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Executives

Nadeem Velani

E. Hunter Harrison - Chief Executive Officer, Director and Member of Safety, Operations & Environment Committee

Keith E. Creel - President and Chief Operating Officer

Jane A. O’Hagan - Chief Marketing Officer and Executive Vice President

Brian W. Grassby - Chief Financial Officer, Senior Vice President and Treasurer

Analysts

William J. Greene - Morgan Stanley, Research Division

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Jason H. Seidl - Cowen and Company, LLC, Research Division

Steven P. Hansen - Raymond James Ltd., Research Division

Brandon R. Oglenski - Barclays Capital, Research Division

Cherilyn Radbourne - TD Securities Equity Research

Ken Hoexter - BofA Merrill Lynch, Research Division

Allison M. Landry - Crédit Suisse AG, Research Division

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Scott H. Group - Wolfe Research, LLC

Cameron Doerksen - National Bank Financial, Inc., Research Division

Keith Schoonmaker - Morningstar Inc., Research Division

Turan Quettawala - Scotiabank Global Banking and Markets, Research Division

Christian Wetherbee - Citigroup Inc, Research Division

Benoit Poirier - Desjardins Securities Inc., Research Division

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

David Tyerman - Canaccord Genuity, Research Division

Canadian Pacific Railway Limited (CP) Q2 2013 Earnings Call July 24, 2013 11:00 AM ET

Operator

Good morning, ladies and gentlemen. My name is Martina, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Canadian Pacific's Second Quarter 2013 Conference Call. The slides accompanying today's call are available on our website at www.cpr.ca.

This presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described on Slide 2 in the press release and in the MD&A filed with Canadian and U.S. securities regulators.

Please read carefully, as these assumptions could change throughout the year. All dollars quoted in the presentation are Canadian, unless otherwise stated. This presentation also contains non-GAAP measures outlined on Slide 3. [Operator Instructions] Mr. Valeni, you may begin your conference.

Nadeem Velani

Thank you, Martina. Good morning, and thanks for joining us. My name is Nadeem Velani, AVP, Investor Relations at Canadian Pacific. I would like to remind you that this presentation contains forward-looking information. Actual results may differ materially.

I'm proud to have with me here today Hunter Harrison, our CEO; Keith Creel, President and Chief Operating Officer; Jane O'Hagan, EVP and Chief Marketing Officer; and Brian Grassby, our senior VP and Chief Financial Officer. The presentation will be followed by Q&A. In fairness and courtesy to all participants, we would appreciate if you limited your questions to 2.

It is now my pleasure to introduce our CEO, Mr. Hunter Harrison.

E. Hunter Harrison

Thanks, Nadeem and Martina. Good morning to everyone and thanks for joining us. I think it's probably pretty appropriate today that before we talk about numbers and dollars and cents and metrics that we take a few moments to reflect on what the tragic, horrific incident that we had Lac-Mégantic, which we were all taken back with. I know all our fellow railroaders here that are joining me from Canadian Pacific, join me in reaching out to all of the families, the victims, the people that have been adversely affected by that horrific event. I mean, clearly, that community will be -- some have reflected will be scarred forever. And it's a solemn reminder to us that the inherent danger in this business and the responsibility that we have to the public.

In that regard, we have made a small donation, a $200,000 donation to the Red Cross to help in some ways. And certainly, our prayers and heartfelt good wishes go out to all the families and the victims, and hopefully, we will never have to experience this type of event again.

Having said that, we are working diligently and cooperatively with other rails, with the regulators to see what additional regs, if any, need to be considered potentially put in place. We have made some steps individually on our own. And I don't want to go into that really from a technical standpoint any further because I don't want to put myself in a position of preempting the regulators. But I did think it was appropriate that we spend that time reflecting on what is happening in that community.

So with that, let me move and give you a real color on the second quarter from 30,000 feet. We're going to try today to make our presentations shorter than normal, so we can have time for more questions because there were a lot of moving parts in the quarter -- both quarters. If you look back last year, we had the strike and we had some, obviously, unusual issues this quarter. But in spite of all that, it was a record performance by all accounts, whatever you want to look at.

Our earnings were up 138% and the operating ratio 1,060 basis points. And I think the one thing that I'm probably proudest of is that of all the issues we had pre-flood then to get hit with a 150-year flood that I've never seen anything like it in my 50 years of railroading. And it's one thing to get knocked down, but it's really the way this team recovered and got back up. And there was minimal disruption to service, to our customers. Our employees all responded in the yeoman's [ph] way, and so I'm very, very proud of that. And I think you will see throughout the presentation today that really what that does is position us for a very strong second half, and I'll have some more comments at the end relative to my outlook there.

So with that, let me let Keith spend a few minutes with you highlighting some of the operating metrics and performance.

Keith E. Creel

Okay, thanks, Hunter. Let me start by saying, overall, I'm extremely pleased with the performance of this operating team. To say it was a challenging quarter given the number of incidents which affected this network would be an understatement. Having said that, I'm not going to minimize the service and the financial impact to our operation, but the challenge they presented that our team responded to each. But I am encouraged that in those incidents, there was no commonality or systemic issues at the root cause of some of the challenges we dealt with. So let me provide some color to some of those comments.

Contrary to what some have suggested, I would like to assume the root cause of our track derailments were not the result of or even remotely connected to cutting back assets, be they manpower, the capital we invest to keep our infrastructure safe at CP. The facts are, we have not reduced the workforces that maintain or inspect our track. We've not reduced our inspection standards. We've made them more rigid. And we actually increased our capital investment in basic infrastructure, which we reported earlier in the quarter by an additional $100 million in 2013.

Suffice it to say, this is not a team that takes our moral or our social obligation to run this railway safely lightly. Going forward, we remain seized with our goal to be the safest railroad in North America, which we've enjoyed for several years. Our efforts are centered around people, and I mean, more specifically, compliance. The way we carried our jobs day in and day out. Process through our inspection procedures and the way we deploy and apply our technologies to enhance them and our physical planned investment, which are all paying off.

Our current performance ratios year-to-date have continued to improve year-to-date. We're at a point where we're actually better than where we finished 2012 on the injury front, on our ratios, and actually have fewer train accidents year-to-date than in 2012. With the reportable accidents, as we said today, now at a ratio, which is approaching our best in class finish in 2012. So the gap is continually closing day in and day out as a result of those efforts.

And as Hunter mentioned, we faced significant challenges with flooding, which included about 40 washouts in our Western network in Southern Alberta and BC. This was a weather event, to Hunter's point, that was monumental, a 150-year event that crippled our routes in monumental proportions.

Just to grasp the order of magnitude, in a 24-hour span, we lost both our core routes west of Vancouver from Calgary, as well as our 7 route through the coal territories. Our railroad was essentially cutoff west of Calgary completely.

To imagine the team that we'd be able to rebuild bridges, repair washouts and restore service in most cases within 48 to 96 hours was beyond even my aggressive expectations. To think at the same time, we'd be able to restore service within 24 hours in getting those routes open is unprecedented in all the years I've railroaded.

I'm extremely proud of the way this team, be it ops, engineering, mechanical, marketing all pulled together, working tirelessly to restore service and limit the impact to our customers and the products that they entrust us to carry. These monumental challenges required equally monumental responses. This team delivered with heroic efforts, both individually, in many cases, and certainly, collectively as a team.

So enough said about the challenges, let me focus my comments on what we accomplished. Despite all of this, we were able to make continued gains at a number of productivity measures, a few of which are highlighted on your slides. These are some of our key productivity drivers from a list of 14 or so that I pay attention to, that we measure, where we set best ever second quarter performance records in 12 of those 14 metrics. This has allowed us to continue and improve our cycle times and take costs out of the system, both on the locomotive front, as well as on the car front, improve service at the same time and improve capacity. This also has put us on a pace to return over 10,000 cars by the end of this year.

In addition to this, as we mentioned in our last call, Hunter and I chaired whiteboarding sessions across the property with each of the regions, which have become an important driver for the next wave of breakthroughs, both on the operating and the sales front. These comprehensive operation reviews involve the review of each element that goes to the movement of the railcars, the customers' lines of business, sidings, car fleets, locomotives, yards, terminals and mechanical aspects. It allowed Hunter and I to communicate directly with over 200 members of our operating team, to explain face-to-face, eyeball-to-eyeball what precision railroading is, what it means to us. And at the same time, allowed us to evaluate the operational team and their abilities and to learn the network at a very accelerated pace.

Cost takeout and service performance improvements were the focus. I can tell you on an annualized run rate, the cost opportunities we've identified exceed $100 million, which obviously will play a key role to helping CP realize our objective to enjoy the best operating ratio in the industry in the near future.

I'm even more excited on the service improvement side, which we've created complexity -- eliminated complexity in the network for the reduced train starts, train meets, et cetera. But beyond that, a huge opportunity was uncovered to dramatically improve our Domestic Intermodal service offering, to create the transit performances, which is not only the fastest rail alternative in the Toronto-to-Calgary market, it is single-driver truck competitive with 30 in-ramp [ph] availability in Calgary. We now have a product in the market, we have been successfully running in Calgary, that offers any company paying for over-the-road truck haul to convert to rail and have substantial savings while we enjoyed fair return for that superior service.

Finally, on the sustainability front, this quarter we solidified our operating team leaders and we've realigned organizationally, allowed them to roll their sleeves up continually and dive deep into their operations daily, driving our service and operational improvement evolution.

Doug McFarlane, who many of you have heard us speak of in the past and have met, potentially, at the presentations, I want to publicly thank him for 37 dedicated years of invaluable service to CP. He's recently made the decision to retire, which allowed us the opportunity to replace Doug with Robert Johnson, who's now the VP of our Southern region, our U.S. operations. Robert brings a background of over 32 years of operational experience with the Burlington Northern-Santa Fe.

Robert and I, our history goes back over 22 of those years, when I first worked with Robert as a young operating officer while employed at Burlington Northern in Tulsa yard [indiscernible] facility. So I've got a tremendous amount of respect, both professionally and personally for Robert. He has fit this team well and has hit the ground running producing results.

Another exciting addition to the team, we brought on Tony Marquis, VP of our Eastern region. Tony brings us over 30 years of experience. And again with Tony, 25 of those years, I've worked with him at CN. So again, I have a tremendous amount of professional and personal respect for Tony and his talents that he brings back to this railroad, which again, will be a key piece in helping us drive forward.

These 2 gentlemen joined our already strong operational leaders in Guido and Scott. Going forward, the structure in this leadership will play a key part in leading our continued pursuit of operational and service excellence as this company, which we're seized with and which we're making tremendous progress towards.

So with that, I'll pass it over to Jane to allow her to add some color on how she's converting the success in the marketplace on the revenue front.

Jane A. O’Hagan

Thanks, Keith. We're very pleased to announce record Q2 revenue performance and our eighth consecutive quarter of double-digit growth in merchandise.

Our revenue performance was driven by an operations team who work tirelessly to restore service for our customers, earning their respect and their confidence. Outages impacted revenues in Q2 by approximately $25 million, half the revenue will be deferred to Q3.

We're delivering on the diversity of our strategic initiatives while making good progress on improving the quality of revenue. And with that, let me review our revenue results. We reported a solid revenue gain of 9%, where volume, price and mix accounted for 9% of the gain and all other impacts were negligible. RTM growth was 11% and carload growth of 3% and this was driven by a significant increase in the volume of long haul crude oil traffic and a reduction of short haul U.S. thermal coal traffic. Average revenue per car was up 6%. We delivered on the upper end of our price renewal target of 3% to 4% and expect to deliver inflation plus pricing through 2013.

So turning to grains. We were up 21% in revenue as we made our markets in grain despite slowing towards the tail end of the current crop year. Our Vancouver export program yielded record results for service. Crop year-to-date, we moved 17% more grains to Vancouver than the previous 5-year crop average, and we delivered on our strategic initiative with the first greenfield elevator built in 10 years on our former Soo Line network.

We also reached a long-term commercial agreement with Cargill Ltd. to play a major role in providing transportation services for the movement of canola oil and meal from their new canola crush facility to be located at Camrose, Alberta. This facility is projected to have traffic coming online in Q1 of 2015.

Our outlook is that plantings at our U.S. and Canadian territories are at or above 5-year averages. And with this, we expect mid-single-digit year-over-year unit and revenue increases in the second half.

Turning to fertilizer, we had a strong year-over-year Q2 revenues that included all fertilizers. Our efforts to overcome the flood-related disruptions allowed us to resume export potash service with minimal delay. Strong nutrient replenishment and heavy crop planting drove double-digit increases in domestic fertilizer volume. We developed and delivered a solid win in our strategic initiatives.

We reached an exclusive long-term agreement with K+S for the movement of potash from their greenfield legacy mine near Bethune, Saskatchewan. Production is slated to start in the second half of 2016. We expect double-digit growth in units and revenue in the second half year-over-year, given easy 2012 compares. We're watching the exports closely as commodity pricing and Asian demand remain uncertain in the potash market, pending renewed international sales contracts.

In coal, revenue was down 3% year-over-year, but Canadian met exports were up in Q2 despite a volatile global market. U.S. domestic volumes were down due to competitive natural gas pricing and unplanned outages at receiving power plants. PRB export shipments were down due to weak global pricing. But revenue per car increase of 6% reflects decline in the short haul thermal traffic and the strength of met coal exports.

So as our outlook in coal, we're modeling to Teck's forecast and we'll be watching for signs of market volatility despite Teck's strong competitive market position, diverse customer base and cost competitiveness.

U.S. domestic delivered coal will remain lower than 2012, the PRB export continues to be opportunistic and we will capitalize on it should it continue. So we expect an increase in revenue in Q3 and low single-digit year-over-year decrease in units, largely because of the reduced short haul traffic in the thermal coal sector.

For Intermodal, we're very pleased with the improved service and the Intermodal product, as well as what Keith mentioned in terms of the introduction of our day-faster service from Toronto to Calgary. We took action this quarter to close down our Saskatoon facility and we're very pleased with our domestic growth in targeted areas that's supported by service improvements through the whiteboarding and discussions with customers.

We just won Lowe's award for 2012's Delivery Partner in Western Canada, and we're growing in the right lanes with the right customers aligned to our service capabilities. We're taking the advantage of our service improvements, growing where we can create competitive advantage, price per value and improve the operating income of the book.

Our journey on renewal and rebalancing is continuing. We're creating value through more cost and service improvements, selling new services to new markets, being disciplined in our pricing and ongoing book of business housecleaning.

We do expect a muted fall peak. We expect to see mid-single-digit year-over-year decline in the second half of 2012 as we lap the purposeful decisions we made to let international contracts go and exited unprofitable low profit, low growth markets to improve operating income.

So in merchandise, our strong growth story continues. RTMs were up 28% versus a carload gain of 9%, representing strong gains for long haul crude oil. Mix changes increased arc [ph] by 7% and decreased cent per revenue ton mile by 10%. And as I've told you before, we expect this to continue as crude forms a larger part of our book.

In terms of industrial and consumer products, RTMs were up 34% in gains and long haul crude traffic. Our crude-by-rail model continues to expand with growth momentum built on expansion of our loading network, diversification of the destination network for optionality and on the commitments of our customers to capital. The pace of growth has moderated in the last few months as spreads have tightened. Our term volumes moving to refiners have been largely unaffected, but we have seen volumes move by marketers shift between markets, and in some cases, slow as spreads have moved and tightened.

We're seeing orders pickup in the fall and beyond as spreads widen again. Our crude market will always be a combination of the consistent term volumes and the opportunistic volumes that respond to the movement of spreads. Frac sand momentum continued to build in Q2, resulting in double-digit volume growth.

So in terms of our outlook, crude by rail remains a complementary and important supply chain option for producers, refiners and transloaders looking to benefit from the flexibility of moving any type of crude to any North American market. Frac sand shipments from new mines will continue to ramp up and other industrial products will trend with GDP. I expect another quarter of double-digit growth for industrial products in Q3.

In auto, we had revenues down 9%, but 2/3 of the Q2 revenue decline was due to a lower volume of one-time machinery movements. The remaining 1/3 was due to lower volumes of finished vehicles. We exited low-margin short-haul markets to improve the book. And through the whiteboarding that Keith referenced, we identified opportunities to leverage our network and reduce cost to drive sustainable profitable growth. On a go-forward basis, we will be making decisions about what freight earns its way in the automotive book as we price for the value of our service. And I expect to finish the year in automotive slightly below last year's revenue.

So in conclusion, we had strong results achieved in the face of 2 significant service outages. We've had success delivering on initiatives, which is highlighting the diversity of growth for CP. Our Intermodal renewal is succeeding in Gaining momentum with volume and growth on a stronger foundation with new service aligned to the network and our service strengths. We're continuing to press harder and faster on our work to strengthen the book of business and the quality of revenue. And I reiterate my expectation of high single-digit revenue growth for 2013.

And with that, I'll turn it over to Brian.

Brian W. Grassby

Thanks, Jane, and good morning, everyone. Keith and his operating team delivered another outstanding quarter despite the difficulties we encountered, and the numbers show it. And let me take you through them.

Revenues were a record for a second quarter and we're up 10%. Despite moving 11% more RTMs in the quarter, expenses were down $50 million, or 4%. Last Q2, we had $42 million in management transition costs. Taking these costs out, our expenses were still down 1%, an impressive result given the greater volumes.

EPS was up 138%. If you strip out the management transition costs, proxy costs and Ontario rate change we highlighted last year, EPS was up 59%. Our operating ratio came in at 71.9%, an improvement of over 1,000 basis points, or taking into account the management transition cost last year, a decrease of 750 basis points.

Our effective tax rate came in at the high end of our guidance, at just under 27%. And I expect it will be close to 27% for the remainder of the year. Other charges totaled $8 million on the quarter. This is above our normal run rate of $5 million, reflected of the impacts of FX on working capital in the quarter.

To the next slide, I will take you through comp and benefits. Overall, comp and benefits were down $24 million, or 7%. Workforce reductions resulted in efficiencies of $40 million in the quarter. Fewer yard starts, longer trains and overall efficiencies across the company resulted in a workforce reduction of close to 3,500. These reductions impact both comp and benefits and purchase services, as well as more efficient execution of our capital programs.

Pension expense was a positive $2 million. The stock incentive compensation was up $19 million, largely a reflection of larger bonus accrual. On the stock compensation front, you can model a 500,000 to 600,000 impact on a $1 change in share price.

Wage inflation had a headwind of $11 million and the impacts of the 2012 management transition expense and the strike net to a benefit of $10 million. Fuel was up $4 million, or 2%, on an increase in GTMs of 10%. This increase in workload was largely offset by a slightly lower fuel price and fuel efficiency savings of $24 million.

The remaining expense lines have some puts and takes. Materials were up $1 million this quarter, a reflection of higher volumes, mostly wheels, offset by efficiency improvements. Equipment rents were down $12 million, or 21%, versus last year. Our focus on asset utilization resulted in efficiency savings of $10 million.

Depreciation rose $6 million, or 4%, mostly due to a higher depreciable asset base. And finally, purchase services were down $25 million, or 9%. On the favorable side, $22 million related to the 2012 management transition cost, $7 million related to a contract termination in Q2 last year and $14 million in inefficiencies related to lower contractor and consulting costs.

Partially offsetting these favorable items, casualty costs came in over $30 million on the quarter. This is much higher than our average run rate of $15 million to $20 million. In the quarter, we experienced the higher severity, especially on the environmental side. We are all focused on reducing these costs going forward.

Other offsets include higher locomotive overhauls and higher Intermodal trucking costs due to higher Domestic Intermodal volumes.

So let me close by saying Q2 was another record quarter despite the missed revenue opportunities due to network outages and the higher incident cost. Our operational improvements are driving real, sustainable savings and there is more to come.

Back to you, Hunter.

E. Hunter Harrison

Thanks, Brian, and thanks, Jane and Keith, for those informative presentations. So I think if you can sort through all the noise here in this quarter, it's -- I think, you can certainly see that it sets a pretty solid foundation for the second half that we will go far beyond what we have seen before. As I talked about the plan, the 4-year plan as we moved into this, clearly, we are ahead of that plan. You can argue whether it's 10 months, a year, but clearly we're headed there. I have more confidence all the time and in spite these setbacks in the second quarter, we did not change our guidance for the full year. And I feel even stronger about the ability to achieve those numbers and possibly, potentially, moving beyond that. So I'm pretty excited about the opportunity as some of these things are starting to take some real traction.

And with that, we will be happy to address questions the group might have, Martina.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes the line of Bill Greene from Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

I'm wondering if we can talk a little bit on -- just coming back to some of these safety issues, I understand that some of this stuff is sort of -- may be related to how we measure things and what not. But can you talk a little bit about how we should think about the fact that the train accidents were up 24% and what kind of things you're doing such that we don't have a casualty expense that remains up at these levels? I think it's just hard for us not being railroaders always to understand kind of how to interpret some of this stuff.

Keith E. Creel

Okay, let me take that one, if you will, Hunter. Let me start by saying the 24% is an exaggerated number. I'm not making excuses, but if you understand the facts, when you reduce train miles, train miles is the denominator. The way that ratio is calculated, Bill, is based on a number of accidents divided by train miles. So inherently, if you've reduced train miles, which we've done to the tune of about 4%, 4.5% year-to-date, same number of instances is going to give you higher or an exaggerated frequency ratio, which is what's driving a portion of that deterioration. The most important point though, I made in my notes, that number is not the same anymore. The gap is closed. We're back to a point on a go-forward basis where we're clipping our year-end performance last year, which was best-in-class. That's the other point. You're talking best-in-class performance and a comparable this year versus last year with the winner that we've had year-to-date, which bled over into this quarter, that is unprecedented. And I'll just give you a case in point. Something as simple as one of those significant derailments that costs us a lot of money, caused a lot of concern that involves crude oil, Northern Ontario this quarter was a result of a catastrophic wheel failure. When I say catastrophic wheel failure, the rim of the wheel exploded under the train. That is not a common occurrence. This year, with the weather, and I want to expand on this, we've had 12 of those failures versus 2 same period in 2012. The 12 versus 2 and of those 12, 3 of those resulted in reportable derailments, which are in those numbers. Now what do we do about that? We've deployed and have invested and continued to invest and to enhance our capabilities wheel detection impact systems across the network that identify these potential wheel defects before they become catastrophic failures. In this case, those wheel defect detectors did not identify the problem. And the end result was the wheel catastrophically failed under the train. Now, if you peel the onion back, a lot of people would say the reason that occurred in Canada, especially when you have a harsh winter, we have this thing called shelling on these wheels. Shelling on the wheels occurs because the metal is broken down generally because of heat and/or wear. And in this case, heat. And what causes heat on wheels? There's 2 things if you really understand this business and that's caused by sticking brake that's caused by hand brakes, which are brakes that you manually put on the car, when you secure the car, be it in a yard for switching operations, be it a customer's facility for loading and/or unloading operations. So what do we do as a result of that? It caused myself and my team to look at our procedures and how we drive compliance in applying and releasing those hand brakes. Unfortunately, those hand brakes, be it, again, at a customer facility or be it in a yard, are not always released. If you don't have employees or if you don't have customers that understand what can happen as a result of not doing that and dragging that car and dragging that break steel-on-steel creating the heat that results in these shells, then eventually it develops to a point, especially in winter, when you get ice and snow and melt inside the shelling on these wheels, it compromises the wheel and you have a catastrophic implosion. Again, it's a rare occurrence, but it happens, and unfortunately, that was part of what happened in the second quarter 2013 for CP rail. So it's not something that's going unaddressed, it's not something that should cause concern, that's systemic, that's going to continue to repeat itself. But it is something that caused us to take a look inherently inside at ourselves what more can we do driving compliance, be it policies, be it procedures, be it technology to dramatically decrease the likelihood something like that occurs again.

William J. Greene - Morgan Stanley, Research Division

Okay. Can I change a little bit now and just turn to kind of core earnings power? I think there's a little bit of difficulty trying to figure out on the second quarter, given all these puts and takes, how we should think about what the core earnings of the company is here in the second quarter looking forward? You obviously are ahead of plan on a lot of your cost-cutting, which is great. But I don't know exactly what you think kind of the core earnings are given these changes you've made to some of the procedures here that -- can you just walk through how do you think about what the right either EBITDA or OR or whatnot is that we should think about as a good run rate going into the third quarter?

Brian W. Grassby

Bill, this is Brian. I think, in my remarks, if I look at the quarter, clearly, and we highlighted in Jane's remarks and the press release about $25 million impact on revenues, really the outages. The other item that I would highlight in the quarter are in, what I talked about, were the higher severity and the casualties, and Keith talked about it. But I would -- in looking at the quarter, I would take those out in terms of looking at what is a sustainable run rate. We've also said we're at 3,500 down in terms of workforce reductions. And Keith -- and we've talked about getting to 4,000 and beyond the 4,500 we talked about in November. And the final point is the whiteboarding sessions, you'll start to see some of the impacts kick on there. So I think what you'll see in the balance of the year and in the future years is, again, strong cost containments, cost reduction. And you'll see that in our numbers and in the future quarters.

William J. Greene - Morgan Stanley, Research Division

Sorry, just a point of clarification. The $25 million has some cost associated with it? Or it's just a pure revenue number that we should just add back? Or how do you think about that number?

Brian W. Grassby

I mean, in terms of the lower revenues, you would have some cost associated with that. But it did mean just running fewer trains, as well as you'll see a small reduction on the fuel side.

Operator

Your next question comes from the line of Tom Wadewitz from JPMorgan.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Keith or Hunter, I wanted to see if you could provide a bit more thoughts on the whiteboarding sessions and what -- you identified $100 million. What's underneath that $100 million that you're changing? And what are -- what's the timing that we can anticipate that $100 million coming in? Is there some of that in the second half? Or is that really a 2014 impact?

Keith E. Creel

Yes. Tom, let me -- if I can take this question. I can tell you now that the $100 million, and I'll stress, that's an annualized number. But there is certainly some immediate savings and we're starting to see those in our metrics as we started to execute. Not all can be done immediately, there's some things we'd look at, opportunities identified, maybe potentially rationalizing part of the railway that we may or may not need on a long-term basis. But immediately from an operational standpoint, it means the underlying factors are reduced crude starts. We've eliminated assignments, road switchers, train starts, train miles to the tune of about 10,000 train miles a day. That's a meaningful number on a base of about 112,000 average daily. Car miles, which allows you to turn in more leased cars, which falls into that number that I talked about, 10,000 by the end of the year, and in pickup, on the revenue side, more loads with the reduced fleet, which means less maintenance costs, et cetera, et cetera. And then lastly, the second part, the real leverage on this is driving the revenue side. We put a service in the market and Jane can provide color on the opportunity here. But rest assured, as we educate our internal marketing department, because you get to think about this as a marketing department that's learning how to sell service, we're giving them a hell of a product to sell and they've got to go out and convert it in the marketplace. A part of that is educating internally, part of that is educating externally. If I'm a trucking company and I'm spending a significant amount of money, my expense on over the rolled truck haul and the premium for that versus equal service in the rail opportunity is about 40% or 50%, it's going to cost me, if I'm doing my job, to look at that opportunity. So as we get out and our educate the market and they understand that we actually have the service that is second to none and that is head-to-head truck competitive, I'm confident, extremely confident over the next year to 18 months we're going to convert some of that truck traffic to rail traffic and realize those revenues and the profit margins that we realize and enjoy on that as we reduce our cost structure base.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

That revenue opportunity would be on top of the $100 million cost? That $100,000 million is a cost number, right?

Keith E. Creel

It's absolutely correct, Tom.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

And then I guess for the second question, Jane, on the crude by rail, can you give us, I guess, a little more granularity in terms of the spread impact? I think some of your business is probably on term arrangements. So if the spreads were going to have an effect, it might be delayed. So maybe that's a year out or something. But how would you think that your, let's say in 2014 that you're crude by rail business would grow if you don't see a significant widening in the spreads from where they are today?

Jane A. O’Hagan

Well, I think that, first off, what I'd like to say is that we do believe that rail is going to be a permanent part of transportation of crude to the marketplace. I think the basic proposition that it offers in terms of optionality, in terms of being able to move quickly between markets and the value proposition, vis-à-vis pipeline, that is complementary, this is being supported by customers who have indicated to us and we continue to work on delivering our longer-term initiatives, to build out that infrastructure to deliver those volumes. As I've said to you in the past, the real key here is that we're going to start to see more of our growth coming from the Canadian side. So when we get into the question around how does it work, vis-a-vis, term contracts versus those that play the ARPs. What I would say is that the industry ships crude really in those 2 ways. The larger producers and refineries ship volumes to basically support ongoing needs and these volumes move on a term basis and, again, these have been largely unaffected by the movement of the spreads. We're seeing a lot of the larger producers and the refiners move into the rail market in this meaningful way with these assets and with these investments. And as I said, that proportion of volume that moves under term will increase as we move these volumes and complete our strategic initiatives with these customers. There's always going to be a portion where a certain number of customers do ship crude to capture the economics of the spreads and as these spreads move the volumes quickly move between the markets and this is part of the benefit of the rail model. So in the last few months, as you said, we've seen the spreads have tightened and we have seen that the volumes between the players have shifted and, in some cases, reduced. But the overall rate of growth, as it slowed last several months, as we look forward, we're still online to deliver our 2x to 3x our current initiatives by 2016, because we see power in the long-term benefit of this model.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

It sounds like you're skewed towards the term side versus the other.

Jane A. O’Hagan

Yes, we have -- the majority of ours are term contracts.

Operator

Your next question comes from the line of Jason Seidl from Cowen and Company.

Jason H. Seidl - Cowen and Company, LLC, Research Division

Hunter, you mentioned that you have a lot of confidence in the guidance that you guys just reiterated today. And then you kind of said that maybe you're even confident in exceeding it. Sort of, I guess, if you could just give us a little more clarity on what's giving you that confidence today.

E. Hunter Harrison

Well, if you look at the first 2 quarters, it gives you some directional indication, if you -- that Brian spoke earlier, you just start to pull out some of these things. You can quickly get to some of the reports I've already seen this morning, you've done the math. Plus the fact that, that did not include much of the whiteboard exercise, which is incrementally on top of that, plus the fact that one of the things that as I had fine tuned and gone back through the model in my initial estimates, I thought this would be more linear stair-step as we got into this phase. I think you're going to see that quarter-over-quarter, the difference in the second quarter this year and third quarter are going to be the biggest spread that you've seen in incremental improvements. So if you start to lay those kind of numbers on the back half with the front half, then you can get there easier than I can. I mean -- and I'm not so concerned at this point about the market. I mean, there's a lot of vagaries out there, a lot of issues. This still is a cost takeout, cost-containment, improve the service. That's what we do best. And the issue that Keith mentioned earlier is this market, for an example, from Toronto to Calgary, our Domestic Intermodal is having phenomenal growth. The international is soft by design. The margins are a whole lot different between international. And so everything I look at just says that you ought to do your own whiteboard or you're going to miss it.

Jason H. Seidl - Cowen and Company, LLC, Research Division

Okay. And if I could just shift gears here for a moment. Can you guys give us an update on any of the potential divestitures on the network included in the DM&E?

Brian W. Grassby

Jason, on the DM&E, we're into the next round. We've got -- we've narrowed it down to 4 to 5 interested parties and we're going through due diligence sessions. So I would expect the end of the third quarter, I'll update you where we are on that. What was interesting during the whiteboarding sessions that Keith and Hunter and the team went through is looking at different parts of our network and I think it's just going to be a continual review in terms of making sure that we have the optimum network. So bottom line, I think on the DM&E west, I'll give you an update, but it's going well.

Jason H. Seidl - Cowen and Company, LLC, Research Division

So with the whiteboarding sessions, do they indicate that there's any more potential divestitures out there?

Brian W. Grassby

I think there are plenty of opportunities that came up and I would leave it at that for now, Jason.

Operator

Your next question comes from the line of Steve Hansen from Raymond James.

Steven P. Hansen - Raymond James Ltd., Research Division

Just was hoping you could speak a little bit to the K+S legacy agreement. It strikes me as a pretty important win for your long-term potash franchise here. And we're just hoping you could walk us through some of the key factors or selling points that allowed you to get this exclusivity out there. I was a bit surprised that, frankly, that they would lock up with the single carrier. But again that probably speaks to some of your selling points, if you could walk us through that.

Jane A. O’Hagan

I would say that, Tom, first and foremost, we have developed over the years a significant expertise in the potash business and a deep collaborative relationship for those that want to develop and manage their own unique supply chains. And K+S was certainly a candidate in this direction. I would say that, by and large, when we look at this -- and we do see this as a solid win because it's the first greenfield potash place in the last 40 years and certainly in Saskatchewan. But our key value proposition that we had with them was we had the network capacity, we had the flexibility and the market access to develop the supply chain for them that included the potential for their export volumes, as well as for domestic volumes. I think that the team, I'm very pleased with the way that they worked with the customer. And the fact that the negotiation and the outcome was such that it really underscored the collaborative approach that our team's been taking and the model to really deliver on the diversity of the growth prospects that this great franchise has.

Steven P. Hansen - Raymond James Ltd., Research Division

Okay, that's helpful. Just maybe a follow-up here. The one line that maybe [ph] did stand out as a large range from our perspective was the bonus accrual in the period, given the strong operating performance and gains you've been achieving here and I suppose the second half strong base that you described. Just give us a sense for -- help us understand what we should be modeling on a go-forward basis.

E. Hunter Harrison

I think -- I mean what you've seen in the first and second quarter, you'll see in, assuming we're keeping on track of where we are, you'll see them in the third and fourth quarter.

Operator

Your next question comes from the line of Brandon Oglenski from Barclays.

Brandon R. Oglenski - Barclays Capital, Research Division

Jane, I wanted to follow-up on your second half revenue outlook. You're maintaining your prior guidance for a high single-digit revenue growth, I believe. But if we look at your result for the last few weeks, even outside of some of some of the derailments and flooding issues, it seems like volume trends have slowed a little bit. And your peer is highlighting a little bit softer outlook for the commodity markets. I'm just wondering, what's driving your more favorable outlook as we're looking at it and especially with the weakness in potash markets developing in the second half of the year.

Jane A. O’Hagan

Well, I think, the softness that we've seen in the first several weeks is really a combination of the difficult compares to southern flooding. And just -- and there is some [indiscernible]. But earlier in the quarter, we have experienced some moderation for some of our lines of business and we have been flat year-over-year through to -- certainly to through July 17. But my remarks that I provide to you the market are really inclusive of this softness which we expected to see, as well as we've looked in, assessed what the upside and downside risks are. And we feel that our revenue guidance that we provided is in line with the nature of the products and the franchise that we have. I think that it's really too early to call the crop. But we really feel that we have good diversity, we have an excellent franchise and that the trends are there in place. I think that the potash fundamentals are strong and that we do expect double-digit growth on the potash side. Certainly, there is some risk. But we feel where pricing is today that if there was any interruption, we hope and we sincerely expect that, that would be short-lived. We also see some benefits on our side, on our met coal franchise, we're modeling to Teck's forecast. They're indicating, given the strength of that market, the product that they sell into that and their diverse customer base, that we should be modeling to their forecast. And I think our oil franchise, we continue to deliver on that side. We continue to deliver to the benefits that we've outlined around the projects, the timing of some of the projects, as I've told you in the past, could be a little slower coming online. But as we've always told you, we'll give you advice when that occurs. So I think the Intermodal side, as Keith indicated, this is giving our team a whole new potential set of products and service for us to get out to the market, different group of customers, different targets. People were very active in the marketplace, so I think from that perspective, we're certainly optimistic and giving as much color as we can on how we think that will move forward.

Brandon R. Oglenski - Barclays Capital, Research Division

That was quite thorough. My second one, Hunter, CP's now in a position where it sounds like you're achieving the guidance even faster by your own words. You're going to have a lot of cash flow looking forward. What are the priorities at the board level? Is it -- are there discussions right now of increasing the dividend? Is there an idea that you could start repurchasing shares? Or are there other capital projects that you'd like to accelerate for market opportunities or increased efficiencies? What are the priorities?

E. Hunter Harrison

Well, I think on the shorter-term, we'd still like to see the balance sheet be a little stronger and we would still like to see us being a little better cash position than we are today. And I think once we reach that level that we have kind of determined internally of where we'd be comfortable with from a cash position, and there's not a lot of opportunity from a debt standpoint now to do things differently, that once we reach that point -- now whether that's next year first quarter, second half next year or whenever that this, if you look at our run rate for what we project cash flow will be, I think at that point in time, when we've got sufficient funds available and gives us a great deal of flexibility, then at that point, we will look at those other potential options of buyback and dividend.

Operator

Your next question comes from the line of Cherilyn Radbourne from DT (sic) [TD] Securities.

Cherilyn Radbourne - TD Securities Equity Research

I'll start with a bigger-picture question. I just wondered if you could speak about, as you reshape the cost structure, can you just talk about how you stay nimble enough to respond to a slowdown in the economy, if that occurs? And conversely, we have enough third capacity to cope with a bumper crop, if we get one, or a sudden surge in potash exports, as has happened from time-to-time on the network?

E. Hunter Harrison

Well, one of the things that we've done to some degree, and I don't want to overstate this, but just to keep as many of our costs variable as we can. This -- we've got a responsibility to our shareholders in good and bad times to produce returns. We have -- I personally stay closely involved in the planning process going forward and our headcount. And we've said many times that there's certain amounts of business at the top of that mountain that we can go after, unless it's got just huge tremendous margins there. So as we improve productivity, less people can produce more. We're looking right now at changing some of our crew districts. We have the shortest crew districts in North America. About 120 to 25 miles. And I'm just making a guesstimate now, but I think probably you would see in North America, if you looked at the other carriers, they're probably more in the 190- to 200-mile range, at least, some of them are running in excess of 300 miles. Well, if you can take -- if you improve the infrastructure, if you improve the precision of the railroad, and you're able to run people 200 miles as opposed to [indiscernible] miles, that's a whole lot of leverage there that the same amount of people can do the same thing. So there was policies here in the past that said, "We wanted to have 125% of what we thought the forecast was." Now that proved not to be a very good strategy because one example there was tremendous cost associated with it and the business didn't hit. So that's something that we stay right on top of, we try to stay on top of the market, the interaction between operating and sales and marketing. And so that's not an area that I see problems with.

Cherilyn Radbourne - TD Securities Equity Research

And then I've got more of a modeling question for Brian. The purchase services line has been pretty noisy for the last couple of quarters. If I just take this quarter's number and adjust for the increment in casualty cost that you called out, is that sort of a reasonable run rate to think about?

Brian W. Grassby

Yes. I think, Cherilyn, you'll see some movement as we go forward over that line. Let me just give you -- I would direct you to the MD&A where we give some good breakdown as to what's in the purchase services line. But -- I mean, the other movement that we saw on the quarter, which is the good news, is on the Intermodal side. We saw our Domestic business go up, so that drives cost. But a big chunk of purchase services, roughly $100 million, contains things like property taxes, which unfortunately go up year-after-year. But also contain a lot of IT consulting where we've outsourced certain services, as well as building maintenance and rent. So you'll see that portion come down over time as Mike Redeker, our CIO, is in-sourcing some -- or a lot of the services, and you will see it show up in the comp and benefits. Also in the building and maintenance and rent, at least on the rent side, you'll see that really start going down in 2014 as we move into our new headquarters in Ogden. So I think in the short term, Cherilyn, it think you'll be close. In the longer-term, you'll see purchase services come down.

Operator

Your next question comes from the line of Ken Hoexter from Bank of America.

Ken Hoexter - BofA Merrill Lynch, Research Division

Jane, during your -- at the end of your kind of run-through on the revenues, you noted that you're targeting inflation plus only through 2013. Was that -- is there a reason why you're bulleting [ph] the end of this year or maybe you can kind of talk us through your thoughts on pricing?

Jane A. O’Hagan

Well, I mean, obviously, we're pricing for value and a big part of what this franchise is focused on is creating sustainable value. I just bookmarked it because it aligns up with our revenue outlook. As we look forward and as we think about the increasing value of the service that we put on this network and we think about that our job is to continuously improve the quality of the revenue, at this point, we're targeting this range for this point in time. But in over time we'd like to be able to be in a place where we're reflecting those increases along with the quality of the service and what we're commanding in the marketplace.

Ken Hoexter - BofA Merrill Lynch, Research Division

Okay. So then it sounds like it would still be maybe even more than inflation if you're creating value from what you're -- your improving service.

Jane A. O’Hagan

Yes. That would be it.

Ken Hoexter - BofA Merrill Lynch, Research Division

Okay. Keith, on the white-boarding sessions and your legacy contracts. I just want to understand, I think Brian was just throwing this out there on the outsourcing contracts, you've talked a lot of opportunities in the past. Is there still a lot of legwork on outsourcing contracts? Are there time limitations on waiting until they expire over the next few years? Can you kind of maybe just give a ballpark of what we could look for from cost savings on outdated contracts?

E. Hunter Harrison

Tim, let me -- this is Hunter. Let me take a stab at that for a moment. From an operating standpoint, non-IT, we don't have any legacy contracts, I'm thinking out loud, that are -- caused us any issues there. In fact, we had 2 facilities that we were doing component work, reengineering and mechanical. That was an odd setup, I'm not sure I understand all the background, but where it was our employees and we paid the pensions and the salaries, but somebody else managed it for a management fee. Well, we brought all that back in-house, and so we've cut the cost there. And I don't know of anything, from a contractual standpoint on the operating side, that presents any hurdle to what we're trying to achieve.

Operator

Your next question comes the line of Allison Landry from Credit Suisse.

Allison M. Landry - Crédit Suisse AG, Research Division

If I remember correctly, the second quarter of 2011 was also a very tough year for CP with respect to flooding and I understand there's a different management team in place back then. But I was wondering if you could give us some perspective on the key drivers or changes that were implemented that allowed the network to bounce back so quickly this time around?

Keith E. Creel

Let me take a stab at that. Well, there is still a silver bullet here, but it boils down to focus, it boils down to passion, it boils down to understanding which -- the steps that you can take proactively while you're out of service, while you're out of commissioning. You don't have an ability to advance trains. That determines how quickly you bounce back. So in the past, I can tell you I don't know what they did then, but I can tell you what we did was due to the team this time as opposed to just letting the train sit and wait for line to be open. We took proactive steps to consolidate trains, reduce the number of trains, to do downstream blocking on the train. So in essence, if you're out for 2 or 3 days, to simplify this, you've got a particular train that goes to a particular destination that might have 3 different blocks on it. Instead of having 3 trains with 3 blocks, we consolidated it to 3 direct hit trains with solid blocks. So the time that you lose in transit while you wait for the track to open, you pick back up on the other end by direct hitting at the terminals as opposed to driving it to the destination terminal, switching the cars out and delivering it to those 3 locations. So if you multiply that across the network, it's the difference between taking a week to recover and taking 48 hours to recover.

Allison M. Landry - Crédit Suisse AG, Research Division

Okay. That's really helpful. And then just as a follow-up question on the materials expense, you've talked about efficiency gains of about $10 million in the second quarter. Is that sort of a good run rate to use going forward?

Brian W. Grassby

Allison, the $10 million I referred to was on equipment rents. And so that -- and that really -- and Keith talked to over 10,000 cars that will be returned by end of the year. So it was on equipment rents. Now what you will start to see is in Q3, Q4, we'll start to lap as we reduced our fleet last year. So the $10 million will reduce, although the absolute amount savings will go forward.

Operator

Your next question comes from the line of Walter Spracklin from RBC Capital Markets.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

My question, I guess, is going down on the revenue side, we'll start with that one first. It's on market share gains versus either your main competitor or on the trucking side and how that impacts your yield progression. I know, Hunter, you talked about explosive growth in Domestic, although International challenged. I don't know if, Jane, you have the breakdown between the 2 of those. And that kind of growth would not be something I'd expect in this current economic environment. So where are you stealing market share, if that indeed is the case?

Jane A. O’Hagan

Well, Walter, I think first off, what I would say in the Intermodal section, as I defined, we certainly are lapping some of the changes that we made quite purposely around the International side and around getting our cost down. This really is a cost takeout story for us on the Intermodal side. Obviously, I want to grow market share, but I want to grow it in a way where we have sustained profitable growth. Our growth plan, as Keith indicated, is really around playing to our network strength. That's where we can develop quality products and services, we can develop them and we can price for them. So there's always a component here [indiscernible] from a competitive perspective, we're offering a different [indiscernible] customers.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

And what is split between domestic [indiscernible]?

Jane A. O’Hagan

[indiscernible] growth this quarter, it was over 10%. So again, this is where we're really focusing on developing where we can have line of sight to profitable sustainable growth and where, again, we can sell a really unique and premium range of services to new customers, to existing customers, and to customers that have the opportunity to make a modal shift.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Okay. And then switching gears, I guess, Hunter, on the expense side, you mentioned you're ahead of schedule. Absolutely, that's an impressive achievement. You'd guided us toward 4,500 headcount reduction when you first kind of laid out your plan from 19,500 to 15,000. Clearly, having achieved, I believe, you said 3,500 of that now. I guess, on the flip side, are we -- do we only have 1,000 left? Or now that you have a chance to get a little bit closer to the operation, is 4,500 the right number? Or can we go -- or are we still sort of targeting that? Or can we go higher than that?

E. Hunter Harrison

We can go higher than that.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

So in terms of order of magnitude I guess where I would be coming from here is that if you've gotten to 3,500 and we're at a low 70s operating ratio to get to low 60s, do we need another round of 3,500? Or can we do it with -- or can we do with less than 3,500?

E. Hunter Harrison

No, you can do it less that -- this is not driven at all driven on headcount. There's a lot of value creation. There's a lot of the things, initiatives that we're doing. And look, we're not obsessed with headcount. This is a kind of a byproduct. You create efficiencies. You take 500 locomotives out of the fleet. You take 10,000 rail cars out. Obviously, you don't need as many mechanics. So you spend more capital on the infrastructure and get it in better shape. You don't need as much maintenance cost, you don't need as many people maintaining it. So kind of like how I used to say with the operating ratio, that it's a byproduct of providing good service and low cost. You don't walk up and say, I'm going to do whatever I got to get to this operating ratio at the same time. The only reason why I really came out with the headcount issue is because everybody wanted to understand the plan, the detailed plan. But they had about 5 minutes to get me to explain it. So nobody bought the plan until I came out with the headcount and everybody bought it. My sense is going forward we'll go -- we're on track to be beyond 45. And the initiatives we see now going forward will take us much beyond that. Now if there were other contracting and opportunities where we could bring more work in and that's going adversely affect the quote headcount getting to 6,000, am I prepared to do that? Absolutely. Just on the kind of a same-store basis with this strategy, there's been -- we'll have a critical decision. There's a couple of critical points here. This year, I want to go to a stable workforce with their engineering forces. I don't think the ups and downs and the seasonality is the right way to go. So we -- this wasn't the year to make the transition, to Keith's point earlier. So I would expect when people are taking out this fall from the seasonal workforce, we're going to be in a position to say what do we need in our 12-month basis to run the railroad? And that will take additional numbers out of it. Next year, in 2014, we have the expiration of some of the IT commitments that we're contractually bound by. So those are 2 rather large buckets, if you will, that'll hit from the headcount issue. But look, we can do this with or without the headcount.

Operator

Your next question comes from the line of Scott Group from Wolfe Research.

Scott H. Group - Wolfe Research, LLC

So why don't you just follow up on the pricing question? First, so you've got -- car load yields are up a lot and revenue ton-mile yields are down a little bit. Jane, do you have a sense on kind of what underlying same-store pricing is? And then maybe for Hunter on the pricing side, and this idea of opportunities to get more pricing ahead, any update you can give us on some of the longer-term contracts that you're hoping at some point maybe you could do some better things with?

Jane A. O’Hagan

Well, let me start off with number 1. Certainly average revenue per car was up and our RTM was down. But again, I'll signal that I've given you guidance in the past that as crude oil grows as part of the book because of it's shipper supplied cars, this unit train model and certainly moving longer haul, this is going to have the impact of lowering our cents per RTM in this segment of the business. And again, this is because the growth that we've had in the crude oil segment has been significant. I'd also say that if you look at this quarter, we also had some of the impact that we had on decreased volumes on shorter haul, thermal coal, which obviously impacts cents per RTM. So I think that when we look at where our price and where our yields are trending, they're where we expect them to be. I'll also tell you that in terms of our same-store pricing, it's within the same range trending with our renewals that I spoke to being at the upper end of our 3% to 4%. So I'll turn it, perhaps, over to Hunter to talk -- you asked the question, Scott, of Hunter around various components around contracts, et cetera.

E. Hunter Harrison

Well, Scott, I would just add this. All my career, I've learned one thing. If you provide better service, you can extract better price. Now does it happen overnight? No. But if we can build and continue to provide a better service, continue to improve that, we're going to get rewarded. I'm not sure exactly of the timing there. And at the same time, while our cost is going down, it opens up opportunities that internally wouldn't meet our hurdle rate, if you will, that now we've got a different set of obstacles, the issues there. So I'm pretty bullish in the out years of this plan and going beyond that we'll start getting -- the first portion of it is driven basically on cost. The second half we'll get to a point where there's -- you can go only so low that it'll be kicking back in on the revenue side, which will be the driver.

Scott H. Group - Wolfe Research, LLC

Just second question. The 10,000 rail car number is bigger than I've heard from you guys before. Is that incremental or cumulative? And then are there any kind of rough numbers that we can help think about the -- how to quantify what you save on every car that you return?

Brian W. Grassby

So I think, Scott, at the end of it last year I talked about 6,000 returns. So the 10,000 is cumulative. And I've talked to $15 million to $20 million in terms of lease savings and it'll be higher than that. But I do caution you in Q3, Q4, we're going to start to lap some of the returns that we started in Q3 and Q4 last year.

E. Hunter Harrison

It's not only returns. This is also taking system cars out of the fleet that are not needed, that are old and obsolete, that are higher-cost that we're scrapping, leasing, monetizing or whatever. So that's an all-in number. As we see it now, 10,000, I think it will go higher over time. And to some degree, it involves TTX with Intermodal and how fast we were to turn that equipment, if we can turn more with less cars. And so it's all a cumulative effect.

Scott H. Group - Wolfe Research, LLC

Okay. So an incremental 4,000 cars are $10 million to $15 million essentially.

Brian W. Grassby

Actually, between $15 million to $20 million over last year.

Operator

Your next question comes the line of Cameron Doerksen from National Bank Financial.

Cameron Doerksen - National Bank Financial, Inc., Research Division

Just one question for me on locomotives. One of the operating metrics that really stands out in Q2 is that locomotive productivity was up 32%. Just wondering if you can update us on where the locomotive removal process is at the end of Q2, where that compared with a year ago and where you expect to be at year end.

Keith E. Creel

Rough numbers, year-over-year for the quarter, about 3, 300. I would expect, as we improve our service, continue to increase our velocity, barring any 150-year floods and things I can't predict, expect another 40, 50 locomotives come out of that number.

Cameron Doerksen - National Bank Financial, Inc., Research Division

Okay. And do you expect to -- that, obviously, to continue into 2014, right?

Keith E. Creel

Well, it all depends on the business. With the growth, of course, they take locomotives. So making those monumental gains, I'd say no. But continued incremental improvements, I'd say yes.

Operator

And next question comes in the line of Keith Schoonmaker from Morningstar.

Keith Schoonmaker - Morningstar Inc., Research Division

Jane, a longer-term question for you. We hear a fair bit of chatter in industrial development in various networks, particularly concerning Mexico. Aside from truck conversion and growth of your existing clients, can you add some color on new business that may be coming on to your network?

Jane A. O’Hagan

Well, I think we've been really clear in terms of where our volume growth is and how we intend to grow the franchise. First, obviously, we're going to make our market given the proximity of the network that we operate. That means growing organically with our customers, improving service. And in terms of offering them a broader array of products and services. The second area obviously that we're growing is on the crude oil side. When we look at the natural reach of our franchise and we think about our origination, we certainly have capabilities. And we believe that given our partnerships with the other Class Is, we can virtually access any North American market that is out there. I think the other area, again, as you know in our bulk sector, when we look at the quality of the bulk services that we offer, think about the successes that we've had on the grain side, think about what we've done in potash, our bulk team is continuing to press on that. When we look at Mexico, obviously, we've got to have that aligned with our franchise. We're always having conversations with other Class Is on how we can extend that reach. But when I think about where our growth is coming from, I would say that you really want to be pointed on those 3 areas that I just suggested.

Keith Schoonmaker - Morningstar Inc., Research Division

Okay, great. Let me turn to operations briefly. It seems like these whiteboarding sessions and implementations of learnings that you had at these sessions were a critical step. One thing you've mentioned, I think Keith mentioned, is sales learning to sell this higher service, and I'm sure they're delighted to have that. But other than executing on takeaways from the sessions you've already had, are there more stepwise changes like these whiteboarding sessions that you've given some attention to?

Keith E. Creel

Listen, the story is an evolution. It's not a destination, it's a journey. So after you implement these changes and you've had this operating plan down, the ebbs and flows of the business, as we bring on business in certain lanes, we've got to constantly reevaluate that. So that's what all -- that what precision railroading is about. You develop the best plan, you execute it and through the execution of it, or through the changes in business, be it up or down, you adjust it, with the endgame being continual, operational and service excellence improvement. And track record says we can do it. Done it previously in previous assignments and I don't expect any different results in a go-forward basis in this one.

Operator

Your next question comes from the line of Turan Quettawala from Scotiabank.

Turan Quettawala - Scotiabank Global Banking and Markets, Research Division

Just a quick one for you, Jane. On the Intermodal side, is it possible to give some sense of the total market that maybe you're going to go at with this domestic new Intermodal service that Keith talked about?

Jane A. O’Hagan

Well, I think, Turan, obviously, the issue that we have in front of us is this is highly competitive business. So I think that from the perspective of what we're doing and what gives us the greatest sense of excitement is not only that we have this opportunity to go to our customers and to talk about lanes of business that we previously have not been able to participate because we haven't had that consistency, we haven't had that reliability and we haven't had this kind of premium [ph] service, that's number 1. But number 2, I think, as Keith pointed out, there's a whole range of customers out there that have been underserved. And where, when you look at having a service that's best in its class, clearly, what we're going to be doing is taking advantage of all those opportunities, showing them what our track record is and being able to sell that service. So I think that I'm not able to give you kind of an exact number of what that looks like. But I can tell you that we're very active in the market and we're going to continue to deliver on that because this is a real source of opportunity for this company.

Operator

Your next question comes from Chris Wetherbee from Citi.

Christian Wetherbee - Citigroup Inc, Research Division

Just maybe a question on the productivity measures. I think, Keith, you mentioned you had records on 12 of the 14 that you got to keep a close eye on. When you think out into the second half of the year, obviously, probably better operating conditions coming here. I guess where do you see yourself in the process here of improving? How much less, I guess, is there to go? I know it's kind of an evolutionary scale, but just curious kind of where you see yourself in that process.

Keith E. Creel

Well, as far as making monumental leaps, I think we're there. As far as making, again, continued year-over-year and quarter-over-quarter improvements, there's definitely some meat left on the bone. They all have their own stories a couple of these like -- this is a fuel conception story. That's a pretty dramatic increase year-over-year. Last year, same time, this company was about middle of the pack relative to our peers and our fuel productivity. We're knocking on the door, best-in-class today. And don't think that I don't expect and require this team to excel and blow right by that number. So that's something that we're going to continue to work on. Will it be an 8% improvement year-over-year? I'd say, no. Will it be several points of improvement? I'd say, absolutely yes. So in this similar story looking at all the different metrics. So it's something that monumental improvement so far, you won't see the same double-digit improvements year-over-year, but you'll see continual single-digit improvements on a go-forward basis.

Christian Wetherbee - Citigroup Inc, Research Division

Sure, that makes sense. And I guess maybe transitioning, Jane, from your perspective, with the improvements that Keith and his team have been able to make, I mean how quickly do customers kind of realize that? And how can you affect kind of change as far as selling the product? I'm just curious kind of customer receptivity to that type of dramatic improvement we've seen so far.

Jane A. O’Hagan

Well, obviously, the key thing that we need to get into the market and that the team is focused on is, #1, getting out there and selling the service and looking for the value and extracting that value. I think that, that transition, whether it's cultural or not, has moved away from apologizing from service. I think the other thing is that the operations team has done a fabulous job of working with us to demonstrate the facts behind that. With fact-based information, with the track record that we have out there in the market, the aggressiveness of the sales team and enthusiasm to sell the product, those are the things that we're doing around that area.

Operator

Your next question comes from the line of Benoit Poirier from Desjardins Capital.

Benoit Poirier - Desjardins Securities Inc., Research Division

Just to come back on the previous Intermodal question, we are airing some comments that it's not easy for shippers at this time. We also understand you provide some very good that good color about the Intermodal in the second half. But I was wondering about the contracts that are up for renewals in the coming 6 or 12 months and whether you feel you have the proper cost structure right now in order to be part of it, or any color on the internal -- Intermodal dynamic at this point, Jane?

Jane A. O’Hagan

Well, I would say first and foremost, this story, as we've indicated to you, is one of renewal and rebalancing. A big component of what we need to do as we look at each individual contract is to understand how do we focus on selling to where our capabilities are and where the network is. This is, again, made choices about, when we look at a package, do we need to be looking at the whole piece or do we need to sell into those components where we know we can be successful in those lanes? I think the other reality is about 20% of the book turns over on a yearly basis. I mean, I think that given where we've come from, in terms of being able to sell to what the segment wants, which is consistency, reliability and a demonstration of that, we have an excellent track record for us to sell to. So I feel confident that we're in a place where we're going to price for value. I'm certainly not going to use price as a means of developing market share, we've been very clear on that because our mandate's around sustainable profitable growth. We're going to continue to focus and work with the operations team to make sure that the product we have is cost-competitive and that we continuously work on that. So as Keith said, it's certainly not a destination, it's a journey. But we're feeling very good about the progress that we're making.

Benoit Poirier - Desjardins Securities Inc., Research Division

Okay, very good color. And my second question you, Hunter, mentioned color about the potential divestitures. Now let's talk about some M&A opportunities. You mentioned in the past that you were obviously looking for a short line. I understand it's maybe too early, you're building a financial position here. So I'm just wondering if there's any comment about the opportunities on the short line, especially after the tragedy in Québec.

E. Hunter Harrison

Well, I don't think there's anything in our sights right now. I mean, I've just simply said this, we think we do a pretty good job of railroading, we're going to get better and better. And depending on the price, if it's a fit and contiguous to our property clearly, and we can get it for the right price, it's something we'd take a hard look at.

Operator

Your next question comes from the line of Jeff Kauffman from Buckingham Research.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Just 2 quick questions. One for Brian. Brian, you answered the question on capital redeployment, but what are you thinking in lieu of some recent events on the CapEx budget for this year, next year?

Brian W. Grassby

I'm not sure what you're referring to, Jeff. I mean, Keith talked to we increased the $100 million, so we've advanced that. But I think we're going to be in the range of CapEx of between $1 billion and $1.1 billion going forward. So I mean, we're going to spend $100 million more this year. I'm very pleased with our free cash flow to date. But as Hunter said, we want to strengthen the balance sheet, build cash and look forward to other conversations next year.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Okay. And Hunter, as you've gotten deeper and deeper into this, I know you've talked a lot about the whiteboarding. I'm just kind of curious, what aspects of the plan have come easier or faster than you expected? What aspects of your plan have been a little more challenging to capture?

E. Hunter Harrison

Well, it's clearly the execution part. It's pretty easy to go up on the board and draw Xs and Os. And we have to be careful, and I'm talking to myself when I say that, that we don't get ahead of ourselves. So clearly, this whiteboard exercise, as Keith alluded to, to some degree, we identified certain opportunities. We're in the process of executing those now, finding out where there's loss and where there's efficiencies and where we need to beef up until we move to "Phase 2" of a whiteboard, which is kind of like getting your Masters degree. So -- but clearly, the toughest part is the execution part of changing the culture, changing the behavior, getting people to understand. That's the challenging part for all of us.

Operator

Your final question comes from the line of David Tyerman, Canaccord Genuity.

David Tyerman - Canaccord Genuity, Research Division

2 related questions for Jane. Jane, I was wondering if you could give us an idea of what the normalized increase in revenues were in the quarter. I guess, taking out the strike effects and also taking out the flooding. And then related to that, do you expect the growth rates in the second half of this year to accelerate, decelerate or what relative to the normalized Q2?

Jane A. O’Hagan

I would say that if you wanted to adjust for the impacts, you'd be talking about the 5% range. I think that when we look at the growth rates in the second half, I've been pretty clear that you really need to refer to my remarks on the individual lines of business. But this franchise has always been a second half company. We always have, given where we're looking with the crop, looking at the dynamics of how the bulk wants to move, looking at the improving quality of the service. I mean, again, I've reiterated our guidance again on the revenue side, so we expect the growth to come in around that area.

E. Hunter Harrison

Okay. Well, as Jeff said, it has been a long call. We tried to accommodate all the questions and hopefully it's been helpful and informative to you. And I just wish we were talking about the third quarter tomorrow because I'm pretty excited about those opportunities. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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