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Genesee & Wyoming (NYSE:GWR)
Q2 2018 Earnings Conference Call
Jul. 27, 2018 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Genesee & Wyoming Q2 2018 earnings conference call. [Operator instructions] As a reminder, today's conference is being recorded. I would like to turn the conference over to our first speaker, Mr. Tom Savage.

Please go ahead, sir.

Tom Savage -- Senior Vice President of Corporate Development and Treasurer

Good morning, and thank you for joining us today on Genesee & Wyoming's Q2 2018 earnings call. Please note that we will be referring to a slide presentation during today's call. These slides are posted on the Investors page of our website www.gwrr.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are likewise posted on the Investors page of our website.

We'll start with the safe harbor statement and then proceed with the call. Some of the statements we'll make during this call, which represent our expectations or beliefs concerning future events, are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which provides a safe harbor for such statements. Our use of words, such as estimate, anticipate, plan, believe, could, expect, targeting, budgeting or similar expressions are intended to identify these statements and are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations, including, but not limited to, factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission. Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements.

We cannot assure you that the forward-looking statements we will make will be realized. We do not undertake and expressly disclaim any duty to update any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law, and you should recognize that this information is only accurate as of today's date. On the call today, we have four speakers, our President and COO Jack Hellmann, our Chief Financial Officer T.J. Gallagher, our Chief Commercial Officer Michael Miller, and our Chief Operating Officer David Brown.

I will now turn the call over to our President and CEO Jack Hellmann.

Jack Hellmann -- Chairman, CEO and President

Thank you, Tom, and welcome to G&W's earnings call for the second-quarter 2018. As always, we'll start our call this morning with safety. On Slide No. 3, you'll see that G&W completed the first half of 2018 with a safety index of 0.74 injuries per 200,000 manhours.

We continue to lead the rail industry and expect to make further improvements for the remainder of the year. Turning to Slide No. 4, which compares second-quarter results to our guidance. In the second quarter of 2018, we reported diluted EPS of $0.73 and adjusted diluted EPS of $0.94.

As noted in the chart, we had several items impacting the quarter ranging from restructuring costs in the U.K. to a prior-period tax adjustment in the U.K., to resolution of cash claims against bankrupt customer in Australia. Looking at our core business, adjusted diluted earnings per share were $0.04 higher than the midpoint of our outlook. At the bottom of the slide is a table that bridges our second-quarter outlook to our adjusted diluted EPS.

The main takeaway is that our North American revenue continued to strengthen, although we didn't benefit from the operating leverage that we typically expect due to certain expense items. First, our diesel fuel costs were higher than planned with a roughly three- to four-month lag on fuel surcharge recovery. Second, we incurred high legal expenses associated with a lengthy arbitration process that is now largely complete with a favorable ruling. Third, we had higher-than-normal casualty and insurance expense, primarily due to an expensive derailment in our Western region that hit our insurance deductible of $2.5 million.

Now let's turn to Slide No. 5 and highlights. I'll start with the share repurchase. Given our strong free cash flow generation and modest leverage, we've been executing on our share repurchase program under our $300 million authorization.

Through June 30, we repurchased approximately 2.7 million shares for $192 million. While our decision to repurchase shares is opportunistic, and based on what we see as the intrinsic value of our cash flow, I should also note that we are simultaneously evaluating a number of acquisitions and investment opportunities in multiple geographies. Finally, I should note that under the terms of our new credit facility that we completed in the second quarter, we've added considerable new share repurchase flexibility for an additional $500 million as well as unlimited share repurchase capacity as long as our leverage is below 3.25 times debt-to-EBITDA on a pro forma basis. Turning to North America, our business outlook is favorable, and our second-quarter carloads provided our highest quarterly growth since 2011.

Our obvious focus now is bringing the stronger carloads to the bottom line. And as you'll see in our third-quarter outlook, we're expecting our customary operating leverage of around 50% incremental margins on additional revenue. Consequently, our earnings growth expectations are strong for the second half of the year. Turning to Australia, our business continues to perform as planned in 2018.

We have now deployed a new wagon set to capture growing spot coal tonnages in the Hunter Valley with initial shipments starting in June. Also, we expect an additional set of wagons to be delivered in late 2018 with the revenue contribution building in 2019. The reliability of our service continues to generate significant customer demand for spot coal shipments, and we're focused on converting these shipments into long-term contracts over time. Now let's turn to the U.K./Europe segment on Slide 6.

After incurring $9.4 million of restructuring charges in the second quarter related to our U.K. optimization program, the U.K./Europe segment performed better than we expected in the second quarter of 2018. Strong bulk volumes of aggregates and spot coal, as well as improved intermodal pricing more than offset a volume shortfall in intermodal caused by congestion at the Port of Felixstowe amid the port's IT system conversion. The rapid strengthening of the U.K.

bulk market is a positive development that is also impacting how we evaluate the use of a portion of our excess equipment. For now, we have decided to differ parking certain locomotives while we determine whether current volume trends can be translated into long-term agreements with customers. There are essentially two scenarios in the U.K., either we incur $23 million of restructuring charges for the remaining equipment rationalization in the second half of 2018 to unlock $8 million of annual savings or we will keep operating the equipment and add new business at annualized profits that exceed the benefit of parking the equipment. As we turn to the second half of 2018, our financial objectives are clear.

In North America, our goal is to bring the benefits of a strong freight market to the bottom line. In Australia, we are focused on maximizing our superior service offering in both markets. And in the U.K, we're focused on accelerating the pace of change in our optimization program and seizing rapidly emerging new bulk opportunities. Now I'd like to turn the call over to our CFO, T.J.

Gallagher, to discuss the second quarter in detail and review our outlook for the remainder of 2018. T.J.?

T.J. Gallagher -- Chief Financial Officer

Thanks, Jack, and good morning, everyone. Please turn to Slide 7. I'll start with the bottom line. Our adjusted diluted EPS increased $0.14 or 17.5% in the second quarter, primarily due to the impact of U.S.

tax reform. North America and Australia results were roughly flat, with U.K./Europe improving $0.03 per share. Now turning to Slide 8 and North America. The same railroad traffic for the quarter increased 8.1% year over year, with strength across most commodity groups.

As Jack noted, this is the largest same railroad quarterly traffic increase we've had in North America since Q1 of 2011. The largest increases were in coal, which increased roughly 13,000 carloads or 28% primarily due to stronger steam coal shipments in our Central and Midwest regions; metals, which increased approximately 6,100 carloads or 18% due to stronger shipments with our steelmaking customers as well as stronger outbound pipe shipments; and last, minerals and stone traffic increased 5,400 carloads or 9.5% due to stronger aggregates and frac sand traffic. Now before we go onto Slide 9 and North American pricing, I'd like to point out that we have included a comparison of G&W U.S. carloads to U.S.

Class 1 traffic for the first half of the year as an appendix to this presentation. Excluding intermodal traffic, G&W U.S. carload growth was roughly 2 percentage points higher than Class 1 growth for the first six months of 2018 primarily due to coal, metals and stronger truck competitive commodities, such as paper and lumber. Now turning to Slide 9.

Our North American same railroad core price increase in the second quarter was around 3%. The slide shows a bridge from this increase to our reported average increase of 0.7%,  the largest components of which are adverse changes in customer mix and commodity mix. The unfavorable changes in customer mix were primarily in coal where we had a new customer start-up in 2018 and agricultural products, which had a shorted average length of haul in 2018. The adverse commodity mix includes a relative increase in lower rated commodities such as coal and Class 1 empty traffic and a relative decrease in higher rated commodities such as chemicals and plastics.

Now turning to Slide 10 and North American revenues. Revenues increased $23.9 million or approximately 8%. As you saw in the carload slide, we had strong broad-based growth across many commodity groups. The largest increases were in metals, coal, minerals and stone and pulp and paper.

The switching revenue increase you see is from our port terminal railroads in Galveston and Savannah, which had stronger grain and intermodal volumes, respectively. Now let's go to Slide 11. Our North American adjusted operating income was relatively flat year over year as the net increase in revenues was offset by higher costs, including the higher net fuel costs, casualty and insurance, and legal expense that Jack already mentioned. Also, freight mix in the quarter reduced income by approximately $3.3 million.

Now let's turn to Australia on Page 12. Australia revenues increased $2.2 million or 2.9%. Excluding FX, revenues increased $1.6 million, primarily due to higher coal revenues, partially offset by lower metallic ores revenue. Now Slide 13, Australia adjusted operating income decreased $0.9 million excluding currency, primarily due to the lag in fuel surcharge recovery and an increase in operating expenses to support our growth initiatives.

Now let's turn to U.K./European operations on Slide 14. Revenues in the second quarter increased $28.5 million or 19.2%. Excluding FX, Pentalver and ERS, which was sold in June, same railroad revenues increased $11 million or 7.7%, primarily due to stronger intermodal pricing and growth and aggregates traffic in both the U.K. and Poland.

Now Slide 15. U.K./European adjusted operating income increased $2 million year over year, excluding FX, reflecting stronger revenues in the U.K. and Poland. Now let's turn to Slide 16 and updated guidance for 2018.

Let me refer you to our earlier safe harbor statement that noted that these statements are subject to a variety of factors that could cause actual results to differ from our current expectations. These statements represent management's expectations regarding future results as of today, July 27, 2018, and we do not undertake any obligation to update this information. Our 2018 guidance is broadly unchanged overall on a consolidated EPS basis. Note that the sale of ERS reduces our U.K./Europe revenue by approximately $60 million on an annual basis or $30 million in the second half of 2018 compared with our prior guidance both with negligible impact on profit.

Also, since our last guidance, the strengthening of the U.S. dollar versus the pound sterling and the Australian and Canadian dollars has had the impact of decreasing our full-year diluted EPS expectations by approximately $0.05. Finally, we expect our share count to be 60.8 million. The bottom line is that we expect adjusted diluted EPS in the range of $3.80 to $3.90.

Now turning to Slide 17 and Q3 guidance. We expect third-quarter revenues in the range of $580 million to $600 million and operating income in the range of $120 million to $130 million. Diluted EPS are expected between $1.10 and $1.20, with 60.3 million shares outstanding. Carload growth in North America is expected to be around 5%, with strength in ag products, metals and minerals and stone.

In Australia, we expect volumes to increase 35% to 40%, primarily due to easier comps. Recall that last year, our coal volumes was down due to industrial action against Glencore in New South Wales, and our minerals and stone traffic was down due to an outage at a customer facility. In our U.K./Europe segment, volumes are expected to increase 9%, excluding ERS, primarily due to stronger aggregates and intermodal traffic. Now let's finish up with the balance sheet on Slide 18.

We ended the quarter with net debt to capitalization of 38%, net adjusted debt/adjusted EBITDA of 2.8 times and over $600 million of revolver capacity. And with that, I'll open up the call for questions. 

Questions and Answers:

Operator

[Operator instructions] Our first question today comes from the line of Allison Landry with Credit Suisse. Please, go ahead.

Allison Landry -- Credit Suisse -- Analyst

Thanks, good morning.

Jack Hellmann -- Chairman, CEO and President

Good morning.

Allison Landry -- Credit Suisse -- Analyst

So you guys have a decent amount of dry powder along with the change in the credit facility. So I just wanted to understand how you're thinking about the M&A landscape in North America and how that might be evolving, specifically with the Class 1 spinoffs. And do you think the opportunity here is potentially a lot bigger than maybe what has been announced so far?

Jack Hellmann -- Chairman, CEO and President

I would just say that we are evaluating both M&A opportunities, including those in North America as well as our own shares on an equal basis right now, and we have the capacity to execute upon both. And so I wouldn't -- yes. No, I wouldn't attach any superlatives to it because everything is a reflection of where valuation ends up. And until you see us do a transaction, you won't know whether or not we're comfortable with where valuations are.

Where we have been comfortable with valuations has been our own shares, and that's why you've seen us focus our attention there.

Allison Landry -- Credit Suisse -- Analyst

OK. And that -- so that seems to be the case right now. Is that -- does that tell us what the valuation levels for some of these transactions are?

Jack Hellmann -- Chairman, CEO and President

Well, or you could interpret it on how you view the valuation levels ourselves, so it's a little of both. Yes.

Allison Landry -- Credit Suisse -- Analyst

OK. All right. Understood. And then my other question, in terms of the strong volume growth that you saw in North America this quarter, is there a way to -- for you guys to quantify how much of that may be attributable to share gains from trucks as opposed to business that you're getting from the strong macro? And are there any share gains from trucks that are built into your second-half volume outlook?

Jack Hellmann -- Chairman, CEO and President

Yes. Sure. Why don't I set that up and we'll spend a little time on that? Because it's certainly the most interesting freight environment we've seen for a while. We've sort of suggested that we saw it coming, but now you're seeing it with some detail.

And as you look out at the back half of 2018, some of the growth -- we saw tremendous growth in the second quarter. There were some easy comps on things like coal, which yielded that 8% volume growth. As we look through the back half of the year, and then I'll turn it over to T.J. and Michael, what is interesting in this sort of uniformly back half of the year.

This is a micro buildup from the plant level. We're seeing 5% volume growth right now, and I can't remember the last time I saw 5% volume growth. It varies by commodity. And why don't I kick it to T.J.

to talk about that and Michael to fill in with any color.

T.J. Gallagher -- Chief Financial Officer

Sure. The -- if you recall our guidance, our guidance call in February, you noted that our overall carload growth and some of the different components, the weather dependent commodities, which were roughly flat, our industrial commodities, which were 2% to 3%, and then the truck competitive commodities that were sort of 4% to 5%. So we're actually still seeing that play out in the back half of the year, where those commodities, which are truck competitive to be in that 5% growth, and Jack mentioned a couple of them. What's a little stronger than we expected at the beginning of the year are some of the industrial products like metals, which you saw up significantly in Q2, and we expect that strength to continue in the back half of the year.

The weather dependent commodities, again, coal and ag products, we see strength, continued strength, but that will depend on -- hopefully on the weather and harvest. Michael, any other color to provide?

Michael Miller -- Chief Commercial Officer

No. I would just point out that even in the metals, even though the industrial sectors were up, some of that was also related to truck conversions. I mean, it's really hard to kind of pinpoint exactly what the difference is given the economic conditions are so favorable. But I would say it's definitely more than 50% of our -- our pickup and our truck competitive business, our consumer base business is certainly heavier weighted to truck conversions than it is just structural lift from the economy.

Allison Landry -- Credit Suisse -- Analyst

OK. All right. That's very helpful. Thank you.

Michael Miller -- Chief Commercial Officer

Sure.

Operator

And we do have a question from the line of Justin Long. Please, go ahead.

Justin Long -- Stephens, Inc. -- Analyst

Thanks, and good morning.

Jack Hellmann -- Chairman, CEO and President

Good morning, Justin.

Justin Long -- Stephens, Inc. -- Analyst

So I wanted to start with a couple of questions on North America. First on core price. We saw a deceleration there relative to the prior quarter. So I was wondering if there was anything unusual going on this quarter.

Just it's a lot different than what we've heard from the other Class 1s. And then secondly, on incremental margins, you talked about getting back to that 50% level in the third quarter. But just given the demand environment right now, the pricing environment, service getting better, why should we not be above that 50% average you talk about? So I just wanted to get your thoughts on both those items.

T.J. Gallagher -- Chief Financial Officer

So I'll hit the pricing first. We had, if you recall from last year, we had pricing strengthen and weaken and strengthened again in the back half of the year. So in a given quarter, we don't see too much of that. Overall -- and Michael will give you some additional color -- our contract rate renewals are 3% or greater and sometimes significantly greater than 3%.

What actually flowed in the quarter in terms of traffic was what it was. So I almost think this is not a deceleration in pricing but more of the mix of traffic that flowed in the quarter. So I wouldn't look too much into it. The rate environment remains very strong.

And with respect to incremental margins, you're right, this is a favorable environment, but we do have higher fuel costs. You saw in this past quarter, we had higher casualty and derailment expenses, some of that can happen in the quarter or not in the quarter. But overall, as you pointed out, there should be strong leverage, and that's what's reflected in our guidance.

Jack Hellmann -- Chairman, CEO and President

Yes, Justin, I would just add to that latter point before we let Michael chime in on pricing. You're right. However, what's hard about a short line versus a Class 1 is the mix of business is kind of highly variable in terms of the longest hauls that we have and the shortest hauls that we have, the incremental margins on it. So the blend to the 50% tends to be broadly accurate, but there can be dramatic -- like the mix of business in this most recent quarter was actually skewed against us, which is why you didn't see a little more leverage.

But projecting it going forward, it's a little tricky because you've really got to be precise on the mix. Some of the incremental margins can be 80% and some can be 30%. And so you could see an outlier event where there were higher margins across the quarter. But I think over time, it will revert to that 50%.

You'll see a low like this quarter, you may see a high in another one. But I think from modeling the intrinsic value of G&W, probably stick around 50%. T.J. did some analysis actually on the outlook and the range of incremental margins that we're seeing, were kind of between 60% and 40%.

Wasn't that the numbers you had, T.J.?

T.J. Gallagher -- Chief Financial Officer

Yes.

Jack Hellmann -- Chairman, CEO and President

So your point is well taken, and it will depend on the mix, which is a little more variable, the short line versus the Class 1. On pricing, why don't -- Michael, do you want to provide some other commentary? Again, it's a unique environment right now that we're in the midst and feel free to share what you'd like.

Michael Miller -- Chief Commercial Officer

Yes. I mean, we still view it as a very strong pricing environment. I would say if you look at this past quarter, it was definitely skewed to some traffic that really pulled down or diluted our revenue per unit a good bit of unit train traffic for us, which is typically lower rated. And then we also handled a lot of empty car traffic to try to support some of the speeding up of the network for some of our Class 1 partners.

And all of that that lift there on the carload volume certainly dragged down the average revenue per unit. But from our standpoint, there's nothing that would signal that we're going to see any deceleration in pricing going into the back half.

Justin Long -- Stephens, Inc. -- Analyst

Great. That's all really helpful. And secondly, I wanted to ask about free cash flow. T.J., any change in your outlook for free cash flow this year? And I know it's a little early to talk about 2019, but is there anything from a CAPEX perspective that would cause you to be outside of that framework for free cash flow to be 140% of booked net income?

T.J. Gallagher -- Chief Financial Officer

In terms of free cash flow, we gave an update on the first-quarter call with free cash flow attributable to G&W before new business of around $355 million and bottom line free cash flow of $285 million. Our new guidance basically confirms that free cash flow estimate, so no change from what we said on the first quarter, no change to CAPEX, core CAPEX or new business CAPEX. And with respect to 2019, I'll just differ that, but you should assume that consistent free cash flow margins that we generate continue on.

Jack Hellmann -- Chairman, CEO and President

Yes. That core number shouldn't change. But when I say that aloud, it probably goes up a tiny bit based on the higher price of steel right now. It's going to have to ripple through our purchasing at some point a little bit.

It won't be a huge number in the scheme of the couple hundred million dollars of core CAPEX that we have. So when you're modeling future cash flow, start with that core number, maybe, I don't know, put $5 million more on there for the higher price of steel based on how much steel we have as part of our CAPEX mix, and you'll probably be at a good number.

T.J. Gallagher -- Chief Financial Officer

It will be consistent with what we've said before, and the 140% will still be good.

Justin Long -- Stephens, Inc. -- Analyst

OK, great. I appreciate the time.

T.J. Gallagher -- Chief Financial Officer

Sure.

Operator

And we do have a question from the line of Bascome Majors with Susquehanna. Please, go ahead.

Bascome Majors -- Susquehanna -- Analyst

Thank you for taking my question. it certainly sounds from your commentary, that the North America environment feels a lot better than it has in some time. But also, coal was helpful here in the quarter. If we take a step back, could you talk a little bit about really what you feel good about or where you feel there maybe has been a change, whether it's by region or by commodity? And on top of that, you've been pretty disciplined on your capital spend these last couple of years when things have been slower in North America.

Is there an opportunity to maybe put a little more money to work in the region and drive growth now that the market seems to be improving?

T.J. Gallagher -- Chief Financial Officer

Bascome, in terms of -- when I look at North America, what's remarkable -- I just ran some numbers this morning looking at the second half year outlook versus last year. And the uniformity of growth, around 5%, which is for the back half of the year across so many different commodities is pretty striking. And some of these are stronger, ag products, we see stronger, but that's more of the drought we experienced in 2017. Steel we see up 15% in the back half of the year, continued strength there.

So the economy still feels very strong for us. Now with respect to CAPEX, we invest for growth on sort of a project-by-project basis working with our customers. And so that's highly variable year to year. So it could go up quite a bit or it could be at consistent levels that we're going to spend this year.

Jack Hellmann -- Chairman, CEO and President

I mean, I would -- Bascome, I would say that the -- I would think that you're going to see, based on what we're seeing right now and based on the pipeline of industrial growth projects that we have, which are, by the way, by commodity group, are very uniform, it's not skewed toward one commodity group or another we're -- our industrial -- our pipeline of industrial projects is as substantial as it's ever been. It's across commodity groups. And implicit in that, probably is some more growth capital coming, but I couldn't identify or quantify what it is. But from a macro standpoint, I wouldn't be surprised at all if a few major projects hatched in the coming -- over the course of the coming year.

I don't know, Michael, do you want to talk about the industrial development pipeline in general because it's pretty interesting today versus where it's been for a while?

Michael Miller -- Chief Commercial Officer

Yes. I think you covered it, Jack. It is pretty much across the board, whether it's in chemicals, metals, agriculture. I mean, we're even seeing some growth opportunities to potentially invest in equipment and capital in some of our pulp and paper operations, which we haven't seen in a long time because it's so truck competitive.

So I would just say, we feel very good about what the pipeline looks like. We'll probably have a few projects that do come on toward the back half of this year. For us, it's all about making sure we have a quality service product. We've seen quarter-over-quarter improvement with the North American freight rail network.

We're still not where we were in '17. So hopefully, we'll see continuous improvement there because we have lost some traffic in the first half of the year just due to service challenges. So we're hopeful that the back half will provide a better service platform and we can convert more back to rail.

Bascome Majors -- Susquehanna -- Analyst

I appreciate that answer, guys. And maybe a high-level one, I don't know if it's better for you, Jack or T.J. But you have a pretty detailed bottoms-up forecasting process that you update every quarter at least from what I hear. I'm just -- has that changed or evolved in any way over the last year or two? Anything you want to shed light on kind of how you're thinking about the way you project the world today versus a year or two ago?

Jack Hellmann -- Chairman, CEO and President

Yes. What I would say, I think implicit in that question is the fact that we haven't been particularly accurate in the past three, four years, and that's an accurate statement, I agree with that. What I would say is what we've tried to do over time -- and part of the inaccuracy relates to the magnitude of macro shock and the fact that whether it's been a positive or negative, it tends to overshoot one way or another. I would say, one thing we have done is we try and put a macro overlay on top of whatever we're seeing at the micro level from the plant to the extent we can.

It's very hard to do. In the current environment, there might be some upside from what we're saying right now, because what we've seen on the downside is typically, if you think it's going to be negative, it ends up being a little bit more negative. Similarly, right now, we're feeling pretty positive. As you saw in the second quarter, it ended up being a little more positive than we thought.

So we do our best to put that macro overlay on it. But the truth is, we're just using our best judgment, and the business will flow as it flows.

Bascome Majors -- Susquehanna -- Analyst

Thank you.

Operator

And we do have a question from the line of Jason Seidl with Cowen & Company. Please, go ahead.

Jason Seidl -- Cowen and Co. -- Analyst

Thanks, operator. Hey, Jack. Hey, T.J. Hey, Tim.

Jack Hellmann -- Chairman, CEO and President

How are you, Jason?

Jason Seidl -- Cowen and Co. -- Analyst

Hanging in. It's the home stretch for earning season. A lot of talk on tariffs and you guys probably hav e the most moving parts, given how many railroads you have. Could you give us a little color on any of the exposure there? And did you see anybody on the steel side, moving steel ahead of time before the tariffs?

Jack Hellmann -- Chairman, CEO and President

Michael, do you want talk a little bit about maybe soybeans on the West Coast and steel in general that we've seen? It's hard to get a firm handle on it, but I think we can anecdotally give you a flavor what some customers are doing.

Michael Miller -- Chief Commercial Officer

Yes. I would say on the metals side, we've certainly -- I haven't seen anybody bringing anything in early to kind of offset some of the potential tariff impacts. We've actually resulted in probably a little more robustness in our domestic production on steel, which has been helpful. We've seen a big spike in our soy meal exports in the first half of the year.

Soy meal is not one that's subject to the tariffs. So I think people were just trying to get ahead of potentially what could happen on the tariffs side. And then probably the biggest impact for us this year has just been the softwood lumber tariffs. We've just seen more and more lumber coming from Pacific Northwest and southern parts of our network versus coming out of Canada.

Yes, I would say we had...

Jason Seidl -- Cowen and Co. -- Analyst

It's a positive for you then?

Michael Miller -- Chief Commercial Officer

Yes, I would say pretty much across the board, it's been a positive for us. I mean, the fear is just the impact of these longer term and what it does to slow down the economy. But at this point in time, we haven't seen really any negative impact associated with it.

Jason Seidl -- Cowen and Co. -- Analyst

OK. That makes sense. I appreciate the color. A follow-up question.

Can you guys maybe touch a little bit on the longer-term outlook for the coal in Australia? I know there are some lumpy contracts coming your way. I don't know when you're going to provide us with some more color on that, or we're too far out. And then also I think there was a coal mine that announced a shutdown in the Hunter Valley in the quarter, if you can talk to us about that.

Jack Hellmann -- Chairman, CEO and President

Yes. I mean, with respect to coal, the way to think about our business is, there's an underpinning to the business, which is the vast preponderance of it, which is very, very stable and under a long-term take-or-pay arrangement. And that consumes probably nine train sets. We've been adding train sets where we've added another and we're about to add one more still, that are being deployed into the spot market.

And so we've entered into, I don't know, probably seven or eight different spot -- long-term spot agreements where we're stepping into places where our services are needed and increasing our tonnages on that basis. Concurrent with that, we're also entering into longer-term agreements with customers, locking up proportions of those train sets for the long term. That is under way. We have signed some of those agreements, and we expect we'll continue to sign more.

So we expect those trains to be full. I would guess you'll see something like one of them be completely contracted and the other one be a little bit more variable. But we continue to see a very good market for us to lock down long-term arrangements.

Jason Seidl -- Cowen and Co. -- Analyst

Appreciate the colors always and the time, guys. Take care.

Operator

We now have a question from the line of Chris Wetherbee with Citibank. Please, go ahead.

Chris Wetherbee -- Citi -- Analyst

Thanks. Good morning, guys.

Jack Hellmann -- Chairman, CEO and President

Good morning.

Chris Wetherbee -- Citi -- Analyst

Let me ask you about the U.K./Europe optimization. I guess a couple of questions there. We're kind of a quarter past the big announcement from before. I just want to get a sense of how you think about the progress toward -- I know there's a small sort of second-half benefit but sort of bigger benefits as you get into '19 and '20.

So a quarter in, how do you feel about that? Jack, can you give a little bit more color on sort of how you're running through some of the equipment variables? I'm not sure I completely understood the two options there and sort of what the progress was going to be, but a little more color there would be helpful.

Jack Hellmann -- Chairman, CEO and President

Yes. Absolutely. I mean, we proceeded aggressively with the optimization plan. Some of the management restructuring initiatives that needed to transpire have transpired.

We're probably ahead of plan there. Some of the technology investments that we're making, we've initiated those projects quickly as well, and those are under way. There's probably one more to go that will be locked down within the next month or so. And so from a -- so organizational energy to affect those immediate changes, that's all happened.

The sense of urgency is very good. In terms of rationalization of the equipment, we have parked a number of locomotives and they're out of service just as we said we intended to do. We plan to park another group of locomotives as well. And what's been interesting is that as that decision point was arriving, the world started to change quickly.

Some of it is derivative of demand within -- organic demand in the U.K. market. Some of it is due to other rail operators not able to deliver service. Some of it is due to the fact that our service is perceived extremely well.

And there have suddenly been some conversations now about some longer-term arrangements in which to deploy the equipment they were going to park. And so we're looking at that right now. We're using some of that equipment in spot moves, but we're not interested in having equipment deployed on a spot basis for traffic that we think is temporary. We're interested in long-term arrangements in a competitive open access market.

You can't tie up a capital like that if it's not locked down under contract, and so that's what we're focused on right now. And so if those arrangements come about, you'll have a nice secure -- some of that equipment will stay and a nice secure revenue stream. And if those contracts don't come about, we'll do -- you'll get the savings, which are precisely in line with what we showed you in the first quarter, and we'll have those lease expense savings. So hopefully, that clarifies it.

Chris Wetherbee -- Citi -- Analyst

That's really helpful. If you get the new contracts, the longer-term contracts on some of the assets that you were going to take out of service, is it fair to assume that that would be sort of incremental to the potential savings that you would've gotten from...

Jack Hellmann -- Chairman, CEO and President

You got it. Yes, that plus the return on capital. That was the return on capital on the equipment, so it's not just lease savings. You've got to actually earn a return on the implicit cost of that capital to make the market disciplined.

T.J. Gallagher -- Chief Financial Officer

But Chris, just to make sure you're not double counting, as Jack pointed out in his slide, if we fully deploy the locomotives that have not been parked, the savings from the rationalization of the locomotive fleet will not be $10 million. It will be a lower number. But the underlying profit of the business will be higher. So it's not going to be -- yes, I just wanted to make sure.

Chris Wetherbee -- Citi -- Analyst

Got it. That's really helpful. I appreciate that. And then one final question just on the buyback and the approach to the buyback.

Just looking at the credit facilities and comments you've made so far, I don't know if I'm sort of misreading sort of your comments here. Are you taking potentially more of a constructive view toward buyback? Or is it just sort of the temporary -- you guys are usually pretty sort of dispassionate about looking at valuation of acquisitions versus your own stock over the last year or two. I just wanted to get a sense, though. Is there a bit of a change and shift there or just you're continuing on and you now have to pass and you continue to plan if you need to do it?

Jack Hellmann -- Chairman, CEO and President

I mean, I would say there has been a slight change in emphasis simply because we've seen more value in ourselves than what we've seen in the market. But you're right, we are dispassionate about it. If we can deploy the capital on acquisitions that are superior to the cash flow value of our business, that's where the capital is going to go. If we continue to see ourselves as an attractive opportunity, the capital will go there.

So it's -- we've always done it that way. We just created more flexibility for us to do it on a going-forward basis.

Chris Wetherbee -- Citi -- Analyst

OK. All right. Thanks very much for your time. Appreciate it.

Jack Hellmann -- Chairman, CEO and President

Thanks.

Operator

And we do have a question from the line of Ken Hoexter with Merrill Lynch. Please, go ahead.

Ken Hoexter -- Merrill Lynch -- Analyst

Hey, good morning. I just wanted to follow up on your -- on your -- I know you said your thoughts on acquisitions you balance and maybe even right now with the buyback as you were just mentioning versus M&A. But I just wanted to understand, has your thought on the process that you go through changed on anything given kind of what you went through after the U.K. acquisition and some of the other acquisitions that might not have panned out? Is there anything you'd do differently as you look at some of these opportunities?

Jack Hellmann -- Chairman, CEO and President

No, I wouldn't -- no. I mean, I think we review every acquisition. I mean, we've made 100, and we review each of them to see how we do compared to our expectations. And then we're constantly trying to improve and do -- improve what we do and make sure that we're not static in our approach to the world.

So you're always -- I mean, the short answer is you're always learning. Whether the deal is a good deal or a bad deal, you're learning all the time. And sometimes a good deal, if you're -- if it ends up being a good deal for the wrong reason, you'd better be learning from that as well. And so we're measuring risk.

We're measuring forecast in a similar framework that we always do. And so I wouldn't say -- no, the broad parameters of how we look at the world have not changed, no.

Ken Hoexter -- Merrill Lynch -- Analyst

OK. And then on the operating leverage. I know you mentioned the kind of back to 50%. But -- and we've talked in the past about the difference between being local versus how the Class 1s operate.

But thinking about the operational shifts at the Class 1 rails that we've seen in many of them. Is there anything you look at the network and see that you can change to get from -- in the North America from, call it, the mid- to upper 70s back to -- what do you think structurally the network can achieve?

T.J. Gallagher -- Chief Financial Officer

The biggest difference, Ken, between -- go back to 2014, which is probably our best year from an operating leverage standpoint in North America. We just had a higher volume. So it's really -- I think it's really a function of just driving more volumes through there and incremental profits, not so much about around changing the way we operate. Our service is sort of the first part of a long trip that we put together in conjunction with our Class 1 partners.

So as they change, we change, we adapt. But overall the goal is to provide the best service for our customers. But I think the real difference is simply volume, not anything from an operating standpoint specifically.

Michael Miller -- Chief Commercial Officer

T.J., this is Michael. One thing I would add, Ken, to that is one thing that does help us is a little more stability in the overall network service. Obviously, there's a lot of moving parts going on across the Class 1s, just optimizing their network, which we are the first or the last mile of that and we kind of get the whipsaw effect of some of those changes. So as those things kind of stabilize and smooth out, that probably helps us a little bit on our operating side of the house.

We do some extraordinary things sometimes to serve our customers. And as we get more consistent service and the plan kind of, I would say, materializes and kind of comes to a formation that's stable, we can kind of optimize our local service a little better as well. So there is some opportunity as the network kind of stabilizes long term.

Ken Hoexter -- Merrill Lynch -- Analyst

And just to follow on that, how is that -- have you seen continued improvement through the area or there's still pockets or areas you'd call out as still maybe seeing some of those service delays?

Michael Miller -- Chief Commercial Officer

Yes. We still have some service delays that we're seeing. I think I noted a little bit earlier, I mean quarter-over-quarter, the overall North American freight network has improved both from a velocity and a dwell standpoint, but it is not to where it was last year this time. And there were some episodic things that happened in the second quarter.

UP had a tunnel outage they run 20 trains a day through that kind of impacted us and some of the reroutes. So those types of things, as we try to serve our customers, do impact us. And our goal is to work with a Class 1 partners and get the service product back to a level that supports their business and gets equipment moving and serves our customers well. But I think, hopefully, we'll see continued improvement through the second half.

I mean, all of our partners are actually putting a lot of resources into improving the service product.

T.J. Gallagher -- Chief Financial Officer

Ken, we -- in the first quarter, we clarified the impact of Class 1 congestion. This quarter, we didn't call it out as a separate number. So that kind of also speaks to the -- it was not zero, but it wasn't the same level of magnitude.

Ken Hoexter -- Merrill Lynch -- Analyst

All right. Great. Jack, T.J. and Mike, thank you.

Jack Hellmann -- Chairman, CEO and President

Thank you.

Operator

And we do have a question from the line of Matt Reustle with Goldman Sachs. Please, go ahead.

Matt Reustle -- Goldman Sachs -- Analyst

Yes. Thanks for taking the question. I thought the comments you made on the industrial pipeline were fairly interesting. Just as you think about getting those to a final decision process, what will drive that? Are you waiting on customer decisions? Or are these existing business opportunities that you see out there in the market that you think you can take advantage of?

Jack Hellmann -- Chairman, CEO and President

Michael, do you want to talk about the customer decision process?

Michael Miller -- Chief Commercial Officer

Yes. I mean, some of it is just timing. Some of it is timing where they're investing assets and they have to get their plant in place before a track gets put in place. Some of it is expansion capital to existing facilities, some of it is new facilities.

Yes, I think it's just more of a timing issue as to when they get to a certain point in their development process and then we would be looking to partner with them to put some rail infrastructure in to support that business. But I mean, most of this stuff is -- well several of these products are very far along and will be coming online in the next six to 12 months, so I would say we'll definitely be looking for some expansion in those areas.

Jack Hellmann -- Chairman, CEO and President

It is an interesting leading indicator of economic activity because this is future CAPEX that will ripple through the U.S. economy in the coming 12 months that probably isn't in any numbers, but you can see that it's coming.

Matt Reustle -- Goldman Sachs -- Analyst

The word peak has been brought up in conference calls, which is essentially what I was alluding to there. It sounds like there is still quite a bit of momentum there in terms of what you're seeing.

Jack Hellmann -- Chairman, CEO and President

Yes. In terms of the broader -- remember, we've got multiple macro variables influencing us right now. It's not just the broader economy itself. There's also mobile shift in the context of diesel fuel prices, a whole host of -- I mean, we've been in a volume recession for three-plus years.

This is the first time we've seen any growth. I can't even tell you when the last time we saw growth was. T.J. knows, but it has been quite a while, and so yes.

In terms of -- so through an apparent period of growth, we've been pretty flat, so it's been feeling pretty good to actually get fuel prices to a more normalized level, coupled with broader economic activity.

Ken Hoexter -- Merrill Lynch -- Analyst

Sure. And just one more on the pricing side. It sounded like it was very tied to mix in terms of that 3.5% to 3%. I guess in terms of any business that -- like-for-like business that you're repricing renewal business, are you still seeing an acceleration in those rates?

Jack Hellmann -- Chairman, CEO and President

Yes. Michael, why don't you just talk about like-for-like negotiations that you have been seeing like, in the last quarter?

Michael Miller -- Chief Commercial Officer

Yes. I would say most of our negotiations in this past quarter or even looking forward, we're still seeing probably mid-threes, fours, in some cases, higher than that, depending upon the lane, the commodity, the competitive factors. From our standpoint, I think we gave some guidance where we've kind of saw pricing to be. I think we're still comfortable at that level.

Probably, without the mix challenges, we'd probably have been much better off, but we had no reason to think it's going to slow down from the 3.5%, 4% in the back half. I mean, it's just a strong market. And if you look at the truck rates as an example, I mean, spot rates are up 28% year over year, contract rates are up 20 -- 18% year over year. Truck fuel surcharges up 60% year over year.

So when we look at our truck competitive commodities, I mean, that just gives us a lot of runway to look at where we can take price. I mean, ultimately, though you've got to have a service product that supports that, and that's really what we focus most of our attention on is making sure we get the service up so we can actually ask for that additional price.

Operator

And we do have a question from the line of Scott Group with Wolfe Research. Please, go ahead.

Scott Group -- Wolfe Research -- Analyst

Hey, thanks. Good morning, guys.

Jack Hellmann -- Chairman, CEO and President

Good morning.

T.J. Gallagher -- Chief Financial Officer

Hey, Scott.

Scott Group -- Wolfe Research -- Analyst

Jack, can you give us any color on the arbitration, was this with the customer or the rail. I'm surprised it had such as surprising impact in the quarter being it's already been sort of completed. I would have thought this would've already been in the process of happening. And then I think you said the outcome is favorable, maybe is there any way to quantify how big and if that's in guidance?

Jack Hellmann -- Chairman, CEO and President

Sure. I mean, as we previously disclosed in our SEC filings, we've had two ongoing arbitration proceedings related to contract disputes. The final hearings for both of those took place during the second quarter, and that's what led to the higher legal expenses. So you basically had everything converging upon one period.

As you can see in our disclosure, as I said, there's two disputes. We recently received a partial award in the CSX proceeding, which was favorable. And the partial award resolves a majority of that dispute and a final decision is still pending. And so it basically -- it's status quo.

It's not whether it's favorable or not. It's just the status quo. We expect a decision in the other proceeding shortly. You could see, again, in our SEC filings that that's the AGR dispute, and that involves a customer's $13 million volume commitment.

And so those are the two, and both of those arbitrations just came to a head in the second quarter.

Scott Group -- Wolfe Research -- Analyst

And then those outcomes, are those going to be -- are any of them ongoing benefits or more just sort of one-time goods or bads?

Jack Hellmann -- Chairman, CEO and President

From what remains, it's one-time, goods or bads.

Scott Group -- Wolfe Research -- Analyst

OK. With the guidance for Australia, I guess if we're looking at this right, volume up 35% to 40% for the third quarter, but flat revenue. Maybe just help us walk through...

Jack Hellmann -- Chairman, CEO and President

Yes. So two things. One, the coal volume increases were covered under a take-or-pay contract. So to the extent that last year volumes fell below the take-or-pay, we got paid anyway.

So the volumes do move independently of revenue. The other big part of the volume increases are minerals and stone. And if you look at our average revenue per carload in Australia on minerals and stone, you see that it's our lowest rated commodity, and so there's not a lot of revenue impact. The other thing that we didn't mention but is also part of the freight mix is we had, and you recall this from our earlier disclosure, we had an iron ore mine that shut down early in Q4 of last year.

And so our metallic ores, traffic is down in Q3 versus last year. And so it's that mix of the take-or-pay low rated minerals and stone and the metals traffic that sort of gives you that revenue mix.

Scott Group -- Wolfe Research -- Analyst

And big picture Australia, if I remember from the Analyst Day from last year, that's probably the region you thought had the best top-line growth potential and you were investing in new train sets. When do we start to see actual top-line growth in Australia?

T.J. Gallagher -- Chief Financial Officer

Well, I think some of the growth we had this year was muted by currency. So the U.S. dollar strengthening kind of masked some of that. Look, we've deployed -- we've put in place one new train set, and we've got another train set that's coming onboard end of Q4.

I think it should be next year because we're going to lap the shutdown of the metallic ores to sort of offset some of the growth. Everything feels really great in Australia. It's just the timing of customer start-up versus the mine that shut down, the size of the grain harvest, etc. So there's always a little bit of noise, but the underlying commercial environment is very favorable.

Scott Group -- Wolfe Research -- Analyst

Did you ever quantify that mine shut down?

T.J. Gallagher -- Chief Financial Officer

Just look at the change in the metallic ores revenue year over year, and that's where you'll find it.

Scott Group -- Wolfe Research -- Analyst

OK. And then lastly, Jack, any update you can give us on the tax credit?

Jack Hellmann -- Chairman, CEO and President

Boy, talking politics in this environment. The tax credit is -- we'll see is the short answer. The -- we received -- we continue to have majority support in the House and the Senate. There was a release within the last 24 hours of a new study that was done by PwC showing the economic benefits of the credit.

I know there have been hearings at the House and Means Committee that have noted the positive economic benefits of this credit. The PwC report reinforces the point of view of that committee. From a legislative process standpoint with the new Supreme Court nominee in the mix, it's going to limit the floor time available for the senator to have to contemplate when something like this might get passed. And so it is very hard to say whether it could be -- the opportunity would be in a lame duck session post-election.

For short-term renewal, there is still -- the bills that are currently being sponsored are still seeking permanency. It's -- I mean, it's really, in the current political environment, it's a really tough call, except that it seems to be the only bipartisan topic on which everyone agrees, Republican and Democrat. It's just a question of where it finds its legislative home.

Scott Group -- Wolfe Research -- Analyst

But is there any talk of you guys got broader tax reform, so we're not going to do short line tax credits anymore? Or is it just, in your mind, the matter of finding the right bill?

Jack Hellmann -- Chairman, CEO and President

No. I mean, this is viewed separately from corporate tax reform as a matter of national economic infrastructure policy. And if you look at the impact of the short line tax credit on investment in the short line and regional rail space, the PwC report shows the case, which shows why there is so much leverage to the structure of that credit versus just corporate tax reform. So it's a very straightforward analysis that shows the merits of what has existed.

And there has been strong bipartisan support for it on that basis, and this will just reinforce it.

Scott Group -- Wolfe Research -- Analyst

OK. Thank you for the time, guys.

Jack Hellmann -- Chairman, CEO and President

Sure, Scott.

Operator

And we do have a question from the line of Brian Ossenbeck with JPMorgan. Please, go ahead.

Brian Ossenbeck -- J.P. Morgan -- Analyst

Hey, guys. Thanks. Good morning.

Jack Hellmann -- Chairman, CEO and President

Good moring.

Brian Ossenbeck -- J.P. Morgan -- Analyst

I have a question on CAPEX as a headwind in the quarter, at least it drove reduction and EPS as T.J. mentioned. So it sounds like the U.S. dollar strength versus the Aussie dollar was part of it.

Can you just remind us which ones matter the most and if there's any sensitivity you can provide? I was looking through the variances for the op income per segment. And when you look at the variance, and then the variance FX and it didn't really change that much. So there's probably something I'm missing. I just wanted to see if you could bring that together for me.

T.J. Gallagher -- Chief Financial Officer

The FX variance I was speaking about related to our full-year guidance that we offered in May versus our update now. In those three months, the U.S. dollar has strengthened, and therefore, the translation of our foreign earnings is lower. The biggest impact is Australia because there's a larger profit contribution there than there is in the U.K., but the pound -- so it's going to be Australia the largest and then the pound second, and the Canadian dollar, third.

If you look at the underlying exchange rates from our May guidance versus today, and you can do the math, we've included, in detail, both places.

Brian Ossenbeck -- J.P. Morgan -- Analyst

OK. Thank you from a more fundamental perspective, now that the dollar has gotten a lot stronger throughout the year. Have you seen anything in the markets, from your customers, I guess, specifically in North America, that are getting affected by currency, either from exports, markets changing or even anything coming in through imports?

T.J. Gallagher -- Chief Financial Officer

I think the relative change in the dollar this year has not weighed through the economy in such a way to impact our customers. I think any of the impacts from a macro standpoint would have been more impacted perhaps by tariffs, which Michael Miller discussed earlier on the call. So I think that would have been the macro overlay, not so much the currency fluctuations during this specific year.

Brian Ossenbeck -- J.P. Morgan -- Analyst

OK. And then last one on the industrial pipeline again. Did paper and pulp projects, looking at more rail using a lot more truck competitive is, did you think this is something that the customers are looking at -- shippers are looking at changing supply chains for multi-period frames? I mean, I guess they kind of have to if they're considering rail. Or is this something where they just need more capacity and it's a bit of a relief valve? I'd be curious to hear what their view is and how they're viewing the trucking market and the mix of loads going forward.

Jack Hellmann -- Chairman, CEO and President

Michael, do you want to handle that one? And remember, the preponderance of paper is linerboard.

Michael Miller -- Chief Commercial Officer

Yes. Yes. Yes, I would say it's a mix. There is a mix out there where some of this is just temporary modal conversion, but we're also working with some of our customers and they're redesigning their supply chain and looking at how they want to distribute their paper products long term.

There is a need to have a little more flexibility in their modal options. Most of these plants are set up to load rail. And just over time, due to really depressed truck rates, they have moved to that mode. And now when it's time to call back on rail, it's harder to claw it back because either cars aren't in the pool or they don't have the warehouses set up to take it for final distribution.

So what we're seeing is kind of a combination of both. To give you exact percentage of the split, it would be hard to say. But I would tell you, most of the major producers are looking at structural changes and just making sure they've got optionality. And rail is an important component of that on a go-forward basis.

Brian Ossenbeck -- J.P. Morgan -- Analyst

One more clarification on that. It's like 30% to 40% of volume that's competitive with truck. Are you seeing this sort of activity throughout that whole chunk? Or is it just sort of on the margin at this point?

Michael Miller -- Chief Commercial Officer

No. It's probably a little bit across the board. It kind of probably depends on where it's manufactured and what the destination markets are. Some of these mills may be more for an export play if they're closer to a port.

Some of these mills may service, some major distribution markets, say, in Chicago, and those would be probably more targeted to rail conversions. So it just kind of depends on the mill and where they actually -- what markets they serve from those mill locations.

Brian Ossenbeck -- J.P. Morgan -- Analyst

OK. Thanks for the time. Appreciate it.

Matt Walsh -- EVP of Global Corporate Development

OK. And with that, we're at the top of the hour. So that concludes our call. Thank you very much, everybody, for joining us.

And operator, I'll turn it back over to you for replay instructions.

Operator

Of course. And ladies and gentlemen, today's conference will be available for replay after 1 p.m. today through August 27. You may access the AT&T teleconference replay system at any time by dialing 1 (800) 475-6701 and entering the access code 439196.

International participants may dial (320) 365-3844. And those numbers again are 1 (800) 475-6701 and (320) 365-3844. Again enter in the access code 439196.[Operator signoff]

Duration: 68 minutes

Call Participants:

Tom Savage -- Senior Vice President of Corporate Development and Treasurer

Jack Hellmann -- Chairman, CEO and President

T.J. Gallagher -- Chief Financial Officer

Allison Landry -- Credit Suisse -- Analyst

Michael Miller -- Chief Commercial Officer

Justin Long -- Stephens, Inc. -- Analyst

Bascome Majors -- Susquehanna -- Analyst

Jason Seidl -- Cowen and Co. -- Analyst

Chris Wetherbee -- Citi -- Analyst

Ken Hoexter -- Merrill Lynch -- Analyst

Matt Reustle -- Goldman Sachs -- Analyst

Scott Group -- Wolfe Research -- Analyst

Brian Ossenbeck -- J.P. Morgan -- Analyst

Matt Walsh -- EVP of Global Corporate Development

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