Union Pacific Corp (UNP) — Q3 2018 Earnings Call Transcript

Thank you, and good morning, everybody and welcome to Union Pacific's third quarter earnings conference call. With me here today in Omaha are Kenny Rocker, Executive Vice President of Marketing and Sales; Tom Lischer, Executive Vice-President of Operations; and Rob Knight, our Chief Financial Officer. This morning Union Pacific is reporting net income of $1.6 billion for the third quarter of 2018 or $2.15 a share. This represents an increase of 33% of net income and 43% in earnings per share when compared to 2017. This was an all-time quarterly record for Union Pacific even without the benefit from corporate tax reform. Total volume increased 6% in the quarter compared to 2017. Premium and Industrial carloadings both increased 9%, while Agricultural Products grew 2% and Energy volumes were down 2%. The quarterly operating ratio came in at 61.7% which was flat with the third quarter of 2017. Higher fuel prices had a 0.3 negative impact on the operating ratio. Strong top-line growth was offset by an increase in volume-related costs, higher spending due to some lingering network inefficiencies and other cost hurdles. While we've reported solid financial results, we did not make the service and productivity gains that we had expected during the quarter. However, we believe that Unified Plan 2020 along with other G55 and Zero initiatives and recent changes to our leadership team, position us well to start driving larger service and operational improvements going forward. We launched Unified Plan 2020 on October 1 in our Mid-American corridor with the goal of creating more streamlined operations on the eastern one-third of our network. While early, I am pleased with the initial results, as we have seen improvement in several key performance indicators on our network. We've also made a number of other changes to drive near-term productivity savings that you will hear about today from the rest of the team. Our entire Union Pacific team is fully engaged in the implementation of Unified Plan 2020 and our pursuit of running a highly-reliable, more efficient network. There is much more to come as we continue to roll-out Unified Plan 2020 across our network, and I'm excited about the opportunities it's going to create for both our customers and our shareholders. I'm confident we have the right people and the right plans in place to improve our operations, to provide more reliable service for our customers and achieve industry-leading financial performance. The team will give you more of the details on the third quarter and Unified Plan 2020 starting with Ken.

Thank you, Lance and good morning. For the third quarter, our volume was up 6% driven by strength in our Premium, Industrial and Agricultural business groups with the partial offset in Energy. We generated positive net core pricing of 1.75% in the quarter with continued pricing pressure in our coal and international intermodal markets. The increase in volume and a 4% improvement in average revenue per car drove a 10% increase in freight revenue. So now, let's take a closer look at the performance in each business group. Ag Products revenue was up 6% on a 2% increase in volume and a 4% increase in average revenue per car. Grain carloads were up 2% driven by strong exports, predominantly shipping to Mexico, coupled with increased domestic demand resulting from lower corn prices. These gains were partially offset by persistent weakness in wheat due to reduced U.S. competitiveness in the world market exports. Grain products carloads were up 6%, driven by sustained demand for ethanol and other biofuels. This renewable fuel strength, coupled with increased meat production, also drove an increase in shipments for animal proteins. Fertilizer carloads were up 5% due primarily to continued strength in export potash. Energy revenue increased 1% for the third quarter as a 2% decrease in volume was offset by a 2% increase in average revenue per car. Coal and coke volume was down 3% primarily driven by contract loss and retirements, coupled with lower natural gas prices which fell 3% versus the third quarter 2017. Sand carloads were down 23% due to the impact of regional sand and market decline in the Permian Basin. Furthermore, favorable crude oil price spreads drove an increase in crude oil shipments which was the primary driver for the 40% increase in petroleum, LPG and renewable carloads for the quarter. Industrial revenue was up 13% on a 9% increase in volume and a 3% increase in average revenue per car during the quarter. Construction carloads increased 10% primarily driven by strong market demand for rock and cement and favorable year-over-year comps due to Hurricane Harvey that impacted the Texas Gulf in the third quarter of 2017. Likewise, plastics carloads increased 14% due to the same favorable third quarter comps resulting from the hurricane and strength in polyethylene shipments with increased production. Industrial chemicals volume increased 14% due to the continued industrial production growth. Premium revenue was up 18% with a 9% increase in volume and a 9% increase in average revenue per car. Domestic intermodal volume increased 7% driven by continued demand for tight truck capacity and strength in parcel and LTL shipments. Auto parts volume growth was driven by over-the-road conversion and production growth at key locations. International intermodal volume was up 12% as new ocean carrier business continue in the third quarter, coupled with strong import and export shipments. Finished vehicle shipments were up 8% due to strong truck and SUV sales, increased production at UP third plant and growth with new customer wins. Although the start was down 1% for the quarter, the light truck segment was up 7%. Looking ahead, for the rest of 2018, our Ag Products growth continues to face uncertainty in the export grain markets from foreign tariffs. However, we are seeing some positive indications in the market due to crop issues in South America and other countries, which has made U.S. grain more competitive in the world markets. We anticipate continued strength in biodiesel fuel and renewable diesel fuel shipments due to an increase in market demand for renewable fuels. We also expect tight truck capacity combined with the value of rail to continue our penetration growth across multiple segments of our food and beverage business. For Energy, we expect favorable crude oil price spread to drive positive results for petroleum products, but tough year-over-year frac sand comparisons coupled with local sand supply and softer market conditions will impact sand volumes. We also expect coal to experience continued headwind for the remainder of the year, and as always for coal, weather conditions will be a key factor for demand. For Industrial, we anticipate upside in plastics as production rates increase. Metal shipments are expected to grow due to strong construction in energy markets coupled with tight truck capacity. In addition, we anticipate continued strength in industrial production which drives growth in several commodities. For Premium, over-the-road conversions from continued tight truck capacity will present new opportunities for domestic intermodal and auto parts growth. Despite challenges within the international intermodal market, we anticipate growth year-over-year for the remainder of the year resulting from new business wins. The U.S. light vehicle sales forecast for 2018 is 17 million units, down 1% from 2017. However, production shifts and new import business will create some opportunity to offset the weaker market demand. So, before I turn it over to Tom for his operations update, I'd like to share a few observations on the progress we are making commercially as we put Unified Plan 2020 into action. We are working very closely with customers to lower our car inventory levels and remove excess cars from the network. This includes both private and system equipment. In the near-term, we plan to make adjustments to our advertorial charges to incentivize greater car and asset utilization across both our carload and unit train networks. More importantly, we are and we will continue to critically evaluate every carload on our network to determine if it fits into our operating strategy at the right margin. In closing, I'm really proud of how our commercial team is communicating with our customers at every turn and in some cases having difficult conversations with them. We are proactively engaging our customers so that ultimately we can provide them with a safe, reliable and mutually efficient service product. And with that, I'll turn it over to Tom.

Thank you, Kenny and good morning. I'll get started with a quick update on our safety performance for the first three quarters. Our reportable injury index was 0.77, an improvement of 1% compared to last year. The reportable rate of our rail equipment incidents or derailments was 3.20, an increase of 8%. In public safety, our grade crossing incident rate was 2.66, an increase of 6%. I want to note that although we have a tremendous amount of transition and change happening with the implementation of Unified Plan 2020, safety is still job one. Our goal is that all of our employees return home safely each and every day. That goal has not, and will not change. So that's a quick update. Now, let's turn to the changes we are making as we implement UP 2020. As I noted in last month's conference call, Unified Plan 2020 is fundamentally an implementation of precision schedule railroading principles in a manner that fits our network and the needs of our customers. It is a change from operations that shifts from focus on moving trains to moving cars. The plan changes are designed to increase car velocity resulting in reduced locomotive and car dwell. In addition, to improve equipment cycle times, the plan is also designed to better balance our resources across the network. The outcome is a more simplified network that improves reliability for our customers while reducing operating costs and investment requirements. We're about one month into implementation of the Mid-America corridor. To level set everyone, the Mid-America corridor, as the map on our slide indicates, encompasses large north-south traffic flows on the eastern end of our railroad and about 50% of our daily carloads touch this corridor. Our progress thus far; in total, we anticipate more than 150 design changes to our transportation plan on this corridor alone. And we are well on our way to implementing those key plan changes. I am pleased and encouraged with the initial results. In fact, let me give you a few concrete examples that represent the types of changes we are making. For one customer on our Little Rock service unit, we changed where we build blocks of cars and how we move those blocks to the destination. As a result, we have significantly reduced the freight car dwell and their cars are now arriving at destination up to three days sooner. Another customer on the North Platte service unit now pre-blocks cars at their own facility. As a result of all this change, the cars are now bypassing UP's origin switching yard altogether eliminating 24 hours to 36 hours of terminal dwell and providing the customer an overall faster transit time to destination. In other instances we have adjusted train schedule frequency to better balance our resources and smooth customer demand. These adjustments improve asset utilization by establishing a more precise schedule across our network, reducing the number of locomotives and crew starts required to manage the business. I want to point out that in all of these cases, we work closely with the customers to end up with a win-win solution. We were able to improve operational efficiency for Union Pacific and service reliability for the customer. And although we have made dozens of these types of changes in a short period of time, we are just getting started. There is more to come. As we implement the UP 2020 operating model, we will begin to focus on new performance indicators or KPIs. These KPIs will align with the operating goals we are trying to achieve and our financial targets. We are in the process of evaluating some of the appropriate indicators at different levels of the organization, and for the operating functions. However, at a high level, the measures on this slide are appropriate KPIs to gauge our progress as we implement UP 2020. For each measure, we are showing a pre-unified plan baseline for September, the current value and our goal for the end of 2019. I want to note that the 2019 goals are not the end state These are interim targets as we implement the Unified Plan across our network next year and as we continue to supply and refine PSR principles beyond 2019. To begin with, freight car velocity is measured in daily miles per car and is consistent with the focus moving from cars versus moving trains. Operating inventory is a subset of the weekly number we publish with the AAR, but excludes cars in storage and cars placed at customer facilities. Measuring operating inventory is appropriate as it will decrease as we successfully increase car velocity. Cars per carload brings together car inventory and volume, acknowledging that inventory levels will fluctuate with seasonality and as we grow the business. Locomotive productivity is a measure in gross ton-miles per horsepower day. Stated another way, it is the number of gross ton-miles that we move each day for each unit of horsepower in the active fleet. This is an all-inclusive locomotive metric, including shop time. Car plant compliance is a measure of how well we are serving our customer compared to our service schedule. And workforce productivity measures daily car miles per full-time employee and will give us a good indication of how efficiently our employees are working. As I stated earlier, this by no means is an exhaustive list as there are a number of other measurements we monitor on a daily basis. Following the announcement of Unified Plan 2020 last month, I have had some – there has been some speculation of what we're doing is a light version of PSR, or that UP is not fully committed to making the changes necessary to achieve PSR benefits. I can assure you that is not the case. We do have a planned phase approach to implementation and we are working to accelerate the changes when and where we can. We are also fully committed to the basic tenets of PSR including increasing car velocity, minimizing car dwell, classification of rent reduction and locomotive and crew requirements. This will be achieved through simplifying the rail network and better balancing resources. While our approach may be different, the fundamental PSR operating principles are the same. As our implementation progresses, we expect to realize benefits other railroads have achieved including service reliability, labor productivity, better asset utilization and reduced fuel consumption. And we have started to see some positive results. Since the beginning of August, we have removed over 625 locomotives from the active fleets and we have line of sight for another 150 locomotives to take out of the network by year's end. On the previous slide, our car operating inventory has come down 6,000 cars since September, and we currently have action plans to reduce this inventory by about 10,000 more in the near term. On the TE&Y front, our September workforce was down 2% versus August on flat volume. While I realize it's only one month, the numbers are moving in the correct direction. We are encouraged by the initial results considering the impact of most of the 150 plus service changes that I spoke of earlier are just beginning to be felt here in October. I'd like to highlight some of the changes we're making in our operational organization as a part of the Unified Plan 2020. Just this week we announced the consolidation of our operating regions from three to two. As a part of the regional consolidation, we are also reducing our operating service units from 17 down to 12. These changes will better align our management structure and decision-making processes with the new operating model, providing more speed and agility as we implement the Unified Plan. In addition, we are closing our locomotive repair shop in South Morrill, Nebraska in January 2019. As we begin to implement the network design changes, car flows and traffic patterns will shift. As a result, we are working through a terminal rationalization process. Further, in an effort to streamline two-way communication with our customers and drive faster resolution of service issues, we are moving our customer care and support function, including car management, from marketing and sales to the operating department. This realignment will be crucial in our initiative to reduce operating car inventory. Additionally, we are in the process of consolidating and restructuring our Engineering functions to drive better accountability and increased productivity. Finally, we are making some near-term reductions in our management workforce beyond reductions related to the consolidations and closures I described. These reductions will occur in the fourth quarter of this year and we expect additional workforce reductions as the Unified Plan is implemented into next year. Wrapping up, we are building new culture here at Union Pacific that will enable successful implementation of the Unified Plan 2020. We're off to a great start and I am confident that we will complete the full year implementation of our plan late next year. In fact, we are about to begin the next phase of implementation on our Sunset Route which is earlier than we anticipated. As we make progress across our network in coming months, the result will be a simplified network that operates more safely, with greater reliability and efficiency. I am excited about the changes taking place and I am encouraged about the early results. Change is never easy and there will be challenges along the way, but I am confident that our talented and motivated team is up to the task. With that, I'll turn it over to Rob.

Thanks, Tom, and good morning. We'll start with a recap of our third quarter results. Operating revenue was $5.9 billion in the quarter, up 10% versus last year. Positive core price, increased fuel surcharge revenue and a 6% increase in volume were the primary drivers of revenue growth for the quarter. Operating expense totaled $3.7 billion, up 10% from 2017. Operating income totaled $2.3 billion, a 9% increase from last year. Below the line, other income was $48 million compared to $90 million in 2017, and as a reminder, third quarter 2017 results included a large land sale in the favorable settlement of a litigation matter. Interest expense of $241 million was up 34% compared to the previous year. This reflects the impact of higher debt, total debt balance, partially offset by a lower effective interest rate. Income tax expense decreased 39% to $483 million. The decrease was primarily driven by a lower tax rate as a result of the corporate tax reform, partially offset by higher pre-tax earnings. Our effective tax rate for the third quarter was 23.3%. For the fourth quarter of this year, we expect our effective tax rate to be in the mid 23% range. And going forward, we now expect that our normalized tax rate in the future quarters will average around 24%. Net income totaled $1.6 billion, up 33% versus last year, while the outstanding share balance declined 7% as a result of our continued share repurchase activity. These results combine to produce an all-time quarterly record earnings per share of $2.15. Our operating ratio of 61.7% was flat with the third quarter of last year. And as a reminder, last year's workforce reduction program and Hurricane Harvey had an unfavorable impact of 1.1 points on our third quarter 2017 operating ratio after adjusting for the change in pension accounting. The combined impact of fuel price and our fuel surcharge lag had a 0.3 point negative impact on the operating ratio in the quarter compared to 2017. Freight revenue of $5.6 billion was up 10% versus last year. Fuel surcharge revenue totaled $482 million, up $255 million when compared to 2017 and up $70 million versus the second quarter of this year. The negative business mix impact on freight revenue for the third quarter was 2 full points. Decreased sand volumes and an increase in lower average revenue per car intermodal shipments drove the mix change in the quarter. Core price was 1.75% in the third quarter. Pricing continues to be a challenge in our coal and international intermodal markets, and excluding coal and international intermodal, core price was 2.75% in the quarter. For the full year, we still expect the total dollars that we generate from our pricing actions to well exceed our rail inflation costs. Turning now to the operating expense. Slide 21 provides a summary of our operating expenses for the quarter. Comp and benefits expense increased 2% to $1.3 billion versus 2017. The increase was driven primarily by volume-related costs, network inefficiencies and increased TE&Y training expenses, partially offset by lower management costs as a result of our workforce reduction program that we initiated last year. For the full year, we still expect labor and overall inflation to be under 2%. Total workforce levels were up about 1% in the third quarter versus last year. Employees not associated with capital projects were up approximately 2%. The increase was driven by our TE&Y workforce, which was up 8% due to higher carload volume and more employees in the training pipeline. Partially offsetting the increase in our TE&Y workforce was a 6% reduction in management employees and employees performing capital project work. Fuel expense totaled $659 million, up 46% when compared to last year. Higher diesel fuel prices and a 5% increase in gross ton miles were the primary drivers of the increase in fuel expense for the quarter. Compared to the third quarter of last year, our average fuel price increased 34% to $2.38 per gallon. Our fuel consumption rate also increased during the quarter by about 4%. While there was some adverse impact from mix, the predominant driver of the increased fuel rate was the service-related challenges that we experienced. Purchase services and material expense increased 3% to $632 million. The increase was primarily driven by volume-related costs, higher prices purchase transportation services and increased locomotive and freight car repair costs. Turning to slide 22, depreciation expense was $547 million up 4% compared to 2017. The increase is primarily driven by a higher depreciable asset base. For the full year 2018, we estimate that depreciation expense will increase about 4%. Moving to equipment and other rents, this expense totaled $272 million in the quarter, which is down 1% when compared to 2017. The decrease was primarily driven by lower freight car and locomotive lease expense, offset by increased volume-related and network congestion costs. Higher equity income in 2018 also contributed to this favorable year-over-year variance. Other expenses came in at $287 million, up 25% versus last year. The primary drivers were an increase in environmental costs as well as higher state and local taxes. For the full year 2018, we expect other expense to be up about 10% compared to 2017. Productivity savings yielded from our G55 and Zero initiatives were largely offset by additional costs as a result of continued operational challenges. The impact of these operational challenges totaled just under $50 million in the quarter, which is down from the $65 million that we reported in the second quarter. The additional costs were primarily in the compensation and benefits cost category, although purchase services, fuel and equipment rents were also impacted. Looking forward, we expect our G55 and Zero initiatives, including Unified Plan 2020, will not only eliminate these failure costs, but will put us back on track to achieve significant productivity savings in 2019 and beyond. Looking at our cash flow, cash from operations through the first three quarters totaled $6.4 billion, up about 18% when compared to last year due primarily to higher net income. Taking a look at adjusted debt levels, the all-in adjusted debt balance totaled $24.8 billion at the end of the third quarter, up about $5.3 billion since year-end 2017. This includes the $6 billion debt offering that we concluded in early June, partially offset by repayment of debt maturities. We finished the third quarter with an adjusted debt to EBITDA ratio of around 2.3 times. And as we mentioned at our Investor Day, our new target for debt to EBITDA is up to 2.7 times which we will achieve over time. Dividend payments for the first three quarters totaled $1.7 billion, up from $1.5 billion in 2017. This includes the effect of three 10% dividend increases over the past year, including the fourth quarter of 2017 and the first and third quarters of this year. We repurchased a total of 44.7 million shares during the first three quarters of 2018, including 2.2 million shares in the third quarter. This includes the initial 19.9 million shares we received as part of a $3.6 billion accelerated share repurchase program that we initiated in June. We expect to receive additional shares under the terms of the ASR as the program reaches completion before the end of this year. Between dividend payments and share repurchases, we returned $8.7 billion to our shareholders in the first three quarters of this year. Looking to the remainder of the year, we expect solid volume growth to continue in the fourth quarter. For the full year, we expect volume to be up in the low to mid-single digit range versus 2017. We will yield pricing dollars well in excess of our inflation costs. With respect to capital investments, we expect full year 2018 spending to be around $3.2 billion or about $100 million less than our previously announced $3.3 billion plan. Previously we guided to improvement in our full year operating ratio compared to 2017. While we believe this goal is still achievable, we are starting to see some risks. Implementation of Unified Plan 2020 in the Mid-American corridor is on track, however, we continue to see elevated levels of spending even as our service metrics slowly improve. While volume growth is still strong, we are not seeing the normal seasonal ramp-up in our export grain business due to tariffs and foreign competition. We have therefore challenged the entire organization to accelerate productivity gains by ramping up our G55 and Zero initiatives and these actions are now starting to gain traction. And as Tom just stated, we have removed over 625 locomotives and over 6,000 cars from our network since August 1. We are simplifying our operating leadership structure by eliminating one of three regions and five of our 17 service units. We have announced the closure of our South Morrill locomotive shop and we are working through a terminal rationalization process. We are taking steps to reduce our management workforce with approximately 475 positions being eliminated by the end of this year. In addition, another 200 contract positions will be eliminated. This is the first of what will likely be additional reductions as we continue to drive productivity within our management workforce. While we are confident the actions that we are taking will produce near-term results, the timing of these initiatives may not support an improved operating ratio performance in 2018. And as we look ahead to next year, we expect to get back on track making significant progress reducing our operating ratio and driving toward a 60 OR by 2020. While we expect positive volume growth and core pricing increases to be major contributors to our operating ratio improvement, productivity gains will play a key role. Unified Plan 2020 will be implemented across our network with the first phase expected to be completed by the end of this year and the following phases by the end of 2019. As we make progress in the coming months, we will see lower costs. Although we haven't finalized our financial targets for 2019 and many aspects of Unified Plan 2020 are still being worked out, it is not unreasonable to expect that we should yield at least $500 million of productivity in 2019. We will see this productivity in the form of lower compensation costs as well as savings resulted from operating smaller locomotive and freight car fleets, including equipment rents and purchase services, materials and supplies and fuel. While we have not yet finalized our capital spending needs for 2019 at this time, we do expect investment dollars to be less than 15% of revenue. We will continue to provide periodic updates to our financial goals and guidance as we make further progress implementing our G55 and Zero initiatives, including our Unified Plan 2020. So with that, I'll turn it back over to Lance.

Thank you, Rob. As we discussed today, we delivered record third quarter earnings per share driven by strong volumes and solid top-line revenue growth. While we recognize that opportunities still exist to improve our network performance, we are encouraged by the progress that has been made so far. Furthermore, I'm pleased with the strength of the economy and the positive impact on most of our business segments. Looking ahead, I'm confident that the recent progress we've made on our Unified Plan 2020 will accelerate in the near-term. As we move forward with the implementation, along with other G55 and Zero initiatives, we will regain our productivity momentum and improve the value proposition for all four of our stakeholders. With that, let's open up the line for your questions.

Hey, thanks, operator. Thanks for taking my question, everybody. Just a follow-up on the $500 million of productivity next year, so that it translates to maybe a little bit more than 200 basis points of margin. Given our revenue forecast, at least, I'm not sure – it's always been hard to kind of translate productivity numbers for the rails into maybe a net savings number and more specifically, how do you contemplate the risks around the frac sand outlook as silica is ramping up in basin Permian mines? I think they've taken up 12 million tons and maybe another 10 million tons to 15 million tons to go. So just given the contribution margins of those carloads, what's the impact to productivity savings next year if those volumes basically go away? Thanks.

Yeah, Amit, as I said – this is Rob – as I said in my comments, we've not finalized for 2019. And all the issues and challenges and questions that you've asked are clearly in the process of us working through and we are not prepared to give guidance on all those items. All I'm calling out here is that we are feeling confident in the early innings of our traction that we're gaining with our G55 and Zero initiatives and most specifically, our Unified Plan 2020. And as we look at that, we know there's going to be – we think there's going to be a positive volume environment, but exactly what that volume looks like and what the mix looks like and how sand or other commodities turn out remains to be seen at this point. But despite all that, all those moving parts, we think we'll be able to drive at least $500 million of productivity from the initiatives that we have well underway right now.

Okay. Maybe just one follow-up on the CapEx, because you did provide maybe a 2019 framework for that at least under 15%, if I look back several years, the company has spent on average almost double depreciation levels and I think that's generally the case with the rail sector as a whole. It is not the case with almost any other industrial sector that's even capital-intensive and even has long-life assets. So I was hoping you could help me understand that. Cost inflation, I don't think explains it fully. There may be some opportunity – I wonder if you should be much more efficient with the cost of CapEx projects because it does seem the sector as a whole, not just you guys, but the sector as a whole, there's just a lot of money that's being left on the table with respect to efficiency of CapEx projects.

Yeah. Amit, I think you're right. I mean, I think the rails – and I think the simple answer or the short answer to why is the capital spending in the rail industry is so much greater than depreciation, really the answer lies largely, I think in the long-lived asset investments that are contained within that investment. So there's a lot of moving parts there, but that really is the simple answer. But I will tell you, as we look at Union Pacific's capital spending, we haven't finalized for 2019, but you're right. I did call out that we're tightening our guidance to be less than 15%, and I'm very proud as we've worked over the last several years to be as disciplined as we can in driving the improvements we've seen in our operating ratio over the last decade or so and more to come. We've been equally focused on being disciplined and thoughtful and lined up around being disciplined around our capital spending, and we were proud to kind of walk that down as we have over the years, and we're just walking it down as a percent of revenue even further as we look to 2019.

Do you think there's an opportunity to get it to 13%, 14% where CSX is today, or is that just a little bit too low given the growth opportunities you're seeing?

Well, stay tuned. I mean, we'll see. Again, I would say that it depends on a lot of factors, but I would tell you that we're as disciplined as we can be around our capital spending. So we'll see.

Great. Good morning. Two questions. Tom, you mentioned the change from the test phase to now if you go back to when you were just starting this, and you saw some changes necessary. How do you tell if it's working? Looking at the stats, some of the KPIs, cars per carload or Trip Plan Compliance seem to have gone, I guess against what you would have thought given the early changes. And how quickly can you make adjustments as you go through the plan?

So, our railroad is going through a lot of changes right now. On the metric side, that's not the primary reason for the failure, of course, you might have seen before. We see improvement as we turn the assets quicker that could create capacity, which is going to improve our reliability and ultimately go out to the efficiency side. It's difficult to say or parse out what part of our improvement is due to the Unified Plan versus other initiatives that we have.

Yeah. But to your question, Ken – this is Lance – clearly, it's very early innings, right? We've just started implementing Phase 1 on October 1. What we're very optimistic about are seeing movement in some of the KPIs that we would consider the first early indicators like car terminal dwell. We're seeing that move in the right direction. We're going to see and are seeing locomotive productivity as we're taking locomotives out moving in the right direction. That car Trip Plan Compliance, that has a lot of moving parts to it, and it's hard to move it early, right, because it's a combination of what are you doing to and from industry, which is first and last mile, what are you doing in the terminals, what are you doing over the road. And so, the fact that it's treading water right now, I don't think that's unusual or unexpected. But, over time, we do expect that to move in the right direction. And then, the other part of your question is how quickly can we make changes. This is turning into a way of life for us. So, while the phased implementation of the first iteration of Unified Plan 2020 or PSR on our railroad is kind of well-conceived, inside of that, there are already opportunities to try something that's part of that plan. And if it doesn't work out just as thought, reconstructing it and doing it again. That's part of what Tom touched on when he said we've kind of reorganized some of our management structure on the operating side, so we can make those kinds of changes more rapidly.

Appreciate that. Just a follow-up, Lance. Your thoughts now on volumes after being up 4% to 6% in the last two quarters, it seems to me, we're going a little slower to get started this quarter. Is that just tough comps? Or are you seeing anything that would suggest a slowing economy from your perspective?

I'm going to start with that, Ken, and I'm going to turn it over to Kenny to give us a little more detail. But, I think, overall, there's not many indicators that we see in our served markets kind of broadly that tell us of a global slowdown. Now, there's plenty of risk, right? Chinese tariffs pose a risk and they can disrupt trade flow. We see international economies, particularly Europe looking like they're slowing down a little bit. So, I don't think it's all rosy on the horizon, but we just don't see any specific markers that tell us that growth isn't going to happen. And, Kenny, can you fill in a little bit?

Hey, Ken. This is Kenny. First of all, we do have tougher comps in our sand volumes, and so we are seeing less sand moving in that Permian Basin. The other thing that Lance alluded to is on our grain side. We are seeing what I'll call a delay of what could be moving out or exporting out here. And so, we'll watch the soybeans and the grains and keep an eye on that. Now, having said all those things, I'm bullish and the commercial team is bullish that we have some areas that we're expecting to grow into the quarter. Our petrochem business will grow. We're expecting the wins on our international intermodal sector to grow. So, we're still feeling that it will be in the positive.

Thank you, operator. Good morning, gentlemen. I wanted to talk about the plan and how that could impact both volumes and pricing going forward. How do you envision that as you start improving service to the customers? Is this a volume grab? Is this going to be your ability in some areas to increase pricing in some of your products considering that your core pricing even excluding some of this other stuff still seems to be lagging some of your competitors?

Yeah. So, I'll start with that, Jason, and then, I'll pass it on to Kenny and Tom for their thoughts. So, the way we think about this plan and the impact on volumes and pricing is first our approach to pricing is not changing, and that is the business has to be re-investable, it has to be attractive to us from a margin perspective. Now, there's a new filter put on that as we implement this plan, and that is it has to fit within the network that we've designed. If you go back, one of the – not one of the, the single biggest prompt for us to switch how we're designing our transportation plan, is that the way we had been doing it resulted in many different boutique services that became very complex to execute and as a result, weren't feeding what the customer wanted broadly which was consistent, reliable service. That's why we're making this switch to Unified Plan 2020. It will generate consistent reliable service as we focus on car movement and focus more of our attention on moving in the manifest network versus boutique unit train networks. And so that the net effect is there is another filter we put on price or on business, and that is will it fit into the network as we've designed it. In terms of the volume side, as we produce a more consistent reliable network, that should generate more opportunity for us from customers. I anticipate that's going to be the case. I don't know exactly when that shows up, and between here and there, there are probably risks to the volume which are customers that either are concerned about the way we're designing their transportation plan and want to try other alternatives; or customers' businesses that don't fit well with the existing plan and they want to try other alternatives. So, with that, Tom or Kenny, you got any other observations?

Just real quickly, Lance. You hit on everything. I'll just say I've been really impressed with the commercial team, because they have been out early and proactively talking with customers about the transportation plan that we're implementing, and I can also tell you that as we look at the business, we are putting that filter on to make sure that it does fit with our network. In some cases, there have been a couple of examples where we have elected not to support the business because it does not fit into the network. So, if you're asking the question, are we prepared to walk away from business if it doesn't fit in the network, then that answer is, yes. But like I started off saying, we're really focused on trying to grow our volumes by educating our customers.

So I'll take a stab at that and then Tom might be able to give a little more detail. So, when you think about the expertise that we have in-house on PSR, we do have employees, some at high levels like a Cindy Sanborn who is now going to be running the entire northern region of the network, along with others, particularly in the operating team and also in the network planning and optimization team who have experience and in some cases deep experience in PSR. Now having said that and understanding that we have complete confidence in the existing team and they're doing a hell of a job, both designing from ground up, because it's not being done in Omaha, it's being done by the people that have to execute the product on the ground. We are always looking for ways to increase our knowledge. One way is we have spent a great deal of time with railroads that have implemented PSR to understand from their perspective what worked, what they wished they would have done differently, what they wish they would have accelerated during their initial phases. So we have learned from that and it's reflected in our own planning. And we are always out in the marketplace looking for talent that can add to the team that we have got.

Yes, good morning. This is Ivan Yi on for Scott Group. First question, just wanted to first clarify your 10% labor productivity target for 2019. Does this roughly mean a 10% spread between head count relative to volumes? And what volume growth are you assuming for 2019? And if volumes are weaker than expected, can you still get to 10% labor productivity? Thank you.

Rob, can you handle that for us?

Yeah. You're referring – on the 10% – I would not take that as an overall head count. That's an efficiency measure on that slide that Tom showed earlier. That's not saying that we're going to have 10% fewer head count. What will dictate what the actual head count number is, is productivity is a big piece of it, obviously, but so will volume. So that did not contemplate volume, which at this point we think will be volume growth. So, there's a lot of moving parts on that. I think the message there was that's one of the key KPIs from an operating standpoint as we roll-out Unified Plan 2020 that labor efficiency around running an efficient operation is something we expect to improve upon.

Great. Thank you. And my follow-up also on labor, how many contractors do you currently have on the network, and how much do you expect to reduce them by as part of the Unified Plan? Thanks.

That's a great question. We don't know – well, we don't have the numbers handy right now as to the total number of contractors on the network. I'll just remind you that not every contractor looks the same. So, we said we are in the fourth quarter taking out 200 contractors. Those are very much focused in the IT world where they work full-time on projects that we give them, and they're supervised by somebody else in a different part of the world. We have many other contractors that do different things on our property, because they can do it either more effectively than we can or because the asset investment to do the work doesn't make sense for us to make because it wouldn't be deployed all the time. So, in that case, you think about something as simple as snow removal and grass cutting, and then you go all the way up to contractors that are running some of our intermodal ramps. So, there's a lot of moving parts there. You've targeted properly, Ivan, that that is an opportunity cost, and to the extent that we can find low value-added work or ways to do that more efficiently, that's another bucket of costs that we're targeting.

Thanks, and good morning.

Good morning.

Wanted to start with one on pricing. On core pricing, could you just talk about what drove that deceleration sequentially? I know you've discussed pressures in coal and international intermodal for a while, but even if you strip that out, we saw a deceleration of about 25 basis points. And then, looking ahead on pricing in 2019, maybe I'm reading too much into this, but you said pricing gains in 2019, but you didn't specify above inflation. So, could you just talk about your expectation for pricing relative to inflation in 2019 as well?

Justin, this is Rob. Let me start with that, and Kenny will probably give a little bit more of a sense of what he's seeing in the market. Number one, you know how – I'll repeat for you and everyone else, how we calculate our price, which I'm very proud of and we've done for the 15 years since I've been CFO, and that is conservatively calculated on an all-in yield basis. So it's not a same-store sales kind of number. It's an all-in yield. And that's a very conservative way of looking at it, but I think it's a most accurate way of looking at what did you really take to the bottom line from your pricing actions. And I would say that as you look at the difference between our 1.75 all-in reported this quarter versus the two that we reported in the second quarter, it's kind of splitting hairs. There wasn't really a big change because of the rounding mechanics is part of it, but also the way we calculate price, volume is a factor. As a simple example, if we take a 10% increase on a piece of business and the volume is down, we yielded fewer dollars. So we don't count that as a 10% increase. We count that as whatever the dollars that we actually yielded. And so mix, which played against us this quarter, mix clearly was a factor in the conservative way that we calculate price. Looking to 2019, as you know, Justin, we're never going to give precise guidance on absolute pricing numbers. But to your point, I can tell you that we do expect it to be above inflation dollars. I mean, so the dollars that we yield from our pricing actions in 2019, we are just as confident as we head into 2019 as we were in 2018 that those dollars will yield above our expected inflation dollars. Kenny, you want to...?

Yeah, you summed it up good, Rob. I will say, Rob laid out our methodology, and we've moved less sand revenue sequentially third quarter versus the second quarter which had an impact. But having said all of that, if you look at some of the other markets, I'm really pleased and impressed with our ability to price to the market. You look at some of our markets like our domestic intermodal market, you look at our carload business, that's right in competition with truck, very pleased with our ability here to walk up the pricing to price to the market.

Thanks. Good morning, everyone. If I can follow-up again on price and thanks for clarification on price versus mix, but just looking at the continued kind of pressures in the international intermodal business, I'm wondering if there is a possibility at all that you guys maybe pull back on that a little bit, kind of, if that is being a drag to overall returns and then pricing. That's the first question. Second is, Rob, you sounded extremely confident about getting price versus positive dollar price versus mix in 2019. We have seen some of the rail inflation benchmarks really spike going into the fourth quarter of this year. Wondering kind of when you think will that positive price mix spread, is that because you expect that inflation number to come back down again? Or do you think you can get the pricing to more than offset inflation if it's like 4% or 5% next year?

Rob, you want to take that price versus inflation? And then, Kenny will...

Yeah. Ravi, let me just state, first of all, at the outset, that – when this ties into your question and the previous question, that we never give guidance on mix. And I have always viewed it as a huge advantage of the UP franchise that we play in so many different markets that there's a lot of mix moving parts, and there is mix within commodities, and so there's a lot of moving mix things which is why we don't even attempt to try to project that or guide to it. We play the hand that the economy deals us. But I will assure you that commercially and across the entire organization, we are focused on driving price where we can on every move, whether it's a positive mix or a negative mix when you add it all up, it might be a short haul move, for example, but we're just as focused on driving price and margin improvement on that short haul move as we are a long haul move. So I wouldn't take mix as implying price is my point there. Number two, to your question on the spread versus inflation, let me just step back and give you the guidance that we have given and that is that our dollars that we yield from our pricing actions will be greater than the dollars that we expend on inflation. So you're right. I would expect at this point that inflation will be higher in 2019 than we have seen in 2018. But the dollars that we yield from our pricing actions should still exceed – may not – I'm not saying by what gap, but it should still exceed the dollars that we expend on the inflation cost, albeit inflation likely be a little higher.

Thanks very much. Good morning, everyone. So, Rob, I guess, I'd like to come back to the OR shift in terms of your confidence level about an improvement and suggesting that something has changed here that will obviously give you less confidence. What has happened over the last few months that's led you to kind of flag this OR guidance for this year to be at risk?

Yeah, that's a good question. And as I pointed out in my comments, we're still focused on eliminating or reducing the risk as best we can. But you're right. We did flag the full year operating ratio year-over-year improvement in 2018 versus 2017 as a slight risk. And I would say, why is that? Well, what we're seeing is the inefficiency cost that we're going aggressively after, we have every expectation that they will be behind us. Certainly as we head into 2019, are still lingering. Some of the revenue shift has not been our friend, notably as Kenny commented, the grain markets have not been our friend. But I'm not going to use that as an excuse as we don't, because volume has still been fairly strong. But that in fact is one of the challenges. And on a smaller scale, some of the costs associated with the right decision to reduce some of the head count, the timing of that we are obviously going to have a little bit of a perhaps a small headwind in the fourth quarter on that. But you add all that up, those are the things that have changed.

Okay. Going forward to next year, you gave us the $500 million, but you did not give us an OR. And going back to a previous point, just holding margin constant and then reducing by $500 million productivity after the revenue change should give you around 200 basis points. So, are you effectively guiding to a 61% OR for next year? And if not, where would the math be wrong there in terms of that calculation?

Yeah, I mean, we're not giving because we're just not to that point yet. We're not giving guidance on a full year operating ratio in 2019. But again, we'll see how it all plays out. We're confident in the $500-plus productivity. At this point in time we do see positive volume. We're confident in our ability to generate price. If you add it all up, I would expect that we will make nice improvement in the overall margins. What that number ends up being, stay tuned. But clearly, we are focused on a meaningful move in the right direction on the operating ratio.

Yeah, thanks for working me in here. Not to beat a dead horse on the operating targets, but I thought it was interesting with the KPIs that you laid out and roughly a 10% productivity improvement ratio on those between now and the end of 2019. If we want to track this with the data that's publicly available to us, and kind of measure your progress in more real-time, what would you suggest we look at? I mean, clearly if you're successful, the OR should improve as you go down this path. But what could we look at weekly or monthly that you would point us to?

Yeah. So, you see a couple of those KPIs that are currently published, terminal dwell is one that will be a good one to watch. That's a good overall indicator. We publish a freight car number. I think it's a big more inclusive number, but that should show some movement as well. And the other thing to note is, those KPIs are now being built into how we monitor our business and we will have an opportunity to review them with you on a quarterly basis as well.

Yeah, thanks for working me in here. Not to beat a dead horse on the operating targets, but I thought it was interesting with the KPIs that you laid out and roughly a 10% productivity improvement ratio on those between now and the end of 2019. If we want to track this with the data that's publicly available to us, and kind of measure your progress in more real-time, what would you suggest we look at? I mean, clearly if you're successful, the OR should improve as you go down this path. But what could we look at weekly or monthly that you would point us to?

So, you see a couple of those KPIs that are currently published, terminal dwell is one that will be a good one to watch. That's a good overall indicator. We publish a freight car number. I think it's a big more inclusive number, but that should show some movement as well. And the other thing to note is, those KPIs are now being built into how we monitor our business and we will have an opportunity to review them with you on a quarterly basis as well.

Thanks. Good morning. I think you mentioned earlier, or gave an example of bypassing classification yards. So just wonder if that means we should maybe expect a rethink of the hump yards and maybe if I could ask it this way, how many cars per day does one of the hump yards need to process in order to justify the economics? And how many of your top 10 classification yards meet this threshold?

Well, I appreciate the question, Allison. As I referenced, we are going through a terminal rationalization process. That is a part of our function as the traffic levels or traffic shifts through our new programs and our new plan. As far as hump yards or switching yards, we're looking at what cars specifically need to be there and assessing if those cars – if we could shut down that facility and become more efficient with surrounding areas. As far as the hump yard goes, they vary a little bit, but a thousand cars-ish at a hump yard is what we're looking at from a rationalization process, but it's going to be predicated on how the traffic flows end up in our organization.

Yeah. Allison, I wouldn't use that as a hard and fast rule, right. You know that I think hump yards are very different around the network. Some of our hump yards are designed to run at 2,000 plus cars a day and some are designed to run at 1,200 cars a day. The end game really is if the cars need to be switched and need to be switched there, is that the lowest cost option and if it is, we'll keep using it. And if we get to a point where utilization drives an alternative decision, we'll do that.

Thanks very much. Good morning, everyone. So, Rob, I guess, I'd like to come back to the OR shift in terms of your confidence level about an improvement and suggesting that something has changed here that will obviously give you less confidence. What has happened over the last few months that's led you to kind of flag this OR guidance for this year to be at risk?

Yeah, that's a good question. And as I pointed out in my comments, we're still focused on eliminating or reducing the risk as best we can. But you're right. We did flag the full year operating ratio year-over-year improvement in 2018 versus 2017 as a slight risk. And I would say, why is that? Well, what we're seeing is the inefficiency cost that we're going aggressively after, we have every expectation that they will be behind us. Certainly as we head into 2019, are still lingering. Some of the revenue shift has not been our friend, notably as Kenny commented, the grain markets have not been our friend. But I'm not going to use that as an excuse as we don't, because volume has still been fairly strong. But that in fact is one of the challenges. And on a smaller scale, some of the costs associated with the right decision to reduce some of the head count, the timing of that we are obviously going to have a little bit of a perhaps a small headwind in the fourth quarter on that. But you add all that up, those are the things that have changed.