happen on the inevitable appeal that will occur or it wasn't going to have a significant issue anyway. So the fact that it was remanded, I don't think is to have a significant impact one way or the other.
Okay. All right, Lance. Thanks for your time.
Thank you.
Our next question is coming from the line of Bill Green with Morgan Stanley. Please go ahead with your questions.
Hi, good morning. Lance and Rob,
I wanted to just explore a
little bit the relationship between OR and the coal franchise. As you know, a lot of investors think of coal as being highly profitable. And so if coal were to come back or even go down further from here in a longer term sense, so like a secular decline, does it impede your ability to achieve your long term OR? Or do you feel like productivity and price alone can allow you to achieve that even if the Colchan franchise ends up much smaller than it is today?
I'll let Rob answer more specifically, but I'll give you an overarching reaction and that is, there are lots of puts and takes in our business over the long term. Our franchise is such that we've always been able to find growth opportunities and take advantage of them. And I'll remind you that our overall business strategy is predicated on a industry best, a demonstrably better service product and pricing for that value. Along with productivity, all of that tells me I am confident in our long term OR guidance. Rob?
Yes. Lance, I'd actually just reiterate what you just said. We are not first of all, we're not calling for the death of coal as a business unit for us. We're experiencing a bit of a hiccup here. But I would say, first of all, that obviously that size of a business is a positive contributor to our OR.
As it shrinks or any business shrinks, we have as we've talked and as you know, we have a lot of diverse opportunities in front of us that give us a lot of confidence and that's what keeps us as confident as ever that we could still meet our long term OR guidance. If we were to see it take a step down, any business unit take a step down, we would have to do the things that we've done over the last decade and that is right size our organization and make sure that we're being smart about adjusting our costs accordingly so that we can continue to make progress on our financial results.
Okay, fair enough. A follow-up question just is on the dollar. A lot of investors sort of asked me about whether rails were really sort of pseudo commodity plays and a weak dollar effectively caused a lot of stuff in North America to move, not just sort of the crude by rail, but a broader industrial implication. And so do you feel like a strong dollar impedes your ability to get the carloads back to, let's say, over 180,000 a week or something? I mean, is this sort of a real kind of risk factor that we need to keep in mind when we think about modeling longer term volumes?
Eric, you want to handle that?
Yes. I don't think so. Certainly, as you know, when you have strong currency moves one way or the other, it could affect commodity flows. We see that in all of our commodity markets. But long term, North America is still kind of a strong productive, secure, relatively low cost place of production.
It's also a huge consumption market. And those things will continue to drive us being in the sweet spot for our transportation services, whether it's export or import. So long term, it's not it doesn't move the needle.
All right. Thanks for the time.
Our next question is from the line of Rob Salmon with Deutsche Bank. Please go ahead with your question.
Hey, good morning. If I could shift it back a little bit to the core pricing, I was a little bit surprised that it actually was stable sequentially at that up 4.5% up 4% rather with 0.5 point coming from the legacy with kind of weaker coal volumes.
Rob or Eric, could you talk
a little bit more about what drove that? Because I would have thought with less coal that would have actually been a headwind to core pricing. So any additional color if it's coming from kind of the 2016 renewal that you got a little bit more of a benefit this quarter? You're just getting stronger pricing across the franchise?
I'm going to throw it to Eric, but I'm very proud of the team for their results in the Q2. In a very difficult environment, they effectively priced for the value of the product and that was a good outcome.
Rob can talk about kind of the legacy impact. But we are doing what we said. We have a value product and we're pricing for it. It. Specifically to your legacy question, I would say that was comparable to what we saw in the Q1 where we said about a half point of the 4% was legacy roughly.
But you're also pointing out and again, I'm as confident as Lance and Eric and pleased with that performance. I think it shows that we're getting value in the marketplace. And as you also are pointing out and just to reiterate for others, way we calculate our core price is if it doesn't move, we don't count it. So we're hopeful that if and when coal resumes some of the volume pickup that some of those repriced contracts will be positive contributors to our margins as we move forward.
Rob, could you give us
a sense had coal either been flat or the decline in line with Q1 in terms of overall carloads, what core pricing would have looked at this past quarter?
Yes, I
really can't give you that size. And there's a big mix even within the coal line. But I'm not giving that level of specificity, but just suffice it to say there was some value left there by not moving it.
Fair enough. Appreciate the time.
Our next question is from the line of Jason Seidl with Cowen and Company. Please go ahead with your question.
Thank you. Good morning, gentlemen. I want to talk a little bit about the intermodal franchise. Can you guys focus on going forward just how much you think the competition has increased from the truckload side as some capacity has crept back into the marketplace? And also longer term, given the issues that the West Coast ports have had, do you feel there's a chance that the West Coast could lose some permanent market share to the East Coast?
So Jason, in terms of the first question, clearly, lower fuel prices will incrementally nominally make truckers more competitive. And clearly, as the shale play has gone down, there appears to be what we think is a temporary alleviation with some of the driver shortages or temporary reduction I should say. There still are long term driver shortages out there, but some of the move from labor from that to truck drivers has alleviated some of the shortage. And so trucks continue to be a competitive option. I would point out in the Q2, we set again another all time domestic intermodal record.
Our volumes set another record. We continue to see huge conversion opportunities and we think as we have the service value proposition, we'll continue to be able to penetrate and take advantage of that. In terms of the West Coast port, clearly, that had an impact certainly in the Q1. In the Q2, as some of the backlogs were cleaned up, that had a positive impact. But as we said, we had a tough comp year over year because of the free shipping that occurred the previous year.
I think one of the things that are instructive to look at is kind of the spread rates, the ocean spread rates between East Coast and West Coast. And the East Coast, ocean rates have actually increased about $2.50 on a spot basis over the last call it couple of months, which basically is making the West Coast ports even more competitive than what they were before the strikes. So we think that there is some risk that there might be some nominal temporary rerouting just kind of as a supply chain We're not really seeing that and we We're not really seeing that and we still think the West Coast ports have an economic and a time value for product going pretty deep into the East.
Okay. And thank you for the details. For a follow-up, Rob, maybe this is for you. Sort of just looking at all the puts and takes in 2Q and looking forward, barring any other volume unexpected volume shocks, do you guys sort of view 2Q as sort of the low watermark for your margins?
There's a lot of moving parts. I would answer that by saying we're focused on making that statement true. Of course, we're going to go after and we are making progress as we pointed out the inefficiency misalignment, but what we'll have to wait and see is exactly how the volumes play out and exactly all those variables and what fuel does, etcetera. But I'd like to believe that that will that statement will become true.
Okay. Fair enough. Gentlemen, thank you for your time as always.
Our next question is from the line of Tom Kim with Goldman Sachs. Please go ahead with your question.
Good morning. Thanks. With regard to domestic coal, were you impacted at all by coal fired utility plant retirements in the second quarter? And then also if natgas has remained stable, would you expect like any further coal to gas switching for the second half of the year?
There is no impact from coal plant retirements. There is still significant surplus capacity both coal and either other sources. So there was no impact on the retirement. We do not expect significant incremental switching. I think all that can switch is switching given kind of current natural gas pricing.
Okay. That's helpful. And then
just on intermodal yields, can you talk about what drove the sequential Q on Q and then year on year deterioration in your average intermodal ARPUs?
Arc, intermodal arc?
Yes. As
for all of our businesses in the Q2, the arc was really dominated by the fuel surcharge reduction. That and I would say Tom and mix within each commodity group can also show up in there. But there's nothing else there was nothing no other kind of marquee driver of that change.
Okay. So no like change to length and haul or anything like that, just mostly just that surcharge?
Right.
Okay. Great.
Thanks guys. Our next question is from the line of Justin Long with Stephens. Please go ahead with your question.
Thanks and good morning. Good morning. With your coal volumes down substantially right now, I was curious, does that change your approach to pricing in your non coal businesses? In other words, do you have the thought process that non coal pricing now needs to move higher to maintain the return profile of the consolidated business? Or do you view the pricing dynamics between coal and non coal completely separately?
Justin, I'm going to let Eric answer in more detail, but our team prices every single move on the value of that move to the customer.
Eric? Nothing else. That's it.
Okay. Fair enough. And as a follow-up, as we look into next year, if coal does continue to weaken and you're losing that high margin business, how are you thinking about where CapEx as a percentage of revenue needs to go in order to maintain or improve the current return profile of the business?
Go ahead, Rob. Yes. Justin, this is Rob. As you know, the long term guidance that we've given on our capital spending is in that 16% to 17% of revenue. And we're not calling for, again, the fall off or the significant further declination in coal.
But if it did, we would as we always do with our costs, we would right size. So I would also just point out, your question reminds me that given what we're seeing this year, we expect that metric of capital spending versus revenue to be a little bit higher this year given what we're seeing in this fall off. But if you look longer term, we would right size the organization both from an OE and from a capital standpoint. But that's not the guidance I'm giving because that's not where we are at this point in time, but we would take those steps.
Yes, something else to keep in mind Justin is we've got plenty of capital capacity already built for the coal network. So it's not really driving CapEx today.
Thanks. That's a good point and I appreciate the time today guys.
Our next question is from the line of Jeff Kauffman with Buckingham Research Group. Please go ahead with your questions.
Hey, thank you very much. A lot of my questions have been asked, but let me come back to the capital question. Just given the realignment of resources, how are your capital priorities changing ex PTC?
So ex PTC, we do our capital planning in a similar fashion year after year after year. We take a long term view of what we think markets are going to look like. We see how that lays in the existing network. We find where the hotspots exist from the standpoint of line of road constraint or terminal constraint, and then we target capital on that. There is a little bit of capital that gets spent on things like a specific project or a specific piece of business development.
And then, of course, there is a very large piece of capital that gets spent on consuming the existing network and maintaining it. And, of course, that's driven by volumes and consumption. And so, Cameron, is there what else you want to add to that? No, I think you covered it all, Lance. Our focus continues to be on the southern region with a lot of our capacity CapEx, and that's being driven by Eric's forecast.
All right.
Let me follow-up to that. Unusual outage in the I-ten freight corridor with the rains in Southern California. Is this an opportunity for the intermodal franchise as this is forcing a lot of trucking capacity from LA to Phoenix to find alternatives?
Eric? That is one of our franchise corridors. As you know, it has been. We've invested in that corridor over time. We are growing.
We'll continue to grow. The temporary flooding that's happening out there because of the rains, as you know, trucks always have lots of ways to reroute. So there will be no significant incremental impact due to that. That is an area and a market that we're going after with our franchise. We have and we'll continue.
Okay, guys. Thanks so much.
Thank you.
Our next question is from the line of Cherilyn Radbourne with TD Securities. Please bear with your questions.
Thanks very much and good morning. Good morning. Most of my questions have been asked. But I was just curious in terms of the resource imbalance, you just give a bit of color as to how much of that is headcount and how much is locomotives and other equipment?
Yes. So I would we are balancing locomotives real time to match the transportation plan, which matches what demand is telling us. So locomotives from a storage count are very close to being about the right size. And right now, we have something like 900 locomotives in storage. The headcount issue again is a little bit part capital, which is all about whatever our capital plan is and part we have too many in the training pipeline and too many kind of coming out of the training pipeline.
That furlough count, which I think we said was about 1200 at the end of the quarter, Depending on what happens with attrition and demand, that will continue to ebb and flow. Right now, it's growing. And so we can make the fungible side of headcount, the individuals that are actually working and productive match real time. It's the mechanism to get qualified trained employees that are taking us a little bit more time to get right.
Okay. That's helpful. That's all for me. Thank you.
Thank you. Our next question is from the line of John Larkin with Stifel. Please go ahead with your question.
Thanks gentlemen for taking my question. Wanted to bore into intermodal a little bit more, which is one of your shining stars in the quarter volume wise. The truckload carriers on the contract side of their business at least are getting in quite a few cases 6%, 6.5% yield improvement. And anecdotally, I've heard from a number of mostly privately held IMCs that you all are putting in some pretty aggressive price actions also that would, in theory, still maintain that cost advantage visavis truckload. But the pricing is sort of obscured by that fuel surcharge that Eric talked about a minute ago, which depresses the ARC.
Can you talk a little bit about whether this is one of your strong initiatives on pricing and whether you're really getting a lot of follow through with that or pushback from customers and whether that has moved the profitability of intermodal so that it is on a par with the other commodity groups?
No customer ever wants to take a price increase. There are always very tough discussions. We are taking market price increases across our book of business, every segment of our business based on our value proposition and we're going to continue to do that.
Are the price increases in the vicinity of what the truckload carriers are getting? Or you're not going to share that with
us? Arlene, we reported the 4% core price increase and we're focused on getting appropriate price increases across. I would add, I mean, you know we don't break it out by individual commodity group. But as Eric and the team, they are laser focused on improving profitability in the intermodal group as they are across the board and we're going to continue to do that.
As a follow on, can we talk a little bit about intermodal service, which had a lot of hiccups in 2014 due to weather, congestion in Chicago, growth in the energy markets, the new energy markets at least. How is intermodal service tracking this year? And when would you expect it to be back at say 2012 or early 2013 levels? And once it reaches that level, do you think there's some latent demand out there that will come back on to the railroad once you have more of a truckload like service product?
Cameron?
Our first OS, that's our on time origin departure for intermodal product continues to increase. We're not quite back to 2013 or 2012 levels, but we're making very good progress, particularly in Los Angeles and in Chicago. Over the road performance, we're still looking, as you can tell by our AAR velocity metric, we're still looking for a mile an hour. We're properly resourced. We've got great initiatives to go find that mile an hour and deliver it.
We just don't have a stake in the ground as to when that will be achieved, but we expect to make that improvement throughout the course of the year.
Hey, John, this is Eric. I would say, our goal is be the best. And so we're clearly not satisfied with where our service is and we're going to focus where Cam and his team, my team, we're working on how do we improve the overall customer experience and it's an intense focus. And I think as we go into the future, our goal is continuous improvement to improve what we take to the market.
Thanks very much.
Thank you.
Our next question is from the line of Matt Troy with Nomura Asset Management. Please go ahead with your
questions. Yes, thanks. Just given the time of year typically from an accounting perspective, people revisit incentive comp and stock based accruals in the second and fourth quarter. I was wondering on a run rate basis, was that a help during the quarter as we've seen at other railroads as everyone struggled with the lower volume environment and stock prices which have declined? And if not, when might we expect in light of the guidance for the lack of earnings growth year that that might flow through and help the comp line?
I just want to make sure we avoid some of
the lumpiness we've seen in other railroads.
Yes, Matt, this is Rob. I would say that it's a little bit in the second quarter. I'm not calling out or guiding that you're going to see anything lumpy in our numbers. But I would say there was a little bit of an impact that showed up actually in our Q2.
And the second piece would be the revisit during the Q4. Is that typical how it runs or is it as we go?
Yes. I mean, we always look at that each quarter we look at what is the performance. So we'll stay tuned in terms of what impact that has in the back half. But I don't envision it being lumpy as you're citing. Okay.
And my follow-up, thank you for that Rob. Bob would be just in light of the $0.01 rally in natural gas today. Could you just refresh us in terms of the switching friction or switching capability of your utility customers? Obviously, there's not a singular point or price in that gas say $350,000,000 where everyone just cuts back. It's more gradated than that.
Just wondering if we kind of buck the consensus that gas is going to stay low and envision or dream that one day gas prices might start to march north? And could you just help us understand when what is the band at which people begin to contemplate going back to coal and where coal might take some share back in the grid relative to your customer base? Thanks.
Matt, as you say, it's a wide continuum. There are probably utilities that COL looks favorable as low as 3, some 3.50, some 4. It's a wide continuum.
Okay. All right. Thanks guys.
Our next question is from the line of Cleo Zagreen with Macquarie. Please go ahead with your questions.
Good morning and thank you. I will follow-up on prior questions. In terms of pricing for coal and intermodal, could you help us explain if maybe fuel was a bigger headwind such that overall in terms of coal price performance was close to the average of 4% for the company? Any insight you could help us with there, I'd greatly appreciate it.
Yes, Cleo, this is Rob. Let me just again reiterate that we don't break it out, what pricing we're actually getting within each commodity group. But I would just point out that to your point on the impact that fuel might have had, we have some 60 plus different fuel surcharge mechanisms. So they do vary from group to group and the timing of those can be different and can impact from quarter to quarter what the reported ARK number looks at. But again, our overall pricing success was 4% core price and we're confident that we're doing all the right things in all of the commodity groups to improve that.
Okay. And then my follow-up relates to the outlook for coal and your network longer term. You were saying that it's tough to adjust the network from 1 quarter to the next, understandably so. But are you seeing any significant challenges to coal volumes from upcoming gas capacities in 2017, 2018? And since you would have time to prepare for that, how can you adjust the network to mitigate that potential negative impacts?
And you're saying also the diversity of the franchise allows for your long term goals to be maintained. What would be the one main positive offset to a decline to continued secular decline in coal? Thank you.
Eric, you want to try that?
Yes. So, Cleo, as we said before, the big factors for coal again will be the cost of natural gas and weather. Today, there's surplus capacity in coal. There's surplus capacity on natural gas today. So the capacity isn't really as much as a driver as it is kind of the point at which one dispatches versus another.
It's different for different utilities. Again, I think $3 to $4 depending on utilities is probably a range that most utilities see today.
Okay. So you're not seeing the need to significantly adjust resources longer term on account of what you see in coal?
Cleo, we are adjusting our resources constantly to match both what near term demand looks like and what we think long term demand looks like. And we'll make those adjustments as the marketplace dictates.
I appreciate it. Thank you.
Our next question is from the line of Ben Hartford with Robert W. Baird. Please go ahead with your question.
Yes, thanks. Quick question, Eric, on the if I look within industrial products and the 35% of the volume that is construction, what is the what's the split between res and non res construction within that? Do you know?
Yes. So I don't have it in terms of the overall construction number. If you want to just split out lumber, historically, lumber was kind of 2 thirds, 1 third. Right now, it's probably closer to half to half. But again, housing starts are improving sequentially.
The housing start number for June just came up. That was significantly improved. I think 10% improved over the previous month. There's still more multifamily than single family, but the split here recently has probably been more sixty-forty versus sixtyfivethirty 5 or fiftyfiveforty 5.
So if I look at the 5% volume contraction within construction, Can you help me rectify that in the context of some of the improvement that we have seen as it relates to housing starts recently?
Yes. As I said in my prepared comments, the majority of that was kind of in our rock and our cement, most of which goes on the commercial side and that was really weather related. The demand is really, really strong and we're seeing that sequentially here even in the recent weeks. The Q2, there were some heavy rains that kind of impacted the volumes that we saw.
Okay. That's helpful. Thanks.
The next question is from the line of John Barnes with RBC. Please go ahead with questions.
Hey, thank you guys. Hey, on
the resource side, is there anything in the labor contracts that prevents you from rightsizing the labor force faster or more aggressively than what you've done already? And are there any prohibitions about shifting that labor around to spots where it might be in more need?
So I'm going to start and then I'll pass it to Cam. The short answer is not really. Our collective bargaining agreements dictate things like rates of pay, what exactly the work needs to look like, some work environment issues, typically doesn't have much headwind to us when it comes to rightsizing. When we talk about again having the training pipeline fatter, if you will, than it was Q2 last year, That's about us making decisions about continuing to train because we will graduate them into work either immediately or in the near term, and it would be just more disruptive and more costly to take them out of training and then start over again from scratch 2 or 3 or 4 months from now. Cam?
Lance, I think you answered that perfectly. And there is great flexibility to answer your second question on flexing appropriate resources to the network as required. So no issue there.
Okay. All right. That's good color. And then to go back to
the intermodal question earlier, if I go back to my notes on your last analyst meeting, you were already talking about the potential for a couple of more percentage points of market share movement from the West Coast to the East Coast. And I understand what you're saying about ocean shipping rates and that kind of thing, but the ILA is already out talking about doing a 10 year labor deal in order to provide labor certainty to the East Coast ports where the West Coast labor contract is a year shorter, still leaves some very large issues like the Cadillac tax out there left kind of un negotiated as of yet. Is there any concern that the severity of the downturn this last time has more permanently impaired the West Coast ability to attract that volume back? And is some of that volume shift we've seen more permanent than maybe you had originally expected it to be?
Yes. So it's always a concern. It's in our franchise interest to have the proportion of business go through the West Coast. So that's always something we look at. At the end of the day, we do believe economics went out and today and we believe in the future unless there is some substantial change difference between East Coast, West Coast today, the West Coast option is the economically better option to go deep into the East.
We've historically said that the Appalachian Mountain chain was kind of a crossover point. Things west of that typically it's clear the West Coast is a better economic option things east of that. The East Coast is a better competitor. So we'll always look at that. We do not believe anything substantial or significant has changed economically from the historical equation.
There may be some minor adjustments for supply chain risk management issues in the short term, but we're not seeing anything significant or sustainable.
Okay.
All right. And just a follow-up on that. If there's any pressure on your international intermodal volumes, are you in a position to more aggressively grow the domestic intermodal piece as a means of offsetting any of that weakness? And thanks for
your time, guys.
So I'm not sure I would connect the 2. The domestic market is where we have been growing. I mean, if you look at it, the international market has been has had a much smaller slope. The domestic market shares huge truck conversion. You're still going to have a huge investment needed for highways.
You could talk about we're not really investing in the Highway Trust Fund even tough to get an agreement. You could talk about the driver shortages. You could talk about the economic and the environmental benefit of intermodal versus over the road trucks. I mean, it's a story that we've been talking about for the last half dozen years. We still think that there is a growth opportunity story there on the domestic and automotive side.
Again, the second quarter was an all time record for us on the domestic and the mobile side. We think that on a volume basis, we think that there's still opportunities. Okay.
Thanks for your time.
Thank you. Our next question is from the line of Keith Schoonmaker with Morningstar. Please go ahead with your question.
I'd like to ask about a sector where I believe there's a little more cause for optimism and chemicals are material high arc segments in the franchise. Excluding crude, I think some classes of chemical carloads grew nicely maybe even double digits in the period. So low natural gas hurts coal, but could you shift focus a little
bit a little further out
and comment on the flip side of cheap natural gas and share some of your expectations for chemical product manufacturing development?
Yes. We talked in the past and continue to talk about the huge plastic expansion that we're going to see in this country with the low natural gas prices. We think that you're going to see it even with natural gas going up to as much as $5 $4.55 we think that's still a sweet spot for the expansion that's happening in the Gulf. We have a great franchise. We it's a franchise strength of ours.
Take advantage of it. There's $1,000,000,000 multi $1,000,000,000 of investments going on. And we think I think we've said publicly that we think we'll see the benefit of a lot of that starting in 2017 2018, but we think that that's a franchise strength of ours.
And then
I'd like to ask a
question about operations. On the subject of rightsizing the locomotive fleet, could you discuss how you think about the value of removing one locomotive from the fleet? Are most of these removed assets going into surge capacity storage rather than being sold or divested or they show up in lower lease expense? So just the value of removing a single locomotive please?
Cam?
This is Rob. Let me jump in on if Cam wants to add, he certainly can. Keith, I mean, I'm not going to break that out, but I would just say that of course, when we get a new locomotive and we have an opportunity to put another locomotive in storage or just through efficient operations we have an opportunity to put a unit in storage. We're putting the least efficient of the fleet in. And we're always looking at are there most part those go into our storage and they're there for available for surge.
Where there are opportunities for us to discontinue an existing lease or something, we'll do that. But that's not a big driver at this point in time. So I think it's safe to assume that as we free up a locomotive, it's going to be our least efficient from a fuel standpoint, from a maintenance standpoint and from a DPU standpoint that goes into that surge category.
And there's an aggregate benefit, fewer locomotives we have active in the fleet, the less maintenance we have to do in aggregate.
Thank you.
Thank you. This concludes the question and answer session. I'll now turn the call back over to Lance Rich for closing comments.
Thank you very much and thank you all for your questions and your interest in Union Pacific today. We look forward to talking with you again in October.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.