Jennifer Hamann
Executive Vice President and Chief Financial Officer at Union Pacific
Thanks, Eric and good morning. Let me start with a look at the walk-down of our second quarter operating ratio and earnings per share on Slide 14, where we've outlined the major drivers. In the June 13th 8-K, we disclosed a one-time ratification payments related to our SMART-TD brake person agreement. That $67 million bonus increased our operating ratio 110 basis points and reduced our EPS $0.09. Falling fuel prices during the quarter and the lag on our fuel surcharge recovery programs positively impacted our operating ratio 200 basis points and added $0.04 to EPS.
While improved operations generally allowed us to meet demand during the quarter, that demand was softer and the combination of an elevated training pipeline, inflation and negative mix all impacted our core results. Below the line, we net to a $0.07 EPS reduction from lower Nebraska state tax rates in 2023 as was noted in that same June 8-K and a large 2022 real estate sale.
Looking now at our second quarter income statement on Slide 15, operating revenue totaled $6 billion, down 5% versus last year on a 2% year-over-year volume decline. Included in that is a $34 million reduction in our accessorials related to lower intermodal volume and faster equipment turns. Operating expense of $3.8 billion was flat, resulting in second quarter operating income of $2.2 billion, which is down 12% versus last year. Other income decreased $70 million, driven by the 2022 real estate sale I mentioned earlier. Interest expense increased 7% reflecting higher debt levels. Net income of $1.6 billion declined 14% versus 2022, which when combined with share repurchases resulted in a 12% decrease in earnings per share to $2.57.
Now looking more closely at our second quarter revenue, Slide 16 provides a breakdown of our freight revenue, which totaled $5.6 billion, down 5% versus 2022. Lower year-over-year volume reduced revenue, 175 basis points. Total fuel surcharge revenue of $707 million was $269 million less versus last year. The impact of falling fuel prices as well as the lag in our surcharge programs, reduced freight revenues 425 basis points. The combination of price and mix in the quarter increased freight revenue 150 basis points. This gain reflects the strong pricing we secured, while also recognizing some headwinds from certain coal and intermodal contracts, where the pricing is more reflective of current market conditions. Mix in the quarter remained negative as fewer lumber shipments and more short-haul rock shipments outweighed the positive impact of lower intermodal.
Turning now to Slide 17 and look at second quarter operating expenses, which totaled $3.8 billion. Compensation and benefits expense increased $177 million versus 2022, with nearly 40% of that amount, reflecting the brake person agreement. Second quarter workforce levels increased to 4%. Although total transportation employees were up 7%, the active TE&Y workforce is only up 1% which is a result of our robust hiring and elevated training pipeline. Excluding the impact of the one-time bonus payment, cost per employee increased 5% in the second quarter and we expect it to be up 3% to 4% for the full year. Both second quarter and full-year cost per employee reflect the impact of that larger training pipeline as well as better crew efficiency, which are partially offsetting wage inflation. I'll provide more details on the impact of our new agreements here in just a bit.
Fuel expense in the quarter increased 29% -- on a 29% decrease in fuel prices. Purchased services and materials expense increased 5%, driven by inflation, partially offset by decreased subsidiary drayage expense and more moderate locomotive repair expenses as we stored locomotives in the quarter. Equipment and other rents was up 8% reflecting higher lease expense for new freight cars secured to support business volume and lower equity income, slightly offset by lower car hire, as we improve cycle times and move less volume. Other expense grew 6%, primarily related to increased environmental remediation accruals as well as persistently elevated casualty costs.
Turning to Slide 18 and our cash flows. Cash from operations in the first half of 2023 decreased to $3.9 billion from $4.2 billion in 2022. The primary driver was $445 million of payments related to labor union agreement, these payments also impacted free cash flow and our cash flow conversion rate. Year-to-date, we've returned $2.3 billion to shareholders through dividends and share repurchases and we finished the second quarter with an adjusted debt-to-EBITDA ratio to 200 -- to 2022 levels at 2.9 times as we continue to be A-rated by our three credit agencies.
Wrapping up on Slide 19. As you've heard from the team, we're pleased that the service product is enabling us to meet available demand. Unfortunately, as you heard from Kenny, consumer-facing markets like intermodal and lumber remained soft. Additionally, the outlook for coal has weakened since the start of the year, but with some near-term opportunities given the extreme heat. Although we still expect to outpace industrial production in certain markets, weak demand for consumer goods has pushed our full-year volume outlook below current industrial production estimates, which are slightly positive. Unchanged is our expectation to generate pricing dollars in excess of inflation dollars. To date, we've made great progress repricing our business to reflect the impact of higher inflation and that momentum will continue.
As it relates to fuel prices, I should point out that the tailwind we've experienced these past 24 months is now expected to shift to a headwind, both on the operating ratio and EPS front. Assuming fuel prices remain relatively stable, this will likely represent a negative second half impact of around $0.50 per share. Eric provided some great context on our labor agreements, and although they clearly come with some upfront costs, we see opportunities as well.
Starting with the sick leave agreements, our current forecast is that they will add roughly $50 million to labor expense in the second half of 2023, which is reflected in the cost per crew numbers I quoted earlier. We view these costs as added inflationary pressures that we will reflect in our pricing. For the brake person agreement, we've already seen the impact of that upfront payment. Our expected payback period is roughly two years, as it allows us to redeploy crew personnel, save on costly borrowed-out position as well as reduce our current hiring needs.
Implementation of the BLET work/rest agreement will start over the next month or so with completion likely in 2024. For this year, we estimate the work/rest implementation will cost upwards of $20 million. The challenge in putting a finer point on that estimate is both timing and forecasting employee behavior. We don't yet have an agreement with SMART-TD and we are still working through some technology and logistics before we start the rollout. And while we certainly expect better availability, better service and more flexibility with our crew boards, providing more access to time-off likely adds employees and expense. The exact math depends on how employees utilize this greater flexibility, as well as how we translate better predictability into increased levels of productivity and service that ultimately drive profitable growth on our railroad.
Looking at our 2023 capital allocation, our capital plan remains $3.6 billion. We also plan to maintain our current dividend of $1.30 per quarter as reflected in our dividend announcement this morning. However, we have paused share repurchases and don't expect to be back in the market for the remainder of 2023. While there is no change to our long-term capital allocation strategy, which is first dollar into the business, industry-leading dividend payment and excess cash to shares, we recognize our cash flows are impacted in the current environment with volumes and cost.
Wrapping up, we are well-positioned to operate a better railroad in the second half of 2023 and for the long-term, our strong fundamentals are unchanged and will allow us to generate significant value for our owners, as team UP drive service, growth and improved profitability.
So with that, I'll turn it back to Lance.
