Apr 29, 2015
Executives
Katie Cook - IR Wick Moorman - Chairman, CEO Jim Squires - President Mark Manion - Chief Operating Officer Marta Stewart – CFO
Analysts
Bill Greene - Morgan Stanley Thomas Kim - Goldman Sachs Rob Salmon - Deutsche Bank Scott Group - Wolfe Research Tom Wadewitz - UBS Matt Troy - Nomura John Barnes - RBC Brian Ossenbeck - JP Morgan Justin Long - Stephens Brandon Oglenski - Barclays Ken Hoexter - Bank of America Jeff Kauffman - Buckingham Research Jason Seidl - Cowen and Company David Vernon - Bernstein Investment Research Cleo Zagrean - Macquarie
Operator
Greetings. Welcome to the Norfolk Southern First Quarter 2015 Earnings Call.
At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.
[Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Katie Cook, Director of Investor Relations.
Thank you, Ms. Cook.
You may now begin
Katie Cook
Thank you, and good morning. Before we begin today’s call, I would like to mention a few items.
First, the slides of the presenters are available on our website at norfolksouthern.com in the Investors section. Additionally, transcripts and downloads of today’s call will be posted on our website.
Please be advised that during this call we may make certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties and our actual results may differ materially from those projected.
Please refer to our annual and quarterly reports filed with the SEC for a full discussion of those risks and uncertainties we view as most important. Additionally, keep in mind that all references to reported results, excluding certain adjustments that is, non-GAAP numbers, have been reconciled on our website in the Investors section.
Now, it is my pleasure to introduce Norfolk Southern’s Chairman and CEO, Wick Moorman.
Wick Moorman
Thank you, Katie and good morning everyone. It’s my pleasure to welcome you to our first quarter 2015 earnings conference call.
With me today are several members of our senior team, including our President, Jim Squires; our Chief Operating Officer, Mark Manion; and our Chief Financial Officer, Marta Stewart. As all of you know earlier this month we announced first quarter earnings of $1 per share, 15% lower than last year.
These results reflected lower fuel surcharges on the top line as well as continued weakness in our coal franchise which restricted growth in revenue and revenue per units. Additionally, very severe weather in our service territories slowed our operations, increased our expenses and impacted our volumes.
With the exception of the ongoing effect of lower fuel surcharges and continued pressure in our coal markets, we believe that most of our issues will be largely resolved by the second half of the year. Having said that, we will be up against strong comps particularly in the second and third quarters as last year’s results were wrecking record-setting quarters for us.
Jim will share with you more detail on the revenue trends and the outlook for the remainder of the year. With respect to service, we've already seen steady improvement in our network and we expect to reach our strong 2012-2013 velocity and service levels in the second half of this year.
Mark will provide you with the latest on the relevant service metrics and our operations outlook and Marta will round it all out providing you with details of our full financial results. Before getting down to the details, I’ll just reiterate what I told all of you on our earlier call.
We have a great team at Norfolk Southern and while there are always uncertainties around our markets, all of us are confident in the long-term strength of our franchise and our prospects for future success. On that note, I'll turn the program over to Jim, Mark and Marta and then I will return with some closing comments before taking your questions.
Jim?
Jim Squires
Thank you, Wick and good morning everyone. First quarter 2015 operating revenue declined 5% to $2.6 billion primarily due to a $102 million reduction in fuel surcharge revenues as a result of lower fuel prices.
Growth in intermodal and merchandise volumes offset coal declines increasing first quarter volume 2% to 1.8 million units. Revenue per unit declined 7% but without the impact of declining fuel surcharges revenue per unit declined only 2%.
Mix shifts between increased volumes of intermodal and decreased volumes of coal offset strong pricing across most of our business segment. We will discuss the mix impact as we review each commodity group.
Overall volume growth of 2% for the quarter was driven by a 5% gain in intermodal and a 3% gain in merchandise markets, partially offset by a 7% decline in coal volumes. After a strong start to the year, volume in the first quarter was again impacted by winter weather conditions and the accompanying service disruptions particularly throughout February.
But similar to first quarter 2014 we achieved strong volume and improved service levels in March. Breaking out the market segments, starting with coal, first quarter volume decreased 7%.
Coal burn at eastern utilities was down 14.5% in the first quarter due to lower national and regional natural gas prices, causing our utility volumes to decline 6%. Volumes to northern utilities were down nearly 9% while volumes to southern utilities were down 2%.
While handling a greater percentage of utility volume to our Southern utilities generally increases our coal revenue per unit, this positive mix impact was more than offset by a 20% decline in export coal volumes in the first quarter. Persistent weak conditions in the global marketplace, soft prices and a strong US dollar made it very difficult for US coals to complete in this oversupplied environment.
Domestic metallurgical volumes were down 1% with weaker demand for met coals related to softer steel production and sourcing shifts partially offset by market share gains of coke ships [ph]. This decrease in volume and lower fuel surcharges reduced revenue by $86 million to $455 million, a 16% decline versus first quarter 2014.
In addition to the previously discussed mix changes, lower fuel surcharges also negatively impacted margin. Turning to our intermodal market.
We continued to see strong volume growth of 5% to nearly 927,000 units. Intermodal pricing gains outpaced our other business units with continued growth expected the rest of the year.
Despite these positive trends, decrease in fuel surcharge revenues drove the decrease in overall revenue and revenue per unit. The effects of lower fuel surcharge revenues more than offset a 2% increase in average revenue per unit already dampened by negative mix, resulting from higher volume increase in international freight.
As we discussed before, international intermodal freight has a lower revenue per unit. Merchandise revenue of $1.5 billion was down 32 million or 2% for the quarter with a 5% decline in revenue per unit.
More than 80% of this RPU decline was due to fuel surcharges. We also experienced negative mix associated with increased volumes in lower rated sand, gravel and aggregates while higher rated iron and steel volumes decline.
Our automotive sector was also impacted by negative mix with its decreased auto parts shipments and increased high level of traffic. Volume for the merchandise was up 3% overall with the strongest gain in our chemicals market due largely to increased shipments of crude oil from the Bakken and Canadian oilfields to East Coast refineries, as well as increased natural gas liquids from the Marcellus, Utica shale plays.
Automotive volumes increased 4% in the quarter with increased vehicle production at several key NS served plants. Our metals and construction markets benefited from increased volumes of aggregates for construction projects in the Southeast as well as increased frac sand volume into the Marcellus, Utica region to support natural gas drilling efforts.
These increases were partially offset by reduced shipments of steel pipe and steel coil driven by a softening of the pipe market and reduced steel production in the quarter. Agriculture shipments were up 2% with increased volumes of corn, moving to Southeast poultry producers as well as increased volumes of feed products and fertilizers.
These gains offset reduced volumes of export soybeans resulting from a record South American crop, strength of the US dollar and limited railcar availability. Finally paper and forest products volumes were flat in the quarter with strength in lumber related to the continuing housing recovery offset by reduced volumes of wood chips and waste materials.
Let me close with expected trends in volume and revenue for the balance of the year. First, we expect solid volume growth in many parts of our franchise throughout the year.
Highway conversions and corridor investments should continue to drive domestic intermodal growth while international intermodal shipments will benefit from the recovery following the West Coast port disruptions earlier in the year. We expect growth in natural gas liquids despite lower oil prices, crude by rail volumes.
Double digit growth in housing starts and increases in construction activity should generate more lumber plastics, soda ash and aggregates traffic. Automotive volumes should grow at a rate better than North American vehicle production driven by output at key NS served plants.
Ethanol shipments should increase due to rising gasoline consumption and project related growth while a stronger crop should push export soybean volumes up later in the year. However lower oil prices are expected to cause declines in our metals and construction group as drilling activity slows reducing shipments of pipe, frac sand and other drilling imports.
Further production curtailments by major steel producers and high inventories will likely dampen shipments of iron and steel products. Lastly though natural gas prices, utility stockpiles at or above target levels, a strong US dollar and global oversupply will make this a challenging year for coal.
We continue to obtain price increases at or above the rate of real inflation in most areas of our business and should see negative price mix effects abate in the second half. However high fuel surcharge recoveries in the comparable periods last year are likely to result in lower revenue in the second and third quarters and for the full year.
By the final quarter of 2015, however, we expect top line growth to assume. Thank you for your attention and I will now turn the presentation over to Mark who will provide an update on our first quarter operations.
Mark Manion
Thank you, Jim. Restoring our service levels remains our primary focus.
However safety is at the heart of everything we do. So let’s take a look at our safety numbers.
Turning to Slide 2, our reportable injury ratio was 1.08 for the first quarter of 2015 as compared to 1.49 for the first quarter of 2014. The train incidents through March 2015 were 71 versus 61 over the same period last year.
Grade crossing accidents through March were 76, down from 88 over the same period in 2014. Now let’s take a look at our service.
While our service composite in the first quarter was lower than 2014 as a whole, we are operating at a higher level than we were in the fourth quarter even with the more challenging operating conditions that existed in the first quarter. In addition, as you can see on the right, our service has been trending upward since the end of February.
The timeline and trajectory of our service recovery I provided on our last call which outlined the incremental improvement in the second quarter with more significant improvement in the second half of this year has not changed. We expect that composite service performance will be near 80% by the end of the second quarter.
And as you see, the sizable improvement in train speed and dwell in December was maintained in January and although February was challenging recovery has been evident. We expect this trend of increasing train speed and terminal dwell reduction to continue through the rest of the second quarter.
We fully anticipate that our end of quarter speed and dwell metrics will be commensurate with the superior service levels we achieved in 2012 and 2013. As you have seen, we’ve made solid improvements and we expect to see even larger gains in our service metrics by the end of the second quarter.
Slide 5 outlines our plan that will lead to these larger gains. We have an increase of 600 conductors and 50 locomotive engineers between March 1 and July 1.
We expect to take receipt of 40 additional SD90MACs during the same time period and we’re already seeing the number of bad order locomotives normalize which will result in 160 additional locomotives available for service. By the second half of the year we anticipate we will be storing some of our older higher maintenance locomotives which will reduce our expenses and strengthen our service reliability.
With regard to infrastructure, the connection track in Chicago as well as Goshen siding east of Elkhart were completed in April. Both of these projects will further improve our fluidity through the Chicago corridor.
Lastly, the second phase of the Bellevue plant has begun with modification of the eastbound flows. The westbound flows will then be implemented later in the summer.
The full implementation of Bellevue will improve velocity through reduced car handling, improved asset utilization and result in an overall reduction in cost structure. In closing, we’re confident our service will continue to trend in the right direction with sequential improvements in the second quarter.
In the second half of the year we expect improved metrics consistent with strong service levels as the full effect of our investments is realized. Thank you and now I will turn it over to Marta.
Marta Stewart
Thank you, Mark. Now let’s review our financial results for the first quarter.
As you can see on Slide 2 and as has already been noted, the weather and service challenges significantly affected our first-quarter results. Jim discussed the 5% decline in revenues and while operating expenses decreased by $61 million or 3%.
It was not sufficient to offset the revenue decline resulting in a 9% reduction in income from railway operation and an operating ratio of 76.4%. Slide 3 outlines the major cost categories affected by the weather and service recovery effort.
These are estimated at $42 million the largest portion of which was in compensation and benefits. Additional service hours were incurred in all areas of operations, including train and engine employees for field service, mechanical employees to maintain the higher number of locomotives and maintenance way employees related to storm clean-up and repair.
Similarly the other listed expenses reflect the increased cost of a slow network and added assets. Purchased services and rents were primarily affected by the decreased velocity, while the last two categories: materials and fuel were principally affected by the rise in locomotive count.
As we previously stated, some of the service recovery costs are expected to continue into the second quarter, however, at a lower level currently estimated at $25 million. Turning now to Slide 4.
This illustrates the year-over-year change by expense category. Fuel was the only category to decline versus the first quarter of last year and the decrease was largely attributable to lower prices as shown on the next slide.
Breaking down the components of the fuel expense change, $160 million of the reduction was due to price as consumption was flat on the 2% increase in traffic volume. Slide 6 depicts a $43 million or 6% rise in compensation expenses.
We had higher than usual wage rate and payroll tax increase. As discussed during our January call, the union wage increase was effective January 1 versus the July 1 timeframe of recent years.
This resulted in a $26 million increase. Payroll tax rates rose on January 1 as well and total payroll taxes were up $14 million.
In addition, employee activity levels, increased hours, more overtime and more trainees added $14 million and signing bonuses related to our recently ratified agreement with the Brotherhood of Locomotive Engineers added $11 million. That labor agreement also calls for a lump sum bonus which will affect fourth quarter expenses by a similar amount.
The final significant item within the compensation area was the reduction in the accruals for incentive and stock comp, reflective of the quarter's results. Slide 7 shows purchased services and rent expense which increased by $31 million or 8%.
This rise is primarily due to higher volume related activities such as equipment rents and intermodal operation. As previously mentioned, lower network velocity also caused these costs to rise.
Turning to the next slide, materials and other expenses rose by $25 million or 11%, about half of the increase was due to higher materials expenses and was associated with both locomotive and maintenance of way usage. Environmental and personal injury expenses also rose in part due to a prior year favorable accrual.
And lastly costs increased largely related to our train service employees who had more overnight stays as well as temporary transfers to areas on our systems with crew needs. Depreciation expense displayed on Slide 9 rose by $8 million or 3%, reflecting our larger capital base as we continue to invest in infrastructure and equipment.
Operating expense headwinds are summarized on the next slide. In addition to the service recovery costs, the wage and payroll tax increases and the lump sum payment, 2015 expenses will include costs associated with the previously announced closing of our Roanoke, Virginia office.
Approximately 450 employees will be affected by this move going from Roanoke to either corporate headquarters in Norfolk, operations headquarters in Atlanta or choosing to retire or resign. Moving and relocation costs in 2015 related to this transition are expected to total $35 million and will begin to be incurred in the second quarter although most of the costs will impact the third quarter when the bulk of the relocation are expected to occur.
Efficiencies associated with this consolidation will begin to benefit expenses in the fourth quarter. Next, income taxes totaled $185 million or an effective tax rate of 37.4% compared with 33.6% in 2014.
As you may recall, last year contained a $20 million or $0.06 per share tax reduction resulting from a tax law change in Indiana. Net income and EPS comparisons are illustrated on Slide 12.
The $58 million net income decrease is a 16% decline compared to last year and diluted earnings per share of $1 was 15% lower than last year. As shown on the final slide, cash from operations covered capital expenditures as well as our higher dividend level $181 million.
On our fourth quarter earnings call in January, I mentioned we anticipated returning to a higher level of share repurchases. During the first quarter, we used cash on hand to buy back $415 million of our shares.
We now expect full-year 2015 repurchases to be between 1.2 million and 1.3 billion. And with that, I thank you for your attention.
And I will turn the program back to Wick.
Wick Moorman
Thanks Marta. Well, as you've heard, clearly our first quarter results were not as strong as we and you expected that they would be.
And in the short-term we face some continuing headwinds and the tough comps from last year. However we see continuing strength in the overall economy and as Jim described we have a lot of opportunities in many of the markets we serve and a great franchise with which to capitalize on these opportunities.
In addition, we’re well on the way to restoring our network velocity and efficiency which will drive further costs out of our operation and as all of you know that will also enable us to secure more business at rates that drive positive returns for our shareholders. As we do that we also remain committed to returning cash to our shareholders as demonstrated through our strong dividend history as well as through our share repurchase program where as Marta just mentioned we’re now targeting between 1.2 billion and $1.3 billion in share repurchases this year.
In sum, we have a proven strategy for success and the right people and resources to successfully execute it. Thanks and I'll turn it back to the operator for your questions.
Operator
[Operator Instructions] Thank you and our first question is coming from the line of Bill Greene with Morgan Stanley.
Bill Greene
Jim, you obviously identified in your slides the challenges ahead from the fuel surcharge mechanism. We asked this last time as well but since we’ve gone another quarter and now with the pre-announcement, is there any reason to think that you might sort of address that again and come back and say, maybe we need to adjust that and change that going forward a number of the freight transports at rebates to fuel surcharges given the volatility there.
So what are your thoughts on fuel surcharges?
Jim Squires
We are working toward shifting more of our revenue to an OHD based fuel surcharge mechanism over time and so that’s going to take a while, it’s contract by contract, customers have their own preferences. Our overall goal will be to increase rate and grow the revenue and -- but we recognize that our reliance on WTI in our fuel surcharge program creates volatility in our earnings and that’s undesirable.
So we will be working over time to shift to a more OHD based program.
Bill Greene
Okay and then Jim, or even Wick, how you get confident in volume growth being actually a good thing? Obviously last year we had service challenges and we had unexpected growth and now we are having sort of a change in the macro outlook that's created some excess resources and yet the service levels aren’t back.
So can you sort of walk us through your thoughts on, does it make sense instead to sort of let’s focus on getting the right kind of business on the network to result in a better margin or better outcome and not worry so much about the volume growth instead, do you know what I am getting at, right? So it seems like there needs to be more of a focus so much on shrinking the business, that will improve the service which is even better for price?
Wick Moorman
Bill, I understand your question that I think it's a very reasonable and interesting one. One of the things that I will say about our volume growth is we don't go out and try to grow volume at rates and margins that don't make sense from the standpoint of shareholder value.
So we're not -- we're certainly not in the mode of let's just grow volume for volume sake, and in fact, if you look at a lot of our volume growth this quarter it's been in intermodal where you know we made a lot of investments and where we're now seeing, as Jim mentioned, a very positive pricing trends. So we don't see that as a problem.
In fact, we see volume growth at good rates as a strength for us. We also don't see that volume growth as severely impacting in any meaningful way our service recovery.
Our service recovery is based upon getting the right resources in there. We think we’ve largely done that and we’re on the right path back.
Last year as you mentioned, we had some volume growth. We clearly did not foresee in the second and third quarter and got caught short primarily on the crew side.
So the volume growth we're having right now we see as desirable, we see as continuing to be a good thing for us. As Jim mentioned in this quarter in particular and although we may see it for a little while longer, we saw some mix effects even within our merchandise business, this didn't overall -- didn't help our overall RPU but even within that, the somewhat lower rated traffic that was growing, was still good margin business and business that we want to continue to handle.
Operator
Our next question comes from the line of Allison Landry with Credit Suisse.
Unidentified Analyst
This is Ken on for Allison. So just a quick question on the buybacks, so I mean as you mentioned the buyback was pretty big in Q1 and you highlight a target of 1.2 million, 1.3 billion for the full year.
Just curious on how that could possibly trend through the next few quarters, and whether there is any limit on how big of a buyback you can do in any one quarter?
Marta Stewart
Well, the estimate of 1.2 billion to 1.3 billion is just a little bit higher than what we projected on the January call and so we are very comfortable with that level. We did not issue debt last year, we have plenty of debt capacity this year and we’re comfortable with our projections, that that’s going to be an amount of cash we’re going to be able to return to the shareholders.
Unidentified Analyst
And just as my follow-ups, so you mentioned that utility coal stockpiles were currently above target. Just curious how far above target you’re seeing the stockpiles currently trend at your utilities and how long you would expect it to take to get back to that target level if we assume a normal weather environment?
Mark Manion
Based on our estimates, utility stockpiles in the south at the end of March were at around 71.5 days, in the North 65.3 days. Rough target for southern stockpiles of 70 and for the northern utilities about 50 days.
So as between the two of the northern utilities are a bit more overstock, the stockpile trends will depend heavily on the weather pattern in the summer and all of our assumptions around utility coal, in fact, you assume a normal weather pattern in the summer which would drive our volume assumptions going forward.
Operator
Our next question is from the line of Tom Kim with Goldman Sachs.
Thomas Kim
Marta, I wanted to ask about your Roanoke relocation. You talked about the incremental costs you’re going to incur this year but I was wondering what are the savings we should anticipate next year?
And then I guess more importantly, are there further opportunities to rationalize or consolidate your operations and is there a pipeline that you might have alluded to?
Marta Stewart
Well, the Roanoke relocation had, Tom, two components to it. I mean the primary reason why we decided to do that was because we think it will be more effective for our people to be in fewer locations.
So we think that will help the operations of all of the departments that are involved. So that was number one.
But as a result of doing that, was sort of a catalyst to accelerate some G&A reductions that we have been planning for the next three or four years and so that allows us to – because some people are choosing not to move, that allows us just kind of accelerate those as I said. So we think we will have about 150 G&A positions between now and the end of the -- between the third quarter and the end of the first quarter of next year that will come out as a result of that.
Thomas Kim
And then a question with regard to the coal and particularly I guess the coal exports. What are the levers you can adjust to a potentially longer and deeper down-cycle for export coals?
I mean to what extent would it make sense to maybe even rationalize terminal interest and then maybe even with rolling stock, is there something you could do there, like you’re satisfied with the utilization levels or could you do anything with regard to even that side of the business?
Mark Manion
For starters, we can be very nimble with our equipment asset, serving our coal business, our export coal business. We can obviously redeploy the locomotives, we can downsize or curtail coal car replacements.
So we have complete flexibility with regard to the equipment. The infrastructure adjustments would involve adjustments to maintenance levels particularly in the coalfield and in some cases perhaps longer-term mothballing of the asset but most likely the infrastructure side would involve service reductions until the volumes return.
Operator
Our next question comes from the line of Rob Salmon with Deutsche Bank.
Rob Salmon
With regard to the merchandise outlook, obviously there are couple of puts and takes with regard to your growth expectations, with weakness on the softening steel production side as well as growth in several other end markets. When I'm thinking about the crude by rail outlook, it sounds like you're expecting continued growth.
I would imagine we should be seeing those that volume growth decelerate and potentially decline in the back half of the year but I was hoping for a little bit more color in terms of your expectations regarding that and commodity.
Mark Manion
So we handled around 29,000 crude by rail shipments in the first quarter of 2015 and that compares to 22,000 crude by rail shipments in the comparable quarter last year. That’s an increase of 34%.
Now since the first quarter of last year we have had a handful of new customers come online. With softening oil prices we do expect the growth rate for crude by rail to decelerate but we think we should be able to maintain a ratable 29,000 or 30,000 car loadings per quarter this year.
That would imply growth year-over-year in the second-quarter and for the full-year but we would be modestly negative relative to the crude by rail volumes in the third and fourth quarter.
Rob Salmon
And then with regard to the train length opportunities on the merchandise network, do you feel like as the service improves that there should be the opportunity to extend out those train lengths in the back half of the year or given some of the softening of kind of the growth in crude by rail as well as likely declines in the steel production, will that be an offset in terms of your ability to gain some operating leverage opportunity in the merchandise network?
Wick Moorman
We’re always looking for ways to increase our average train lengths and in fact we are seeing an increase in our merchandise train lengths even now, I think we are in the neighborhood of 5900 feet thereabouts currently and keeping in mind that our system our siding capacity at a minimum is in the 8000 foot range. So lot of room to grow there and that’s something we continue to work on and that has mostly to do with continuing to adjust our train plan, our operating network plan to be the most efficient.
Operator
Our next question comes from the line of Scott Group with Wolfe Research.
Scott Group
Jim, I know you talked about expectations for revenue to remain down the next couple of quarters. I am wondering is if you can share with us your view, if you think that the revenue declines kind of moderate in the second and third quarter or do they kind of stay here, maybe even get worse and if you think based on that -- should we continue to expect kind of these double-digit type range declines and I know you don't typically give that level of color but obviously a lot of us have struggled modelling the numbers in the first quarter, so might be helpful just to get your perspective on your earnings and revenue?
Jim Squires
Well, let me start by reminding you of the fuel surcharge comparisons in the second and third quarter. So in the first quarter of this year we booked $163 million in fuel surcharge revenue, that was a $132 million decline year-over-year.
Last year in the second quarter we booked 358 million in fuel surcharge revenue, 369 million in the third quarter of last year. So assuming stable oil prices for the next couple of quarters that would imply roughly $200 million less fuel surcharge revenue per quarter for the second and third quarter.
Then in the fourth quarter the comparisons get a little bit easier. Last year we took in $308 million in fuel surcharge revenue in the fourth quarter.
So that right there is a pretty significant revenue headwind for the next couple of quarters. On the other hand, as I said we expect some of the negative mix effects we saw in the first quarter to begin to abate.
And so by the third quarter – based on our current forecast we would be looking for revenue for shipment excluding FSCs to turn favorable. And similarly revenue ex fuel surcharges in the third quarter will turn favorable and then by the fourth quarter we start to see overall growth in the top line.
Now that obviously has a volume component as well and there we are feeling pretty bullish. Obviously the declines in coal volume are not helping but we’re feeling as if on the utility side, natural gas substitution has run its course and we should be able to see a fairly stable utility coal volume run rate for the balance of the year albeit with the tough comparisons to last year.
So that’s our overall outlook on the revenue and so we have a lot of opportunities to grow revenue and as I said the negative mix effect should begin rolling off in the second half.
Scott Group
And then just other question as we think bigger picture and a lot of rails have operating ratio targets in that 60%, low 60% range and I'm wondering as you think about the business, Jim, are there -- do you think that there are structural differences for you or Eastern rails in general or is that eventually a place where you think you can get to with the right mix of revenue and costs?
Jim Squires
No, last year at this time we were on the verge of producing some of the best quarters that we’d produced in this company’s history and the lowest operating ratios as well. And that was possible because we were seeing significant growth, volume growth in our merchandise and intermodal businesses in particular and that was sufficient to more than offset declines in our coal business and that's the formula for us going forward.
We will begin to see our coal volume stabilized at some point and we will, we believe, grow our merchandise volumes, our highest incremental margin volumes and our intermodal volumes with a substantial price increases to grow. That is a formula for continued improvement in our financial performance and for materially lower operating ratios in the future.
Wick Moorman
Yes, let me add to that. I think that sure inherently if you -- relative to franchise businesses, the west looks different than the east, looks so different in Canada but we, as Jim mentioned, we came off of -- we come off a year where we took our operating ratio for the year below 70 for the first time.
We expect to continue to drive operating ratio improvement and we have a very very strong franchise particularly in terms of intermodal and merchandise. So I think that the pace of when you get there is obviously always something that the economy will largely determine as well as our own efforts but we have internal goals for driving operating ratio down and we believe that we will continue to do that.
Operator
Our next question comes from the line of Tom Wadewitz with UBS.
Tom Wadewitz
Wanted to ask you a little bit about the pricing. You got a lot of moving parts in the revenue side and you’ve highlighted the mix headwinds.
But is there any way to kind of disentangle that and talk about core price, give us a sense of – were you at in the first-quarter or if you don’t want to do that, if you just talk about progression, should we expect ex-mix to see acceleration in year-over-year price or did you kind of already get the step-up from tighter rail capacity in the first quarter and the negative mix rolling off, or how do we think about -- how much core price you’re getting and whether that accelerates if you look in the second quarter, third quarter?
Jim Squires
We were successful in meeting our goal of increasing pricing, core pricing at a rate at or better than rail cost inflation measured based on all inclusive less fuel in the first quarter, in most of our businesses. Generally speaking outside coal, we were able to drive pricing higher and I think most encouragingly we saw the largest core pricing increase across our book of business in our intermodal line.
Tom Wadewitz
What do you see – you referred to a lift, where did you a lift in the first quarter?
Jim Squires
So reported a lift [ph] in the first quarter 2.8%.
Tom Wadewitz
So it’s not really caveat lifting across the board, you would have done better than that 2.8% if we looked at the core price kind of taking out next, is that fair?
Jim Squires
Right, right, with the exception of coal as I mentioned, virtually across the board, there were pockets where we were stronger. But on average we were able to meet the goal of increasing core prices at that rate.
Tom Wadewitz
And what about the aspect of accelerating? I mean it seems like you are pretty optimistic about improving the network performance, so you would think that customer service would improve as you look into through second quarter and second half, I guess the truck market seems like it boosts into a bit maybe freight overall isn’t as strong.
But do you think there is more momentum in pricing, that would accelerate or have you kind of achieved the run rate in the first quarter and if you stay stable in the next couple of quarters.
Jim Squires
We will stay focused on raising prices at a rate better than, at or better than rail inflation. That’s our long-term goal.
The contracts vary by quarter, the pricing opportunity varies quarter by quarter but overall we’re going to stay very very focused on that goal and are confident we can achieve it.
Operator
Our next question is from the line of Matt Troy with Nomura Securities.
Matt Troy
I just had a question, maybe a big picture overview of the network. You guys have done a good job of explaining your target of returning the service metrics, speed or dwell or your composite service indices back to kind of the peak 2012 2013 levels by 2Q.
And you’ve also kind of outlined very nicely what you intend to do to get there. I just wanted to take a step back and maybe understand from an operational perspective, if we were to look at a network map, sort of a heat map if you will, what are the key areas that you need to address, the pinch points if you will, as you’ve given us the pieces to get us there, the targets that you like to reach, I just would like a better understanding because we’re only 6 to 8 weeks out from kind of the middle of the second quarter, or the start of the third quarter when you can hit these goals.
What are the focal points that will help you get to – to get to these targets?
Jim Squires
Well our most challenging part of the system last year and into the first quarter was our Chicago line and really principally between Chicago and the Cleveland area and a lot has gone on in order to increase our velocity and I will say that, that area is running really well now. There’s just really been a lot of focus on it.
So in order to do that there was a – we really pinpointed the manpower increases which has come along very nicely and I will just say that we’re in pretty darn good shape up in that area from a manpower standpoint. Now another thing that has been going on for a longer period of time is infrastructure improvement up there and I did mention the fact that we got a couple of significant infrastructure projects that are now complete, that just give us -- it just gives us a bigger pipe around that traffic through there.
So keeping in mind that parts of that area, they will run a 100 or more trains a day. So infrastructure improvement, nice increases the Bellevue project like I said, it’s more to come which will be very helpful as well as we go through the summer.
So that’s the area we put a lot of concentration into and it’s paid off very nicely and of course a lot of the things going around the other parts of the system and other very important parts of the system but that was the big focus and it’s really had a nice ending.
Matt Troy
And my follow up would be on the intermodal piece. The international volume growth of 8%, makes sense given the potential for some diversions, residually from the West Coast port strike, work stoppage but the domestic piece, the volume is up only 3%, was a little bit lighter than I think we become accustomed to seeing through given your good traction and progress in highway conversions.
Wondering if you could just update us on the corridor gateway strategy and was that 3% representative kind of more of a GDP level growth what you'd expect this year or were there certain mix factors or contractual factors that we saw a little bit of a dip in the growth in domestic intermodal for you folk should kind of resume at a multiple of GDP as it has been in the past?
Jim Squires
Sure Matt. Let me take a stab at that.
So within the domestic intermodal we obviously have several channels. The intermodal company IMC channel principally hub and hunch grew at 6%.
So that's a little closer to our historical growth rate and that’s a sort of growth rate we would expect to see or better out of that channel going forward. Our premium and triple crown books declined somewhat and that's what led to the overall 3% increase in volume and the total domestic book.
Going forward we do think that that we can continue to drive the entire domestic intermodal franchise at growth rates more like mid high single digits.
Operator
Our next question is from the line of Chris Wetherbee with Citigroup. Our next question comes from the line of John Barnes with RBC.
John Barnes
First on the operating ratio improvement, so asking for a specific target but whatever we model for OR improvement you’ve given – you got the service related costs, you got the savings from Roanoke, you got some things like that, can you just talk about the magnitude of each of those and kind of from most important to least important, what's going to drive the improvement going forward?
Marta Stewart
The main thing that will drive improvement will be getting the network back to the velocity that Mark mentioned. So the train speed, the terminal dwell, improvements that he mentioned, he thinks will have in the second half of the year, that is the main thing that will help us with expenses.
I would like to point out if you are looking at the OR that going forward as Jim mentioned the fuel surcharge component of it is going to be quite a drag on our operating margins the rest of the year.
John Barnes
And then from network velocity, kind of what’s the next couple of catalysts there?
Marta Stewart
After network velocity? So it’s just general productivity – and again that network velocity we think will begin to – will happen towards the end of the second quarter.
So we expect that improvement to happen in the second half of the year.
Wick Moorman
If you look at our track record for the 2012-2013 period and we discussed this a lot. When you ramp the network up you start to take -- not only do you take the costs out that Marta has been discussing but it then sets the stage for even further projects to continue to drive costs down particularly as volume grows and it's that combination of an ever higher network velocity Mark mentioned Bellevue and we talked to you about the savings that are coming online as we turn Bellevue on.
But it’s a combination of having a stable high velocity network which then sets the stage for continuing projects to drive velocity along with the leverage as Jim mentioned the volume growth that really drive the economics of Norfolk Southern and for that matter any railroad.
John Barnes
And then my follow up is – Jim, you talked about stability on the coal franchise. Can you talk about how – how you weigh getting to maybe a more stable but lower level of coal both on the domestic and the export side and when you sort of make maybe some of those service adjustments and begin to take assets out, begin to downsize or rationalize the size of your coal support network, I mean when do you begin to do that, what do you have to see from a stability standpoint to really start to hammer again with the costs on the coal side if stable is going to be what we get going forward?
Jim Squires
Let me start with the utility side of the franchise and give you some of our assumptions for the balance of the year, and I will be referring to utility tonnage here. We did 21.1 million tons of utility coal in the first quarter and our current forecast has that level of utility volume holding basically steady for the remainder of the year.
As I mentioned, we do believe that gas substitution with met gas in the current price range has run its course, there's very little tonnage left to come out due to match and of course the implications of carbon regulation down the road are somewhat unknown at this point. But in terms of mets we will maybe see 500,000 fewer tons this year and so at that level of volume that’s albeit significantly depressed from last year and even more so from years past.
We probably do not have an opportunity and would not want to take out significant infrastructure. On the other hand we can and already have downsized our equipment investments in our coal business.
At this level of volume we can make do with our current coal car fleet for some time, that have been relieved of the significant capital investments in coal price. That pertains really more to the export side of the business.
So let me touch on that as well. We handled 5.3 million tons of export coal in the first quarter, that’s down significantly from last year first quarter which was our peak quarter for export coal.
For the remainder of the year we are calling for 4.5 million to 5 million tons of export. Feel pretty confident on the thermal side of that.
If there's a downside potentially it would be more on the met side or central app producers are very challenged right now. But again at kind of a $20 million annual run rate, 20 million ton annual rate for export coal, we probably would not want to significantly downsize our infrastructure, although we do have the opportunity to reduce spending on equipment and people side of it is something we can modulate as well.
Operator
Our next question is coming from the line of Chris Wetherbee with Citigroup.
Unidentified Analyst
This is Prashant [ph] in for Chris. I apologize, earlier we were having a little headset issue here.
I realized running a little bit late in the call. So I could be brief – we’re curious to know the growth potential for the core business and taking apart, leaving aside fuel surcharge and coal, if you got the core normalization do you think we could see the core grow in double-digit and in 2015 are really corn services the biggest factors preventing that, is there any way to isolate either, is that the right way to sort of think about that?
Jim Squires
Well, if by core business, you mean our merchandise, our industrial product businesses. So we do see growth potential there in 2015 and beyond, definitely.
Now there are always puts and takes. We have some challenges on our metals and construction franchise right now due to very low steel prices and reduced demand for pipe in particular.
Wall Street Journal quoted $444 per ton as the going price for hot rolled coil this morning, that’s down from $474 at the end of March. So steel prices are very depressed and the capacity utilization is tracking below 70%.
So we have some challenges on that side of our MetCon franchise. On the other hand, our steel within MetCon, aggregates were up significantly.
Construction car loadings were up, cement traffic was up, driven by housing and road construction. So there are definite bright spots.
On the energy side of the core franchise as well we see continued opportunity. Over in chemicals we were able to grow NGLs, crude by rail, we’ve already discussed.
Our plastics businesses were up, those are all indications of a pretty healthy industrial economy and should be the drivers of significant growth in our industrial products franchise going forward. Our ag volumes were up in the first quarter as well and that we see continued promise there for the balance of the year as well.
So overall we feel real good about our industrial products franchise albeit there are always a few soft spots. And the intermodal continues to grow and on top of the volume growth this year we expect to see significant price increases.
I mentioned that our core prices were up in our intermodal business more than in any other business segment in the first quarter and that’s very very encouraging.
Unidentified Analyst
And just as a quick follow up, on the comp and employee issue, it looks like on a per average employee basis the year over year change is just under about 2% which, kind of thinking about that and going forward on a year over year basis, how to think about that line item? Are there offsets to the headwinds and what are some of the initiatives that you guys see on the table, maybe in terms of combating some of the headwinds you pointed out on slides?
Wick Moorman
Well, if you look at our comp right now, obviously and we discussed this before, we have the labor agreements which cover about 85% of our workforce. We had the effectively an early pay increase as a result of the last round of negotiations that kicked in, in January rather than July 1, as Marta has discussed.
As we look at overall headcount clearly we’re focused right now on getting the right number of people in our train and engine service workforce to handle the traffic without delay. I will say that as these numbers and Mark showed you the conductors and engineers we expect to bring on in the next couple of months most of them are included in the headcount today because they are trainees at the end of the first quarter.
As they come on they come off training status in which they are effectively paid a salary ad start to be paid on the trip rate. So that that will then be proportional to our operations and then on the non-agreement side and in a particular G&A side as Marta mentioned we’re always looking at ways to do everything we need to do with the lower headcount and the Roanoke closure will help precipitate some of that.
We will continue to look at that and try and drive those costs down wherever we can.
Jim Squires
Let me just add a footnote to Roanoke office closure question, having spent a lot of time with our marketing team in the last couple of months I'm really really excited about having all of our sales and marketing team under one roof here and that is going to allow us to produce a much focus and consistent approach to growing our top line and will have an opportunity to move people around between jobs that might not have been able to move around between in the past and there will be similar surgeries from a workforce standpoint across all of the functions that are currently in Roanoke today or IT and accounting departments.
Marta Stewart
On the operation side, what I would add is Wick is exactly right, the increases that Mark described we have – you see those reflected in the average headcount which was up sequentially from the fourth quarter by 500 and what we’re projecting for the remainder of the year is another 500 increase, most of that will occur by the end of the third quarter and that is almost exclusively in the operating area. So by the end of the year we think we will be up 1000.
Operator
Our next question comes from the line of Brian Ossenbeck with JP Morgan.
Brian Ossenbeck
So just two quick ones. Jim, you mentioned a lot of the headwinds of the strong dollar and some of the disruptive imports that we’re seeing in the steel.
You also mentioned you expect ethanol and soybeans to be up. So maybe if you could just summarize why you think those are moving and overall do you think that a strong dollar has a positive factor or a negative excluding coal and for the rest of the business, is strong dollar a positive or negative?
Jim Squires
Well, most of our business is US domestic economy focused. So there are certainly pockets of resistance in the revenue based on the stronger dollar.
We highlighted a few of the most prominent of which would export coal and pockets elsewhere as well. But I don't see an overall dampening effect on the total revenue necessarily outside export coal from the much stronger dollar.
In certain pockets of our business it will be an additional challenge but we have enough drivers of revenue growth within the US domestic economy to push the top line higher based on our portfolio even with the strong dollar.
Brian Ossenbeck
And just one follow up on export coal side. You mentioned you’re pretty confident on the thermal side and how that looks for the rest of the year but I know the mix has kind of bounced around a little bit.
Could you just give us a refresher on what mix was in the first quarter and perhaps what you expect for the rest of the year?
Jim Squires
In the first quarter of this year 64% of the export tons we handled was metallurgical and 36% was thermal and that compares to last year’s 69% met, 31% thermal. So we had a relatively high proportion of thermal coal in the first quarter this year.
We think that will revert in the balance of the year to more of the 75:25 type of split. Now going back we were almost all metallurgical coal, the last couple of years kind of 70%, 80% met and the rest thermal has been kind of the common split and we think we will get back to something like that split.
I will say though that the demand is still firm around the thermal side of the franchise right now and north app producers were able to jump on some opportunities there in the first quarter and that’s why we saw the thermal part spike somewhat relative to the metallurgical coal moving predominantly over Lambert’s Point. And by the way as you probably know most of the metallurgical coal we handle moves over Lambert’s Point and most of the thermal coal moves over Baltimore.
If there is a potential downside in our assumptions roughly 4.5 billion to 5 million tons per quarter for export coal, it would be on the metallurgical coal which in our case is coming out of central app and because of all of the factors we mentioned, stronger dollar, the global over-supply of coal, Queensland and 109 and spike coals moving prices below that, because of very low bulk dry shipping rates, it’s just an extremely difficult environment for central app producers in particular right now.
Operator
Our next question is coming from the line of Justin Long with Stephens.
Justin Long
I wanted to ask a question about PTC. As you’ve continued to roll out this technology how much of a disruption is it causing to the network?
Is this a contributor to congestion in the rail network today or would you say it's not a significant needle mover when you think about fluidity?
Wick Moorman
It’s something we’re paying a whole lot of attention to and it has everything to do with how well we plan it. Those PTC cutovers take place on a regular basis each month and the good thing is that our signaling communication group are doing a very good job of reducing the amount of disruption that takes place with each of the events and case in point when we started this out and we’ve been doing it for a while now but when we started these out the outages were in the neighborhood of 12 hours and of course we do a lot of scheduling and planning around that to really minimize the disruptions but as we've gone along here outages have gone to eight hours and now in more cases down to six hours.
We’ve got some things going on where we think we can reduce them even below six, some of them to little as four hours. So a lot of planning and schedule workarounds so the disruption factor will be minimized going forward but still something we do a lot of planning around.
Jim Squires
No, I will add one thing to that which I think it's very good question which – and we have not talked about that in any detail nor of the other railroads but I will say that we got a lot of the really problematic areas on the railroad in terms of traffic disruption down last year. We still have some more to go and my analogy for it last year was we were almost – it was almost like we were constantly running a low-grade fever.
We had a lot of work to do out there and a lot of significant disruption that as Mark said we planned around it, we did everything we could but nonetheless it was disruptive and it's something that as Mark has described we continue to work on and in fact it's a real point of focus for us right now as we look at restoring our network velocity.
Justin Long
That’s helpful color and I will just sneak one more in on intermodal. I was curious are you getting a lot of pushbacks from your customers and your IMCs on the Intermodal price increases you are going out with today?
And also as of today how much of your book of business in Intermodal had been repriced at higher levels call it at mid-single-digit range over the past year?
Jim Squires
We are not getting a lot of pushback on price increases. We are aligned with our intermodal partners in view of the marketplace and in desire to take prices higher at this point.
If you look at our equipment by line of business as an indicator of where we have the opportunity to lean into price most, E&P is about 70% of the total book by volume and that’s where as the rail owned fleet, rail equipment fleet is that's where we have the most ability to take prices up on spot basis. So also on the triple crown side of things at 10% of our total book by volume we can lean into rate for us as well.
Operator
Our next question is from the line of Brandon Oglenski with Barclays.
Brandon Oglenski
Jim, welcome to the hot seat. And as you guys know we have been supportive of the stock here, so I am going to be conservative with these questions.
But I do think it’s worth of your shoulders to ask some of the difficult questions here though too. And granted I have never on train, we just live in Axle model, so please tell us we are wrong.
But this quarter volume was up 2%, 3% growth in merchandise and intermodal is up 5% and yet earnings are down 15% on what was a pretty easy comp from last year given all the weather disruptions. So I mean that’s a lot of the frustration I think with your shareholders and if I listened to the strategy to drive improvement going forward it’s getting price above inflation which we got this quarter, it’s getting growth in those intermodal merchandise segments and it’s stability in the coal book.
But I guess my concern here is where is the profitability outside of coal? I think you've even said and Wick said it in the past no, coal is a very profitable segment for you but where are the margins and returns on intermodal merchandise and is that going to be enough to drive future earnings growth for this company or do we have all these continual cost pressures and fuel surcharge headwinds or are we just not going to be able to see a lot of earnings expansion even with those pretty robust growth rates outside of coal?
Jim Squires
But let me add we appreciate the candor and by all means essence of questions. And we demonstrated last year that we can drop the operating ratios significantly based on solid general merchandise volume growth and intermodal volume growth even with coal headwinds.
Now when you are talking about coal volumes down 7% overall in the quarter that's a pretty strong headwind and that is more difficult and we lost ground this quarter, no doubt about it. But that will stabilize.
We will see a bottom on coal volumes and as we discussed on this call we think we may be there already. And then we have the opportunity to see continued growth in many areas of our merchandise franchise and in our intermodal franchise.
Put on top of that significant price increases and you do have a recipe for growing earnings. It's essential that we get the network back up to speed, we have a plan to do that, we have the resources coming online.
There will be some cost headwinds as we get from here to there in the short-term but once the network is back up to 2012, 2013 service levels we will see significant cost drop out as well. So it’s the combination of that basic efficiency and the cost reductions, it comes from running a faster network, bottoming out of coal volumes and combination of volume growth and price in our general merchandise and intermodal businesses.
Brandon Oglenski
I mean you are not doing a railroad to see some pretty challenging coal numbers and I do agree with Wick’s assessment that there is differences between the East and Western Canada but there are some similarities between Western Canada at least in terms of achieving a mid to low 60s OR for a lot of these carriers with public targets to get there, and if I am hearing you correctly, Jim, it sounds like we need to have stability in coal before we can get any real traction on the operating ratio. But I think there will be a lot of skeptics on the buy-side at least or your investor base where if we look at natural gas being up 5$ in the future, there is still some incremental gas capacity in the east and on top of it the export market doesn’t look all that solid as you’ve confirmed on this call.
So can Norfolk get traction on margins even if coal continues to be maybe a modest headwind heading forward?
Jim Squires
I really do. This is going to be a tough year.
We will start to see the top line grow again in the fourth quarter we think based on our current forecast. Until we get the top line moving it will be difficult for us to make a lot of improvement.
That’s coming. These mix effects that you saw in the first quarter are somewhat transitory.
Over lings will bottom out, now we cannot say with total assurance that we have hit bottom in terms of coal volume today but we started our utility franchise pretty carefully and gas substitution becomes more difficult at this point with gas plants running full out. Now the export side of things there are headwinds there but there are opportunities as well particularly on the thermal side of that franchise.
So we think we can do it, we’ve got a couple of tough quarters ahead of us with the fuel surcharge headwind with some additional costs out there to get service back up. But once we are there on the service, once we see coal volume stabilized and we get past this fuel surcharge headwind we are in great shape to continue with the performance.
Operator
Our next question is from the line of Ken Hoexter with Bank of America.
Ken Hoexter
I am going to take a little bit of a different take on some of the same questions there but it looks like service starting to show some improvement still at the mid-70s operating ratio for the quarter. Why such a contrast?
Maybe I could address this to Mark between your need to add the 650 employees between the conductors and engineers, the 200 some on locomotives and when you look at Canadian Pacific's plan to cut resources which creates a lot of capacity. Maybe Mark, can you just describe maybe a little bit of the differences in the operations or how you’re running it so we can understand why we can see such a great contrast between one creating capacity and the ability to move more versus what – how you’re structuring the operations?
Mark Manion
Well as far as the resources we’re adding we know that when we’re in the process of ramping up it's almost like you can’t have enough locomotive, you need a certain number of locomotives just to spin yourself up, and that’s what we’re in the process of doing and in fact, I've got my sights set on restoring locomotives before long, in fact, we will probably get into that by May and give ourselves a surge fleet, we will see how far we go one to 200 locomotives. And same thing on the people side, I mean you need a certain number of people that man your trains and it is activity based, we pay them when they work.
So we need to take on more people, we will stabilize on the people side by the end of the second quarter and from there on we essentially outside of business growth opportunities as we get into the second half, we’re going to be levelled off on people and we will be hiring for attrition. So we don't see ourselves doing anything particularly differently than with the other railroads do as far as that goes.
Ken Hoexter
So I guess maybe just to key taking into there – to take a step further, is it the network resets you’ve done a few times over the long weekends or is it changing the operating plan which creates that extra capacity?
Mark Manion
No, we said last year that depending on the severity of the winter that we would do as we typically do as we come out of these winter events. These are big network systems and they ramp up on a gradual basis, that is what has been happening ever since March.
And so we’re seeing some nice nice ramp-up now and I'm sure you look at our numbers as well you see our cars online going down, you see our bad order ratio going down, our train performance is improving, our connection performance improves, the number of locomotives available improves, all that drives overall network velocity but it happens in a gradual way. And we will see that, we will continue day in and day out see that gradual improvement take place through May, through June and I think by the end of June we will see some pretty darn good numbers.
Wick Moorman
Just in overall theme let me say one more thing about that. And it goes back to this idea every franchise is different, every railroad is different and the Eastern carriers obviously are as all of you know shorter haul complex networks and that’s fine.
For one thing we live where all the people are and we think that has a lot of positives in terms of growing. But the overall belief that I think everyone in the railroad industry shares is that velocity creates capacity and that's where we are going.
The first thing you do is get your velocity where you want it to be, where we’ve had ours in the past. As you see velocity go up, as Mark mentioned, cars online goes down, our terminals get more and more fluid and that’s what then drives further operating and cost improvement and that's the path we’re on.
And if you look at some of the things we've done in the past here we've done a lot of work on our terminals in terms of we closed two significant yards. We've expanded one to make up for that and to make up for changes in our traffic base.
So the patterns may look somewhat different based on the franchise but the theme is always the same in terms of constantly improving the velocity of your railroad no matter whose railroaded it is in order to create cost efficiencies and create further capacity.
Ken Hoexter
And if I could get to follow-up, I guess Jim as you prepare to take over in two months or so what are your thoughts on M&A? Obviously we’ve heard Wick’s kind of thesis in the past.
I am just wondering how you view the world and obviously given the discussions that we've heard from some of the Canadians and maybe your peer on the east in the past, just want to get your insight and whether you think it's possible -- if not, why not and then if not now, does that mean something could happen in the future, maybe just some thoughts on that?
Jim Squires
Sure. Well I will share a few thoughts and then I will invite Wick to chime in as well.
First of all, let me start by saying that we are a public company, we’re obviously here for our shareholders. So there are no categorical answers in that regard.
On the other hand we do see significant challenges associated with further consolidation. The regulatory review process for consolidations in this industry is very very time-consuming, onerous and risky and I say that as one who practically lives at the surface transportation board for year and a half or so as we were going through Conrail.
It's a very unpredictable process, and it is a very costly and risky process as well. And there are relatively few synergies to be achieved in exchange for those risks as well, the remaining combinations in this industry are end to end and by definition fewer synergies available.
So we don't it's a good idea and we think we have a freight business plan around this company on a standalone basis, that what we can do with this company is better than anything that could be achieved.
Wick Moorman
Jim and I agree completely about this but I think Jim's first caveat obviously is important here. We are a publicly traded company.
We are interested in long-term welfare and benefits to our shareholders. That is our job and we understand it very clearly.
But I think that what is sometimes really underestimated by those who don’t live or immersed themselves in the regulatory environment in the way that we do is just how hard it would be a) to have any kind of transaction approved particularly under the new merger rules where a) by definition it has to be pro- competitive whatever that -- and no one has defined that. And second, the enormous risks that the conditions imposed if you were even able to get a merger approved by the STB would negate any and all benefits and beyond of the transaction itself.
And there would be an enormous amount of resistance on the certain parts of our customer base and we just think that you never say never and the time may well come, but right now it’s not a time where trying to do a transaction of any size makes any sense.
Operator
The next question comes from the line of Jeff Kauffman with Buckingham Research.
Jeff Kauffman
I want to ask a question on a different aspect of the coal franchise. Given that most US based coals are well out of the money globally and given that the utility inventories remain quite high, I think up till now everybody is focused mainly on the volume aspect of the coal franchise.
But I guess the question becomes at what point do either the coal producers or utility customers say if we want to keep the coal moving we need a pound of flesh and let’s revisit the pricing so that we can keep coal competitive and keep coal moving? When we look at your contracts both for export and domestic, can you give us an idea of when they get repriced, come up for renewal and how much confidence do you have in this kind of environment that we won't have this new leg down this fall when these contracts or next year we go to reprice?
Jim Squires
We believe we continue to have a compelling value proposition and our ability to deliver coal from various basins and various ways to our utility and export customers and we’re going to reprice that on a value basis. So on the export side there just isn't that much we could do unfortunately.
Our major customers are finding it very difficult to place coals into the global market particularly on the metallurgical side. So our goal as is the case across our franchise is to obtain the maximum value for the dollar for the value that we provide our customers and we will continue to do that in the coal business sense as I flip throughout our financials.
Jeff Kauffman
And domestic?
Jim Squires
Same story. A I said we think natural gas substitution which has been the driving factor in the decline in utility volumes, has largely run its course and we are in position to continue holds to our utility customers.
A normal summer weather is critical to our assumptions in that regard though. Another very cool summer and we could see further declines but provided we have a normal summer we think we are in good shape to manage a pretty consistent run rate on the utility coal this year.
Operator
Our next question is from the line of Jason Seidl of Cowen and Company.
Jason Seidl
Two quick ones. One, can you talk a little bit about your ability to price as your service levels start coming up, because clearly you are getting price now and services as well, let’s call it less than optimal.
Is there any relation between rail service and pricing or should we not look at that way?
Jim Squires
Clearly there is and our pricing potential will only improve with better service levels in the long run. You have to give the customer something more in order to obtain price increases and that’s one of the big reasons we're spending now to get service back up so that we will be able to grow volumes but also so that in the long run we will be able to take prices up for a better and better product delivered to the customer.
Jason Seidl
And I guess my follow up but I apologize if you guys already covered this because there were some overlapping calls this morning. We haven't seen any announcements out there in terms of getting Don's positions, so I was wondering where you guys are out there and are you reviewing outside candidates?
Jim Squires
We are reviewing both internal and outside candidates. We have been running a process, we expect to complete that process and make an announcement within a matter of a few weeks.
Operator
The next question is from the line of David Vernon with Bernstein.
David Vernon
Hey Marta, first question for you, how much additional borrowing capacity do you have and have you gotten more comfortable raising the overall borrowing and leverage profile of the business going forward?
Marta Stewart
Yes, we have quite a bit of additional borrowing capacity as I mentioned earlier and as I am sure you know, we didn’t issue any debt last year. So we are planning to issue debt this year and we're comfortable bringing up our leverage levels but staying within our current credit ratings BBB plus, Baa1.
David Vernon
Is there like a target level of coverage that you are shooting for?
Marta Stewart
Well the target is stay within the credit ratings band, because last year we did issue we floated down a little bit within the band. We are still within the band of floated down a bit.
So we're comfortable ramping up towards the upper end of that band but staying within it.
David Vernon
And then maybe just as a quick follow up, Jim or Mark, I guess have you guys given any thought into how much of the service related costs you guys are pouring into the network right now actually do come down and I mean I get the velocity driven improvement, you pulled some costs down but I would also think that the change in the freight flows across your network are requiring a different level of resources than you had in the past, and changing like haul, the longer haul intermodal, less short haul coal, that kind of stuff? I mean how much of the extra investments you are putting in, should we expect to actually come out?
Marta Stewart
We are expecting the 42 million that we highlighted in the first quarter. We think it’s going to moderate to 25 million and roughly the same categories that I outlined, a little bit less percentage wise and compensation because the compensation part in the first quarter had a transportation part and maintenance of way part related to the weather.
So percentage wise the comp part will come down a little bit and the total will be 25 million and then we believe if we get up to the train speed levels that Mark described in the second half we think we will not have services, so that 25 million in other words would go away in the third and fourth quarters.
David Vernon
But do you get like the 42 million or the 25 million back next year or do you think there’s going to be some of that costs, it’s just going to be in the network?
Mark Manion
No, I think those costs are the costs that we view as purely transitory in nature and the answer to your other question is that yes, as we see business mix change we can see some shifting in resource requirements particularly in terms of maybe where we need train crews but net, net I don't think that those changes are material in terms of overall crew requirements or train operating costs.
David Vernon
Even that, with the difference in length of haul and coal, do you think that would just take more labor hour but –
Wick Moorman
Well you are looking at length of haul on coal changing as basins change, the Illinois basin coal comes on, we hold the coal longer farther as the mix changes within coal. In intermodal we’ve done a pretty good job and expect to continue to of really not necessarily running a lot more trains but just getting more and more containers on each one of the trains through stacking and additional train length.
As I say, Mark, I don't think net net that amounts to a whole lot.
Operator
The next question is from the line of Cleo Zagrean with Macquarie.
Cleo Zagrean
My first question relates to coal, so I appreciate that we may be looking at a stabilization in quarterly run rate on the domestic and maybe I guess export front to grow but still this year we are looking to – it sounds like 10% decline in the domestic volume and maybe mid-teens in exports. So let this [ph] coal alone do to your operating margin or to the operating ratio this year in terms of the headwind?
Jim Squires
It unquestionably is a headwind, when we see the kind of year over year declines that we experienced in the first quarter of 2015 and projecting for the balance of the year. So yes, we think it’s steadier run rate both utility and export coal tonnage but the comparisons are difficult.
Second-quarter of 2014 was our peak quarter for utility coal volume and so we are comping that very difficult comparison and similarly in the third quarter as utilities rebuild stockpiles into the third quarter, we are facing some difficult comps now. By the time we get to the fourth quarter it gets a little bit easier and we would expect to see lesser year over year volume declines.
On the export side of the franchises as we discussed the comparisons really get easier in the second half, beginning in the second half and again particularly the fourth quarter. Fourth quarter of 2014 export – total export tonnage was 4.8 million, dropped below 5 million by the fourth quarter of last year.
So tough middle part of the year, tough couple of quarters coming, by the fourth quarter we start to see growth.
Cleo Zagrean
Can you say maybe if you face specific challenges in your franchise compared to your peers and how we can think about the operating ratio impact?
Jim Squires
No, we don’t we face peculiar, particular challenges relative to our competitors in this regard.
Cleo Zagrean
Also on your operating ratio, if you would like to quantify or maybe just say that you are prepared for this to maybe assess the impact of coal, that’s fine but on the ex-coal, ex the fuel surcharge hit this year, would you comment as to whether you see mix just below the top line being the tailwind or headwind on the operating income level? I mean we are focusing too much on the top line but surely there must be benefit in growing intermodal and merchandise right, if you can help seeing that for us, that would be very helpful.
Jim Squires
Absolutely and we said in the past and it’s still true today that our general merchandise business is particularly volume moving in our scheduled network, or our highest incremental margin businesses. You layer it on top of the natural spontaneous favorable economics of volume growth in this business significant core price increases and that’s really a key driver of improvement for now.
Now much of this unfortunately will be masked in the middle part of the year by the fuel surcharge headwinds which will be significant and with the kinds of deltas to last year we are talking about in the top line from fuel surcharge alone, we will probably see margin pressure in the second and third quarter unlike in the first quarter where the decline in fuel expense actually exceeded the fuel surcharge reduction. That will slip most likely given the magnitude of the fuel surcharge revenue headwind in the second and third quarters.
End of Q&A
Operator
At this time I will turn the floor back to Wick Moorman for closing comments.
Wick Moorman
Well thanks everyone for bearing with us on what has been a somewhat long call but hopefully we have given you a lot of data and a lot of color on what we are doing. We appreciate your time and we look forward to talking to you next quarter.
Operator
This concludes today’s teleconference. You may disconnect your lines at this time and we thank you for your participation.